Accounting Flashcards
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What is working capital?
Working capital, also known as net working capital (NWC), is the difference between a company’s current assets, such as cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable.
Working capital = Current Assets – Current Liabilities
The working capital formula tells us the short-term, liquid assets remaining after short-term liabilities have been paid off. It is a measure of a company’s short-term liquidity and important for performing financial analysis, financial modeling, and managing cash flow.
Name the financial statements:
- Income statement
- Balance Sheet
- Cash flow statement
What the most important components of the income statement?
The Income Statement gives the company’s revenue and expenses, and goes down to Net Income, the final line on the statement.
Income Statement: Revenue; Cost of Goods Sold; SG&A (Selling, General & Administrative Expenses); Operating Income; Pretax Income; Net Income.
What the most important components of the balance sheet?
The Balance Sheet shows the company’s Assets – its resources – such as Cash, Inventory and PP&E, as well as its Liabilities – such as Debt and Accounts Payable – and Shareholders’ Equity. Assets must equal Liabilities plus Shareholders’ Equity.
Assets:
- Current Assets (cash, accounts receiveable, etc.)
- Long term tangiable/intangiable assets (investments)
- Other assets
Liabilities:
- Current Liabilities (Accounts payable, etc.)
- Long term liabilities (bonds, loans etc)
Equity:
- Stock
- Retained earnings
A=L+E
What the most important components of the cash flow statement?
The Cash Flow Statement begins with Net Income, adjusts for non-cash expenses and working capital changes, and then lists cash flow from investing and financing activities; at the end, you see the company’s net change in cash.”
Cash Flow Statement:
- Cash Flow from operating activities
- Cash flow from investing activities
- Cash flow from financing activities
-> Net change in cash
How do the 3 statements link together?
“To tie the statements together, Net Income from the Income Statement flows into Shareholders’ Equity on the Balance Sheet, and into the top line of the Cash Flow Statement. Changes to Balance Sheet items appear as working capital changes on the Cash Flow Statement, and investing and financing activities affect Balance Sheet items such as PP&E, Debt and Shareholders’ Equity. The Cash and Shareholders’ Equity items on the
Balance Sheet act as “plugs,” with Cash flowing in from the final line on the Cash Flow Statement.”
If I were stranded on a desert island, only had 1 statement and I wanted to review the overall health of a company – which statement would I use and why?
You would use the Cash Flow Statement because it gives a true picture of how much cash the company is actually generating, independent of all the non-cash expenses you might have. And that’s the #1 thing you care about when analyzing the overall financial
health of any business – its cash flow.
Let’s say I could only look at 2 statements to assess a company’s prospects – which 2 would I use and why?
You would pick the Income Statement and Balance Sheet, because you can create the Cash Flow Statement from both of those (assuming, of course that you have “before” and “after” versions of the Balance Sheet that correspond to the same period the Income Statement is tracking).
Walk me through how Depreciation going up by $10 would affect the statements.
Income Statement: Operating Income would decline by $10 and assuming a 40% tax rate,
Net Income would go down by $6.
Cash Flow Statement: The Net Income at the top goes down by $6, but the $10 Depreciation is a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $4. There are no changes elsewhere, so the overall Net Change in Cash goes up by $4.
Balance Sheet: Plants, Property & Equipment goes down by $10 on the Assets side because of the Depreciation, and Cash is up by $4 from the changes on the Cash Flow Statement.
Overall, Assets is down by $6. Since Net Income fell by $6 as well, Shareholders’ Equity on the Liabilities & Shareholders’ Equity side is down by $6 and both sides of the Balance Sheet balance.
What Is Goodwill?
Goodwill is an intangible asset associated with the purchase of one company by another. Specifically, goodwill is recorded in a situation in which the purchase price is higher than the sum of the fair value of all identifiable tangible and intangible assets purchased in the acquisition and the liabilities assumed in the process. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill.
What are Current Liabilities?
Current liabilities are a company’s debts or obligations that are due within one year or within a normal operating cycle. Furthermore, current liabilities are settled by the use of a current asset, such as cash, or by creating a new current liability. Current liabilities appear on a company’s balance sheet and include short-term debt, accounts payable, accrued liabilities, and other similar debts.
What Are Current Assets?
Current assets represent all the assets of a company that are expected to be conveniently sold, consumed, utilized or exhausted through the standard business operations, which can lead to their conversion to a cash value over the next one year period. Since current assets is a standard item appearing in the balance sheet, the time horizon represents one year from the date shown in the heading of the company’s balance sheet.
Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and other liquid assets. In a few jurisdictions, the term is also known as current accounts.
