FIN 201 Ch2: Balance Sheet, Income Statement, Cash Flow
CFF (cost flow from financing)
(either borrowing or issuing equity to finance the company, when to repay debts or repurchase stock, and whether or not to pay dividends.) -Change in Gross Fixed Assets = -(Change in Net Fixed Assets + Depr Exp)
Income statement
A financial statement that reports a company's revenues and expenses and resulting net income or net loss for a specific period of time. More susceptible to misinterpretation than balance sheet Show profitability
he describes the revenues and expenses associated with a company's operations for a given period of time (that is why it is dated "for the period ended").
A. income statement
current liabilities
Accounts Payable Notes Payable Accrued Salaries
retained earnings
An amount earned by a corporation and not yet distributed to stockholders.
Balance Sheet Equation
Assets = Liabilities + Owner's Equity
he balance sheet equation states: Assets = Liabilities + Owners' Equity. Which of the following best describes the logic behind this equation? Assets must generate revenues equal to the firm's liabilities and owners' equity. Assets have to be financed by either by other people's money or the owner's money. Assets are financial resources used to obtain debt and equity. A firm must use assets to payback debt and equity.
Assets have to be financed by either by other people's money or the owner's money.
The is a snapshot of the firm's assets and financing of those assets at a given point in time (that's why it's dated "as of" a particular date)
B. balance sheet
financing expenses include
BSD (i.e. Borrowing, Stock, Dividends
free cash flow vs CFO
CFO does not consider required reinvestment in the firm. Hence, CFO is not a measure of the CFs available to investors. Free Cash Flow (FCF): measures cash flow available to all investors after: 1) Required investment in fixed assets (CapEx) 2) Required additions to working capital (WC) Note: FCFF measures the CFs that are available to the providers of capital (both debt and equity).
current assets
Cash Marketable Securities Accounts Receivable Prepaid Expenses Inventories
What reveals the true health of a business?
Cash flow not net income
owners equity
Common Stock ($1 Par) Add'l Paid In Capital Retained Earnings
non cash sources
Depreciation Accounts receivable is used on income statement but excluded from cash flow means sales were received on credit not in cash so it is NOT a source of cash A decrease in common stock means that the firm must have bought back shares, meaning an outflow of cash. Thus, this is NOT a source of cash. A decrease in AP means that the firm paid off its debts to its suppliers; thus, this is NOT a source of cash, but an outflow of cash.
How can you increase current assets?
For assets to increase, cash must have been used to acquire the asset. (ex. Buying a car with cash)
operating accounts charges
Generally, current assets and current liabilities are interpreted as operating accounts we have to note whether the change from last year to this year indicates a source or use of cash and then adjust net income accordingly
Ways that earnings can lie (fictions) RED FLAG
Inventory (if the chosen system is changed from original) Rising receivables (they become more lenient on credit but then people are less likely to make payments) Extraordinary expenses Investigate asset sales sale-leaseback impact: the seller regains use of the capital that otherwise would be tied up in property ownership; at the same time, the seller retains possession and continued use of the property for the lease term. Ex bank sells building they had originally bought for $10 which is now worth $20 and then begins to lease it for 30 yrs Skimping on research and development Changing what counts as revenue policies Spot out of balance growth
fixed assets
Land Intangibles Plant & Equipment Less: Accum. Depreciation
long term liabilities
Mortgage Debt Debentures
Gross Fixed Assets =
Net Fixed Assets + Accumulated Depr
cash flow from operations formula
Net Income + Depreciation + Decrease in operating asset accounts - Increase in operating asset accounts + Increase in operating liability accounts - Decrease in operating liability accounts = CFO
Is CFO the cash flow available to distribute to the firm's investors [i.e. creditors and stockholders]?
No! It does not consider the firm's investment needs in working capital or fixed assets.
Revenues minus Cost of Goods Sold minus Operating Expenses equals:
Operating Profit Earnings Before Interest and Taxes Operating Income All of the above
Accounts payable represent money a firm: Owes to a lender under a borrowing arrangement with an explicit interest rate. Owes to suppliers for purchases made on credit. Owes to its employees. Owes to a landlord or leasing agent for rental costs.
Owes to suppliers for purchases made on credit.
investing expenses include
PP&E, Land, LT Assets
what is a critical difference between the income statement and the balance sheet
Remember that the balance sheet is a snapshot of the firm's financial standing at one moment in time, while the income statement covers the firm's results over a period of time (usually one year)
How can you decrease current assets?
To assets to decrease, cash must increase (example selling the car for cash)
Operating Accounts
What type of accounts are accounts receivable and inventory?
examples of current liabilities
accounts payable (no interest, with open line of credit to the supplier), notes payable (has interest), accrued salary( salaries paid owed but not paid)
Which is better: accural or cash accounting?
accural because you can see the operations Accrual basis accounting applies the matching principle - matching revenue with expenses in the time period in which the revenue was earned and the expenses actually occurred. This is more complex than cash basis accounting but provides a significantly better view of what is going on in your company
The is a snapshot of the firm's assets and financing of those assets at a given point in time (that's why it's dated "as of" a particular date).
balance sheet
why will net income often differ from CFO?
because of accounts receivable
can the liabilities side of a balance sheet just liabilities without equity and vice versa?
can be 100% equity but not 100% liability
What are some examples of current assets?
cash marketable securities (example CDs) prepaid expenses ( rent, insurance, utilities or anything you pay for before you use it)
assets increase
cash decrease
equity decrease
cash decrease
liabilities decrease
cash decrease
assets decrease
cash increases
equity increases
cash increases
liabilities increase
cash increases
cash flow from investing formula
change in net PP&E plus depreciation expense (*?)
what makes up owner's equity
common stock additional paid in capital retained earnings
the sum of all of these cash flow sources should equa
company's change in cash for the year.
CFI (cost flow from investing)
cost flow from investing (purchase and sale of long-term assets, such as the installation of conveyor belts or the construction of new production facilities.)
CFO (Cash Flow from Operations)
cost flow from operations (what to produce, how to produce it, whom to sell it to, how to collect on debts, whom to use for suppliers, etc.)
The is an example of a non-cash expense. A. tax expense B. accrual expense C. depreciation expense D. sale-leaseback expense
depreciation
net income is the same as
earnings before interest and taxes
When creating an income statement, what is sales revenue, minus cost of goods sold and operating expenses?
earnings before interest and taxes (EBIT)
Manager's never practice earnings management in order to fabricate or "smooth" earnings.
false
T/F accumulated depreciation is listed on the income statement
false
T/F the amount of dividends is listed on the balance sheet
false
when calculating for the investing section, do you use the gross or net PP&E?
gross PP&E Note: If gross PP&E and accumulated depreciation are not listed separately, use net PP&E plus depreciation expense
what is sales - cost of goods sold?
gross profit
The describes the revenues and expenses associated with a company's operations for a given period of time (that is why it is dated "for the period ended").
income statement
_____ in liabilities current liabilities signal a source of cash while ______ a in current liabilities signals a a use
increases; decreases
A decrease in a financing account
indicates that the company used cash to pay lenders or to buy back stock
Historical cost accounting
items that appear on the financial statements are stated at their historical cost Does no reflect true market value
What are some examples of fixed assets (>1yr)
land (at historical cost) intangible (reputation, intellectual property, brand) plants and equipment accounts depreciation= sum of depreciation/ yr
The is the notion that revenues recognized and expenses incurred to generate those revenues must be reported together.
matching principle
is an increase of long term debt a source of cash?
means that the firm took on new loans during the year, meaning that the firm brought in new cash. Thus, this IS a source of cash.
examples of long term liabilies
mortgage debt debenture (unsecured bond without collateral)
assets are listed in order of
most to least liquid (how fast they will turn into cash)
what must be done with depreciation in cash flow problems (esp regarding operating expenses?
must be added back to net income
calculating CFO
net income + depreciation (change in depreciation) change in AR change in I change in AP change in other CL
can you find the value of a firm on the balance sheet?
no because assets are listed at historical cost; true value of employees, etc
can you pay bills with retained earnings?
no because it is not cash--it is to fund existing assets
calculating CFF
notes payable LT debt equity dividends
dividends formula
old RE+ net income- new RE
what are the three parts of a cash flow
operating expenses, investing, and financing
what are the only two things you an do with net income?
pay it out as dividends (payout) retain it within the firm (plowback)
PP&E
property, plant, and equipment An increase in gross PP&E from one year to the next represents a use of cash
Matching principle
requires that expenses be recorded when incurred in earning revenue
ebit aka operating income
sales - COGS - depreciation- operating expenses
Cash flow statement
shows the flow of money in and out of the business and where it went most honest
is depreciation a cash or non cash expense on the income statment?
since this expense is created solely for taxation purposes and does not involve actual cash flow, we have to add back depreciation expense to net income (non cash)
An increase in a financing account (e.g., debt, including notes payable, and equity) signals
source of cash (cash flowed into the company)
Which of the following is not a red flag that earnings are being manipulated? A. rising receivables B. changes in inventory policies C. skimping on research D. steady growth in revenues
steady growth in revenues
Earnings management
the practice of using flexibility in accounting rules to manipulate the apparent profitability of the firm
The accrual accounting system enables much better financial analysis than would be possible under a cash-based system.
true
accounts receivable decreases when
we collect what our customers owe us on credit
Balance sheet
what you have and what you owe lists assets to the left and liabilities and equity to the right the two sides must equal each other
accounts receivable increases
when we have sold things on credit to our customers
