ACCOUNTING Flashcards
What are the 3 financial statements, and why do we need them?
Income Statement: revenues/expenses, taxes over a period of time. Ends with Net Income - which tells us the co’s after tax-profits
Cash Flow Statement: tells us the actual cash inflows/outflows over a period of time. Starts w/ Net Income, adjusts for non-cash items and changes in working capital (operating assets and liabilities), shows CF from Investing & Financing activities, Ends w/ Net Change in Cash. & co’s ending cash balance
Balance Sheet: tells us the company’s resources (Assets) and how it paid for those resources (Liabilities, Equity) during a specific moment in time (“snapshot”). Assets = L + E.
We need them b/c: difference between company’s Net Income and actual cash flow it generates => 3 statements allow you to estimate cash flow more accurately.
How do the 3 statements link together?
- Net income (to Common) from the IS flows to the top (first line) of the CFS and to the CSE in the BS.
- CFS: add back non-cash charges & changes to operational BS items = CF from Operations. Then, account for CF from investing & financing activities
- Change in Cash from the bottom of the CFS flows to Cash on the BS.
Income Statement - items/structure
- Revenue (net sales)
- COGS (expenses linked to individual units sold)
- Gross Profit / Gross Margin (profit before fixed expenses; –> add. profit from each add. sale)
- Operating Expenses (expenses NOT lined to specific items; ex - sales & marketing; R&D; G&A)
- Operating Income (income from core biz)
- other income / (expenses) (ex: “side activities”)
- interest income / (expenses)
=> PRE-TAX INCOME
- income taxes
==> NET INCOME (bottom line - what a co earns after taxes)
Income Statement - criteria for appearing on IS?
1) must 100% correspond to the same period shown
2) must affect net income available to COMMON SHs
- revenue/expenses = recorded when products/goods are DELIVERED
- if useful for many years (ex: expense) –> does NOT correspond 100% to this period
Examples of BS Items that create differences between differences between Net Income & Cash Flow:
(based on short-term timing differences:)
- account receivable
- accounts payable / accrued expenses
- prepaid expenses
- deferred revenue
- inventory
(based on long-term timing differences:)
- capex (PP&E)
- debt
- equity
- preferred stock
Why is CFS the most important statement?
- CFS tells you how much cash a co is generating
–> valuation = based on cash flow
Why does IS not accurately represent cash flows?
- includes non-cash items (non-cash revenue & expenses, taxes)
- excludes certain cash spending items (ex: CapEX)
Balance Sheet - examples of Asset items
Assets = items that will deliver a future BENEFIT
examples:
- accounts receivable
- cash
- prepaid expenses
Balance Sheet - examples of Liability items
Liabilities = items that represent a future OBLIGATION
examples:
- accounts payable
- accrued expenses
- deferred revenue
Balance Sheet - Equity
Equity = source of funding for the biz that will NOT result in future cash costs.
includes:
- money contributed by the owners
- money raised by selling ownership in the biz
- co’s cumulative after-tax profits (net income) over time
Equity issuance - effect on 3 statements?
- IS: NONE - not recorded
- CFS: cash inflow
- BS: increase in cash (A); increase in CSE (L&E)
*no “direct cash cost” as w/ debt (interest expense)
- rather: cost = dilution of existing ownership -> 1) get less in dividends (when issued) and 2) if co gets sold, get less proceeds from sale
Dividends issuance or stock repurchase - effect on 3 statements?
- 3
Most impt financial statement?
- CFS: shows how much actual CASH a company is generating –> & valuation is based on cash
- contra IS: contains NON-CASH revenues, expenses, taxes & excludes cash spending items (ex: CapEX) -> doesn’t accurately represent co’s CFs
Criteria (for revenue or expense line item) to appear on an IS?
1) correspond 100% to period shown
- revenues/expenses = recorded based on DELIVERY of product or service
2) affect biz income available to common SHs
- ex: preferred dividends on IS: reduces after-tax profits that could go to common SHs
BS: Diffs bt Assets, Liabilities, and Equity line items?
- Asset = result in future benefit
- L&E item = result in future obligation; funding source for co’s resources (assets)
- liability = usually related to external parties
- equity = related to internal operations; tend not to result in direct cash outflows in the same way as Ls
Diffs bt IFRS & GAAP?
IFRS:
- CFS = starts w/ something OTHER than Net Income: Operating Income, Pre-Tax Income, or if direct method: Cash Received or Cash Paid
- items in more “random” locations on CFS
- Operating Lease Expense = split into Interest & Depreciation elements
GAAP:
- Operating Lease Expense = simple Rental expense
CFS - criteria for appearing?
1) HAS appeared on IS & affected Net Income, but is non-cash –> so need to adjust to determine co’s CF; or
2) has NOT appeared on IS & DOES affect CF
ex of 1: D&A
ex of 2: CF from Investing & Financing - CapEx; Dividends
- changes in WC can be in either category
Cash vs. Accrual accounting
- cash accounting = records revenues & expenses when cash is actually received or paid
- accrual accounting = revenues are recorded when collection is reasonably certain; expenses recorded when they are incurred
Examples of line items from each of the financial statements?
- IS: Revenue, COGS, D&A, SG&A expenses, Operating Income, Pre-Tax Income, Taxes, Net Income
- CFS: Cash Flow from Operations (Net Income; Depreciation & Amortization; Stock-Based Compensation; Changes in Operating Assets & Liabilities); Cash Flow from Investing (Capital Expenditures, Sale of PP&E, Sale/Purchase of Investments); Cash Flow from Financing (Dividends Issued, Debt Raised / Paid Off, Shares Issued / Repurchased)
- BS: Cash, AR, Inventory, PP&E, Accrued Expenses, Debt, CSE, SE
If you could only look at 2 statements - which would you use?
- IS & BS: can create CFS from both (assuming you have “beginning” and “ending” BS that corresponds to same period as IS)
CFS - add-back for non-cash expense - why?
- reflect tax savings w/ non-cash expense
Depreciation (of X) - effect on 3 statements?
*intuition: non-cash expense –> doesn’t “cost” co anything, BUT reduces taxes
- IS: Operating income declines by X –> Net Income decreases by X * (1-tax rate) = Y
- CFS: net income at top decreases by Y –> X in depreciation expenses is non-cash expense that gets added back ==> overall CF from Operations is up by -Y + X. Net change in cash is also up by this amount.
- BS: Cash from CFS change is up. PPE is down. –> Overall assets are down. SE is down by net income decreased amount –> L&E side is down. Both sides balance
Why does depreciation (non-cash expense) affect cash balance?
- it is tax-deductible –> tax savings –> increases cash by reducing amount of taxes you pay (since taxes ARE a cash expense)
Depreciation - where is it on the IS?
- separate line item or
- embedded in COGS or operating expenses