Finance 450 Chapter 2
OCF equation
= EBIT + Depreciation - Taxes
What does stockholders' equity represent?
A residual claim against the book value of the firm's assets
CFFA equation
CF to creditors + CF to shareholders
GAAP
Generally Accepted Accounting Principles
Why is positive net working capital important?
It means the firm should have sufficient cash to meet its current obligations.
assets =
Liabilities + Owner's Equity
Which of the following are classified as liabilities on a firm's balance sheet?
accounts payable, notes payable
A customer has yet to pay the bill for products purchased on credit. The seller records this debt in which balance sheet account?
accounts recievable
Debt vs Equity
amount of assets left for owners if all debt was to be paid off
The short run is
an imprecise period of time
liability
assets, cash
The statement of cash flow explains changes in
cash and equivalents
What a firm owns at a given point in time
its assets
3 important takeaways from balance sheet
liquidity, debt vs. equity, market value vs. book value
high d/e ratio
lots of financial leverage
low d/e ratio
more financially sound
EPS
net income/# of shares outstanding
if CFFA is +
payment of cash generated by assets to creditors and S/Hs
short-run fixed costs
property taxes, rent payments for a warehouse, management services
cash flow identity
CF from Assets = CF to Creditors + CF to Stockholders
cash flow from assets (CFFA)
Operating Cash Flow - Net Capital Spending - Changes in NWC
Income Statement
Revenues - Expenses = Net Income
- NWC
cash received over the next 12 months < cash paid out over the next 12 months
+ NWC
cash received over the next 12 months > cash paid out over the next 12 months
net capital spending
cash spent on fixed assets less cash received from the sale of fixed assets
Change in Net Working Capital
cash spent/received from current assets and current liabilities
variable costs
change
Net working capital (NWC)
current assets - current liabilities
income
revenue-expenses
The short run for a firm is the period of time during which
some costs are fixed, output can vary
true or false: long term liabilities aren't due in the current year
true
The cash flow identity reflects the fact that
-Cash flow from the firms = total cash flow to creditors and cash flow to stockholders -A firm generates cash through its various activities -Cash is either used to produce the product or service, pay creditors or pay out to the owners of the firm
Which of these questions can be answered by reviewing a firm's balance sheet?
-What is the total amount of asserts the firm owns? -How much debt is used to finance the firm?
turning assets to cash (easiest to hardest)
-cash equivalents -accounts receivable -inventory -plant and equipment
cash flow (CF)
-cash in less cash out -how much net cash a firm is generation
liquidity
-the ability to easily convert financial assets into cash without loss in value -liquid firms are less likely to experience financial distress -liquid assets earn a lower return
Accounting Equation
Assets = Liabilities + Owner's Equity
CFFA
OCF - NCS - Change in NWC
book value of assets
according to GAAP/balance sheet
Assets=
are value to the company
fixed assets
buildings, trademarks
If CFFA is -
capital raised from creditors and S/Hs to be spent on assets
Networking capital + current liabilities
current assets
The more debt a firm has, the greater its
degree of financial leverage
CF to shareholders equation
dividends-net new equity
Net income is often expressed on a per share basis called
earnings per share (EPS)
change in net working capital equation
ending NWC-beginning NWC
NCS
ending net fixed assets - beginning net fixed assets + depreciation
Operating cash flow includes capital spending and working capital requirements
false
Costs that do not change in the short tun arise because of
fixed commitments
How are assets on a balance sheet listed?
in order of decreasing liquidity
CF to creditors equation
interest paid - net new borrowing
Current assets (inventory, cash, A/R)
life < 1 year
Current liabilities (A/P, accrued interest, payroll)
life < 1 year
Fixed assets (PPE, trademarks)
life > 1 year
Long term liabilities (L/T debt, loans, bonds payable)
life > 1 year
liquid assets vs illiquid assets
liquid: cash, A/R, inventory illiquid: PPE, fixed assets
Whose responsibility is to create value for a firm?
management
The price at which willing buyers and sellers would trade is called ________ value.
market
the ______ matching principle of GAAP states that costs associated with a good or service should be recorded at the same time as revenue fin selling a good/service
matching
CF to creditors
net cash paid to or received from creditors
CF to shareholders
net cash paid to or received from shareholders
Non-cash items are expenses that directly affect cash flow but do not directly affect
net income
income statement includes
non cash items (depreciation)
Book value of assets is generally
not what the assets are actually worth
cash flow from assets (free cash flow)
operating cash flow less nat capital spending less any change in net working capital
Equity (ownership, shareholders)
ownership (retained earnings, stock) Shareholders: owners
Operating cash flow (OCF)
revenue less costs, cash items
period costs
selling, general, and administrative expenses
Who is entitled to the residual value of a firm's cash flows?
shareholders
an official accounting statement that helps to explain the change in cash and cash equivalents is called the
statement of cash flows
depreciation
systematic expensing of an asset based on the assets estimated life
What should you keep in mind examining an income statement?
time and cost, GAAP, cash vs. noncash items
debt equity ratio
total liabilities/total equity
market value of assets
what the firm could sell the assets for
