FIN 3403 - chapter 3

The Balance Sheet

* Current Liabilities - Liabilities scheduled to be paid within a year (or one operating cycle) + accounts payable (30-60 days) + accrued wages + debt with less than a year's maturity taxes

The Balance Sheet total assets = total liabilities + total stockholder's equity

* Firm Assets & funding at a point in time - Left side of a balance shows assets (listed in order of decreasing liquidity) a firm owns and uses to generate revenue - Right side of the balance sheet shows sources of the funds used to acquire assets

Statement of Retained Earnings

* Retained earnings: - Shows cumulative effect of adjustments to shareholders' equity resulting from profit, losses, and paying dividends - Shows changes in the account for a period based on profit, loss, or dividend paid

Equity

*** Common Stock: ownership with control in a firm ***Ownership rights: -Preemptive right: the right to buy new share to keep the same percentage of ownership. + Common stock account: initial funding to start business, priced at par value. + Additional paid in capital: additional amount of capital received in excess of par-value. ***Preferred Stock + ownership without control in a firm + Fixed dividend, but not guaranteed Priority over common stock

The Income Statement ( net income = revenues- expenses)

*** Measures the profitability of a firm for a reporting period - Revenue is income from selling products and services - for cash or credit - Expenses include costs of providing products and services, and asset utilization (depreciation and amortization)

Cash Flows invested in Long-term Assets

***CFLTA = Long-term assets (current)-Long-term assets (previous) ***Long-term assets = Plant equipment + Goodwill and other assets Long-term assets (current)= $911.6 + $450.0=$1,361.6 million Long-term assets (previous)=$823.3 +$411.6=$1,234.9 million CFLTA=$1,361.6 million-$1,234.9 million=$126.7 million ***Cash Flow to Investors (CFI) CFI = CFOA - CFNWC - CFLTA= $207.2-$320.0-$126.7 = -$239.5

Market Value vs. Book Value

***Recording Asset Value - Assets are traditionally reported at historical cost on a balance sheet - Balance sheet amount does not reflect current market value - only the acquisition cost - marking-to-market reporting: balance sheet items at current market values + difficult to determine market values of assets - Current assets have short life-cycle, market value is close to book value

the balance sheet ( other balance sheet accounts)

**Retained earnings: Profit kept and used to acquire assets: it's a liability **Treasury stock: Shares of its own stock a firm holds rather than sell them to the public.

The Income Statement

- Amortization: Amortization expense is related to using intangible assets + goodwill + patents + licenses - Like depreciation, it is a non-cash expense.

Cash Flows to investors

- Cash flows available to investors from operating activities (CFOA) CFOA= EBIT - current taxes + noncash expenses - Alternatively using Net Income: CFOA= net income + interest expense + noncash expenses

Federal Income Tax

- Corporate Income Tax + U.S. has a progressive tax with rates ranging from 15 percent to 39 percent higher taxable income = higher the tax liability - Average versus Marginal Tax Rate + Average tax rate total taxes paid divided by taxable income for the period + Marginal tax rate rate paid on the last dollar earned or the next dollar that will be earned

The Balance Sheet

- Current Assets * Assets likely to be converted to cash within a year (or one operating cycle) + marketable securities + accounts receivable: 30-45 days + inventory

The Income Statement

- Depreciation: + The cost of a physical asset, such as plant or machinery, is written off over its lifetime. This is called depreciation, a non-cash expense + Firms use one of these depreciation methods * straight-line depreciation * accelerated depreciation - Companies can prepare two sets of financial statements: one for tax (accelerated depreciation) and one for internal purposes and SEC (straight-line).

the balance sheet ( Inventory Accounting )

- During increasing inflation FIFO reporting says a firm sold the oldest less expensive inventory and leads to + higher balance in inventory The inventory that remains is the newest (most expensive) + lower cost-of-goods-sold + higher taxable income + higher income taxes + higher net income

The Balance Sheet (Inventory accounting)

- Inventory Accounting Inventory (least liquid current asset) reported using one of two methods * FIFO (first-in-first-out) assumes merchandise is sold in the order it was acquired by a firm. * LIFO (last-in-first-out) assumes merchandise is sold in the reverse of the order it was acquired by a firm. - Discussion: When inflation starts increasing and the merchandise production costs increase, which method should be used - to report a higher profit? - to pay lower taxes?

cash flows

- Operating Activities * cash inflows sell goods and services (positive) * cash outflows ( negative) raw materials inventory salaries and wages utilities rent

the balance sheet (Long-Term Assets)

- Real assets decline with use and are depreciated Depreciation expense reduces taxable income and income taxes. Assets are depreciated using either the straight line or accelerated depreciation method. - Intangible assets lose value over time and are amortized (equivalent to depreciated)

Retained earnings

- Shows cumulative effect of adjustments to shareholders' equity resulting from profit, losses, and paying dividends - Shows changes in the account for a period based on profit, loss, or dividend paid

International GAAP

- Uniform accounting rules and procedures promoted by the International Accounting Standards Board - Firms in the European Union are moving toward a "European GAAP" - Economic and political pressure is building in the United States and Europe to develop a unified accounting system: US IFRS (International Financial Reporting Standards) by 2015?

Financing Activities

- cash inflow + issue debt + issue equity + borrow money - cash outflow + pay interest or dividends + repay loan principal + purchase treasury stock

Compare and contrast depreciation expense and amortization expense.

--- Depreciation expense is the amount by which a firm's fixed assets are written down in a period during which the assets are utilized for generating cash flows. --- Amortization is the amount by which intangible assets like goodwill, patents, license, copyrights, and trademarks are written down in any period that they are utilized by the firm to generate benefits. Both depreciation and amortization are noncash expenses that will serve to boost the firm's after-tax cash flows, and generate actual value of the asset at the end of a period.

the balance sheet ( Long-Term Liabilities)

--Long-term debt bank loans mortgages bonds with a maturity longer than one year

Generally Accepted Accounting Principles (GAAP)

-accounting rules and standards that public companies must adhere to when they prepare financial statements and reports -established by the Financial Accounting Standards Board (FASB) and authorized by the Securities and Exchange Commission (SEC)

Five Important Accounting Principles

1. Assumption of Arm's Length Transaction 2. Cost Principle 3. Realization Principle 4. Matching Principle 5. Going Concern Assumption

The Balance Sheet

A financial statement that shows a firm's financial position (assets, liabilities, and equity) at a point of time.

annual report

A firm's annual report is typically divided into three sections: ----financial tables with an accompanying verbal explanation of the firm's performance over the past year; ---a corporate public relations section discussing the firm's operations, ----and the audited financial statements (balance sheet, income statement, statement of cash flows, and statement of retained earnings).

How do increases in fixed assets from one period to the next affect cash holdings for the firm?

An increase in fixed assets from one period to the next is a use of cash. If a company purchases fixed assets during the year, it decreases cash because it must use cash to pay for the purchase.

2. Cost Principle

Asset values are recorded at the cost for which they were acquired (except marketable securities: stocks are recorded at the current value)

5. Going Concern Assumption

Assume a company will continue to operate for the predictable future.

4. Matching Principle

Costs are matched with the associated revenue.

accounting concept behind depreciation

Depreciation in accounting is a noncash expense that helps to allocate the cost of an item over its expected life. It reflects the estimated decrease in the value of an asset due to wear and tear and obsolescence.

What is EBITDA, and what does it measure?

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBIT is defined as earnings before taxes and interest. The main difference between these two figures is that EBITDA shows the income earned purely from operations and reflects how efficiently a firm can manufacture and sell its products without taking into account the cost of the productive asset base.

Earning per share ( EPS)

EPS= net income / number of shares

EBIT

Earning before interest and taxes

EBITDA

Earning before interest, taxes, depreciation, and amortization

EBT

Earning before taxes

Differentiate between FIFO and LIFO accounting.

FIFO (first in, first out) refers to the practice of firms, when making sales, assuming that the inventory that came in first (at a lower price) is being sold first. During the period of rising prices, LIFO (last in, last out) implies that a firm is selling the higher cost, newer inventory first, leaving the lower cost, older inventory on the balance sheet.

How does the calculation of net income differ from the calculation of cash flow to investors from operating activity?

Net Income = revenue - expense CFOA= EBIT - current taxes + noncash expenses - Alternatively using Net Income: CFOA= net income + interest expense + noncash expenses

Net Working Capital

Net working capital = Total current assets - Total current liabilities Ex: Total current assets = $1,039.8 million Total current liabilities = $377.8 million Net working capital = $1,039.8 million - $377.8 million = $662.0 million *** Current ratio = Current assets/current Liabilities = 2.75 What does 2.75 mean?

Depreciation and amortization expenses are:

Noncash expenses that cause a firm's after-tax cash flows to exceed its net income.

The going concern assumption of GAAP implies that the firm:

One of the key assumptions under GAAP is the going concern assumption, which states that the firm: (c) will continue to operate and that all assets should be recorded at their cost rather than at their liquidation value.

1. Assumption of Arm's Length Transaction

Parties involved in an economic transaction arrive at a decision independently and rationally

3. Realization Principle

Revenue is recognized when a transaction is completed, although cash may be received earlier or later

Explain how the four financial statements are related.

The four financial statements are linked together as follows: -- the ending cash balance from the statement of cash flows is used as the cash balance on the balance sheet, --- and the net income reported in the income statement is transferred to retained earnings on the balance sheet. So as you can see, the balance sheet is the one financial statement that ties all four statements together.

Annual Report

The overall performance of a firm for the fiscal year Information The company, its products, its activities, and future five-year summary of financial data Most important report, 3 sections: 1. Financial tables, summary 2. Public relations report 3. Audited financial statements: -the balance sheet -the income statement -the statement of retained earnings -the statement of cash flows

Cash Flows to Working Capital

To compute the net cash flows into or out of working capital: NWC ( net working capital) = Total current assets - total current liabilities CFNWC = NWC (current period) - NWC ( previous period) - Diaz Manufacturing NWC 2011 = $662.0 million NWC 2010 = $342.0 million CFNWC = $662 million-$342.0 million=$320.0 million

treasury stock

Treasury stock is the stock that the company purchased back from its investors. These shares do not pay dividends, have no voting rights, and should not be included in shares-outstanding calculations.

What accounting events trigger changes to the retained earnings account?

Two events will trigger changes to the retained earnings account: (1) a firm's report of a net income or loss and (2) the board of directors' declaration of a cash dividend.

What does it mean when a firm's cash flow to investors is negative?

When a firm's investment of cash flow from net working capital and long-term assets exceed the firm's cash flow from operating activity, the cash flow to investors will be negative. A negative cash flow to investors means that the firm must raise money from new issues of debt or equity.