2: Financial Statements, Taxes, and Cash Flows

Question 1

What is the balance sheet?

Answer 1

A financial statement showing a firm’s accounting value on a particular date

Question 2

What are the two classifications of assets?

Answer 2

1) Fixed asset

2) Current asset

Question 3

What is a fixed asset?

Answer 3

One that has a relatively long life

Question 4

What are the two types of fixed assets?

Answer 4

1) tangible

2) intangible

Question 5

How long is the life of a current asset?

Answer 5

Less than one year before being converted to cash

Question 6

What are the two classifications of liabilities?

Answer 6

Current liabilities

Long-term liabilities

Question 7

What is the difference between current and long-term liabilities?

Answer 7

Current liabilities have a life of less than a year, meaning they have to be paid within the year, and they are listed before long-term liabilities.
A debt that is not due in the coming year is classified as a long-term liability.

Question 8

What’s the finance jargon to refer to long-term debt and long-term creditors?

Answer 8

Bonds and bondholders

Question 9

What is shareholder’s equity?

Answer 9

The difference between the total value of assists (current and fixed) and the total value of the liabilities (current and long-term)

Question 10

What are the other names for shareholders’ equity?

Answer 10

Common equity and owners’ equity

Question 11

What is the balance sheet identity?

Answer 11

Assets = Liabilities + Shareholders’ Equity

Question 12

Why does the balance sheet equation always hold?

Answer 12

Because shareholders’ equity is defined as the difference between assets and liabilities

Question 13

What is net working capital?

Answer 13

Current assets less current liabilities.

Question 14

What is liquidity?

Answer 14

The speed and ease with which an asset can be converted to cash.

Question 15

Explain the “two dimensions” of of liquidity

Answer 15

Ease of conversion vs loss of value; any asset can be converted to cash quickly if we cut the price enough

Question 16

How are assets normally listed (ordered) on the balance sheet?

Answer 16

Decreasing liquidity

Question 17

Why is liquidity at once both valuable and unproductive?

Answer 17

The more liquid a business is, the less likely it is to experience financial distress, but, liquid assets are generally less profitable to hold

Question 18

What are the three particularly importnat things to keep in mind when examining a balance sheet?

Answer 18

Liquidity; debt vs equity; market value vs book value

Question 19

What is market value?

Answer 19

The true value of any asset; the amount of cash we would get if we actually sold it

Question 20

Explain book value

Answer 20

Book value is what the firm paid for an asset, no matter how much it is worth today

Question 21

Why is the balance sheet not useful for determine a firm’s market value?

Answer 21

The fact that balance sheet assets are listed at cost means that there is no necessary connection between the total assets shown and the market value of the firm. Some of the most valuable assets a firm might have — good management, a good reputation, talented employees—don’t appear on the balance sheet at all

Question 22

What is the income statement?

Answer 22

The financial statement summarizing a firm’s performance over a period of time

Question 23

What is the income statement equation?

Answer 23

Revenues - Expenses = Income

Question 24

If you think of the balance sheet as a snapshot, then you can think of the income statement as:

Answer 24

A video recording covering the period between a before and an after picture

Question 25

What is usually the first thing reported on an income statement?

Answer 25

Revenue and expenses from the firm’s principal operations

Question 26

What is the equation for earnings per share?

Answer 26

EPS = Net income / Total shares outstanding

Question 27

What is the equation for dividends per share?

Answer 27

DPS = Total dividends / Total shares outstanding

Question 28

An income statement prepared using GAAP will show revenue _____

Answer 28

when it accrues.

Question 29

What is the recognition principle?

Answer 29

Recognize revenue when the earnings process is virtually complete and the value of exchange of good or services is known or can be reliably determined. In practice this usually means that revenue is recognized at the term of sale, which need not be the same as the time of collection.

Question 30

Expenses shown on the income statement are based on ______

Answer 30

The matching principle.

Question 31

Describe the matching principle

Answer 31

The basic idea is to first determine revenues and then match those revenues with the costs associated with producing them

Question 32

What can an income statement’s revenue and expenses tell us about cash flows?

Answer 32

Nothing. As a result of the way revenues and expenses are reported, the figures shown on the income statement may not be at all representative of the actual cash inflows and outflows that occurred during a particular period.

Question 33

What is the primary reason that accounting income differs from cash flow?

Answer 33

An income statement contains no cash items, the most important of which is depreciation

Question 34

What are noncash items?

Answer 34

Expenses charged against revenues that do not directly affect cash flow, such as depreciation