Accounting and the Three Financial Statements

Question 1

What is revenue?

Answer 1

Net sales. The total value of products/services that a company delivers in the period.

Question 2

What is Cost of Goods Sold (COGS)?

Answer 2

Expenses that can be linked to individual units sold/the delivery of products/services (i.e.: materials and shipping for physical products or human labor for services, etc.).

Question 3

What is Gross Margin?

Answer 3

Revenue - COGS

How much additional profit the company earns from each additional sale before fixed expenses (i.e.: employees, rent, etc.)

Question 4

What are Operating Expenses?

Answer 4

Expenses/items that cannot be linked directly to individual products sold, such as sales and marketing, rent, employee salaries, and customer support.

Question 5

What is Operating Income?

Answer 5

Revenue - COGS - Operating Expenses

Tells you how much the business earns before “side activities”, interest, and taxes.

Question 6

What is Net Income?

Answer 6

Company’s bottom line - how much the company earns after ALL expenses and taxes/how much it earned in after-tax profits.

Question 7

What two things must be true for an item to appear on the Income Statement?

Answer 7

1. The item must correspond 100% to the period shown. (This is why PPE does not show up - because the asset purchased will be useful for many years/corresponds to more than just the current period; same logic for CapEx, Stock Issuances, and Debt Issuances)
2. Affect the business income available to common shareholders (i.e.: net income). (This is why Preferred Dividends and Interest Expense appear on the I/S because they reduce the amount of income available to common shareholders since these investors get paid first.)

Question 8

What are Assets?

Answer 8

Items that provide some future benefit (i.e.: future cash flows (i.e.: A/R), the ability to grow the business (i.e.: Net PPE), higher valuation due to IP, Brand, Customer Relationships (i.e.: Other Intangible Assets), reducing future cash flows (i.e.: Deferred Tax Assets), etc.)

Question 9

What are Liabilities and Equity?

Answer 9

The company’s future obligations or how the company paid for its assets or the claims against the company’s assets.

Equity does not result in direct, predictable cash outflows in the same way that Debt (i.e.: interest payments and principal repayment) does because a company does not have to pay anything in cash to new shareholders.

Question 10

What are some (shorter-term) items that create (temporary) differences between Net Income and Cash Flow?

Answer 10

Accounts Receivables (A/R) because record revenue (because product/service delivered to the customer), but no cash payment received
     - Net Income goes up, Cash Flow goes down and therefore Cash Flow Generated < Net Income

Accounts Payable and Accrued Expenses because record expense, but not cash outflow/payment
- Net Income goes down, Cash Flow goes up, and therefore Cash Flow Generated > Net Income

Prepaid Expenses because no expense recorded (because haven’t received the service/product yet) but cash outflow/payment
- Net Income unchanged and Cash Flow goes down and therefore Net Income > Cash Flow

Deferred Revenue because no revenue recorded (because performance obligation not yet met) but cash received
- Net Income unchanged and Cash Flow goes up and therefore Cash Flow > Net Income

Inventory because expense (COGS) not recorded on I/S until inventory sold, but cash payment
- Net Income unchanged and cash flow goes down and therefore Net Income > Cash Flow

Question 11

What are Accrued Expenses? How do they differ from Accounts Payable?

Answer 11

Accrued Expenses are similar to Accounts Payable, but typically represent expenses that are regular and recurring and lack specific invoices such as utilities, rent, employee wages, insurance premiums, etc.

Question 12

What are the three financial statements and why do we need the them?

Answer 12

Income Statement, Cash Flow Statement, and Balance Sheet.

There’s always a difference between the company’s Net Income and real CF generated - the statements let you estimate the cash flow more accurately.

We need the three statements to track everything/all of its activities and understand any timing differences between its net income and cash flow. Short-term timing differences.

Together, the statements provide a comprehensive portrayal of a company’s business activities.

Question 13

What are accounts receivables?

Answer 13

Tracks payments the company is owed.

Question 14

What are prepaid expenses?

Answer 14

Expenses the company has paid in advance, but not yet received.

Question 15

What is Inventory?

Answer 15

Goods the company has ordered but not yet delivered to the end customer.

Question 16

What is Accounts Payable?

Answer 16

Tracks what the company owes to other vendors.

Used for specific items with invoices (i.e.: legal bills) (vs. accrued expenses which are used for monthly, recurring items without invoices (ie.: utilities).

Question 17

What is Deferred Revenue?

Answer 17

Tracks cash the company has collected upfront for products/services it has not yet delivered. It represents the company’s obligation to deliver them in the future. It is a liability.

Question 18

What is Equity?

Answer 18

Represents the initial amount contributed to start the business plus the after-tax profits that the company has saved or retained over time.

A funding source that will not result in future cash costs. It includes money contributed by the owners, money raised by selling ownership in the business, and the company’s cumulative after-tax profits over time.

Unlike liabilities, equity does not necessarily result in direct cash outflows.

Question 19

What are some (longer-term) items that create differences between Net Income and Cash Flow?

Answer 19

Property, Plant, and Equipment (PPE) because initial CapEx expense not recorded on I/S (because does not correspond 100% to current period), but cash outflow/payment

Long-term funding sources such as Debt, Equity, and Preferred Stock.

Debt because issuances does not show up on I/S (because last for many years), but cash inflow and when company repays debt, does not show up on I/S but cash outflow

Equity because nothing ever shows on the I/S, but cash inflow

Preferred Stock (or Preferred Equity)

Question 20

Where do companies embed Depreciation on the I/S? Where should you look to get the full Depreciation amount? How about Stock-Based Compensation?

Answer 20

Other line items such as COGS and SGA.

Cash Flow Statement, specifically the Cash Flow from Operations section.

SBC is often embedded in Operating Expenses.

Question 21

True or False: Initial Debt issuances always boost the company’s Cash balance, but Cash will decline over time as the company pays more Interest Expense and repays the Debt principal.

Answer 21

True.

Question 22

True or False: CapEx initially reduces Cash Flow. After the initial cash outflow, Net Income decreases in future years because of Depreciation, but the Cash balance will increase due to the tax savings from that Depreciation.

Answer 22

True.

Question 23

Does Equity cost the company anything?

Answer 23

Yes. Although raising equity is not a direct cash cost, additional equity dilutes existing shareholders, meaning they will get less in cash proceeds if the company decides to pay its shareholders and if the company ever sells itself, they will receive less from the sale.

Question 24

What are Dividends?

Answer 24

Cash payments made to shareholders.

Question 25

Why are Dividends not recorded on the Income Statement?

Answer 25

Although Dividends correspond to the current period, they do not reduce the income available to common shareholders (i.e.: Dividends do not affect Net Income). Instead they are distributed out of that income.

Question 26

What are Stock Repurchases?

Answer 26

The company offers to repurchase shares from existing investors at an agreed-upon price, which is usually a premium to their original purchase price. They reduce a company’s Share Count.

Question 27

What is Preferred Stock (aka Preferred Equity)?

Answer 27

Preferred Stock is similar to Debt because it carries a fixed coupon rate for a “Preferred Dividend”, which appears as an expense on the I/S, and issuing and repaying PS does not affect the company’s Common Share Count or existing investors’ ownership percentages.

Preferred Stock tends to be more expensive than Debt, but cheaper than common Equity because Preferred Coupon Rates tend to be higher than interest rates on Debt, but lower than the average annualized return on stocks. Also, Preferred Dividends are not tax-deductible.

Preferred is often issued when lenders refuse to buy additional Debt issuances from the company and Equity issuances are also not feasible

Question 28

True or False: Net Income - Preferred Dividends = Net Income to Common and therefore Preferred Dividends reduce the income available to common shareholders/Common Shareholders’ Equity

Answer 28

True because Preferred investors get paid first before Common Equity investors, reducing the amount of cash available for Common Dividends.

Question 29

How are Operating Leases captured on the Balance Sheet?

Answer 29

Operating Leases appear as Liabilities and their corresponding Assets (called “Right-of-Use-Assets”) appear as Assets.

Question 30

What is the difference between Finance Leases and Operating Leases?

Answer 30

Finance Leases have an “ownership” transfer option or the option to purchase the asset at a “bargain price” - essentially the company is given the potential benefits and risks of ownership.

Operating Leases do not have an ownership transfer or bargain purchase option, and the company does not own the asset it is leasing. When the lease ends, the company either renews it or lets it expire and returns the asset to its owner.

Question 31

Explain the US GAAP accounting for Finance Leases.

Answer 31

1. The company records a Lease Asset and a Lease Liability based on the PV of the future lease payments
2. Record Interest and Depreciation expenses on the Income Statement (because the company pretends as if it has issued Debt to purchase the Asset, and that it now owns the Asset)

Lease Interest Expense = Discount Rate * Lease Liability
Lease Depreciation Expense = Initial Lease Asset / Lease Term

3. Record adjustments on the CFS: add back the Lease Depreciation, record/subtract cash outflow for lease principal repayment (in CFF section)

Lease Principal Repayment = Cash Lease Expense - Annual Interest Expense

Lease Asset = Lease Asset (t-1) - Depreciation
Lease Liability = Lease Liability (t-1) - Lease Principal Repayment

*Lease Asset and Lease Liability decrease by slightly different amounts because depreciation is constant while principal repayment changes

Question 32

Explain the US GAAP accounting rules for Operating Leases.

Answer 32

1. The company records a Lease Asset and a Lease Liability based on the PV of the future lease payments
2. Record a constant Lease Expense on the I/S each year (vs. splitting it into Interest and Depreciation)
3. Record a “Change in Operating Lease Assets” and “Change in Operating Lease Liabilities” based on Lease Depreciation and Lease Principal Repayment on the CFS

Interest Expense = Discount Rate * Lease Liability
Lease Depreciation = Cash Lease Expense - Interest Expense
Lease Principal Repayment (if Cash Lease Expense Constant) = Lease Depreciation
Lease Principal Repayment (if Cash Lease Expense != Constant) = Rental Expense - Interest Expense

*Lease Asset and Liability decrease by the same amount each year if cash lease payments are constant; change by different amounts if cash lease payments are not constant

Question 33

What are Financial Investments? Explain how they are handled under US GAAP.

Answer 33

Stocks, bonds, and other assets that pay interest and dividends that companies buy when they have substantial cash balances and no idea what to do with it.

Investments can be short- or long-term.

The initial purchase shows up on the CFS under CFI and the interest income appears on the I/S. The sale of financial investments also appear on the CFS as a cash inflow. If there is a gain or loss on the investment sale, then there would be an I/S impact.

Question 34

True or False: All large companies prepare two sets of financial statements: one for “Book” Purposes (shown in annual and quarterly reports) and one for “Tax” purposes (for the government).

Answer 34

True.

Taxes on Income Statment = Pre-Tax Income * Tax Rate
Cash Taxes = Taxable Income * Tax Rate

Question 35

What are Deferred Taxes? What is Deferred Tax Liability (DTL)?

Answer 35

Represent the difference between the company’s Book Taxes (the number on the I/S) and its Cash Taxes (what the company pays to the government).

These “timing differences” exist because companies use accelerated depreciation, some expenses might not be deductible for tax purposes, and/or companies might get tax credits.

Another example from accounting class: Unearned revenue

DTL tracks these timing differences on the B/S.

If Book Taxes > Cash Taxes, DTL increases (because the company paid less than it should have and will need to pay higher Cash Taxes in the future)

Question 36

What are Deferred Tax Assets (DTAs)?

Answer 36

Represent potential future tax savings.

Question 37

What are Net Operating Losses (NOLs)? How do they impact DTA and Cash Flow?

Answer 37

If a company has lost money (i.e.: has had negative Pre-Tax Income) in previous years, it can reduce its Cash Taxes in the future by applying these losses to reduce its Taxable Income (assuming its Pre-Tax income turns positive).

NOLs are included in DTA (along with many other items). DTA decreases when a company uses NOLs (cash flow also increases) and increases when a company accumulates NOLs (and CF decreases).

• NOLs and DTA are not the same; DTA represents the tax savings potential from NOLs (i.e.: $100 NOL would be recorded as a $25 DTA at a 25% tax rate).
• Full NOL is an off-balance sheet item.

Question 38

True of False: Deferred Income Taxes are reflected as non-cash adjustments in the CFO section of the CFS.

Answer 38

True.

Question 39

What is the formula/calculation for Net Deferred Tax Assets (Net DTA)?

Answer 39

Net DTL = DTL - DTA or Net DTA = DTA - DTL

Question 40

What is another way companies can raise funds beyond issuing Debt and Equity?

Answer 40

Selling Assets such as financial investments or physical equipment.

Question 41

True or False: The purchase and sale of PPE doe not affect the income available to common shareholders and are long-term assets and thus are not reported on the I/S.

Answer 41

True.

Question 42

When does a company record a gain or loss on the I/S (esp as it relates to selling assets such as PPE)? How does this affect the CFS?

Answer 42

If the company sells an asset such as PPE for less than its Book Value (the value on the Balance Sheet), it will record a Loss.

If it sells the asset for more than its Book Value, it will record a Gain on the I/S (since it relates to an action or event in this current period only).

Reverse the Gain or Loss on the CFS (in the CFO section because non-cash) and then capture it in the CFI section as part of the proceeds from the sale (because Gain/Loss is not operational but rather related to investing in long-term assets).

Question 43

What is a Write-Down or Impairment Charge?

Answer 43

Companies record Write-Down or Impairment charges when an asset turns out to be worth less than expected to reflect the change in value.

They are non-cash expenses that reduce Pre-Tax Income and Net Income and then get added back on the CFS, reducing the corresponding asset. Similar to Depreciation.

However, unlike Depreciation, Impairments and Write-Downs are not usually cash-tax deductible (because they are not regular, predictable events and because the company has not yet sold the asset). When the sale happens and cash changes hands, the company can realize the tax benefits from a Write-Down.

Question 44

What is Stock-Based Compensation? What are some of the advantages of SBC?

Answer 44

Companies pay their employees with stock and stock options (rather than salaries, bonuses, benefits, etc.) (and thereby grants the employee a small percentage of ownership in the company and potentially creates additional shares outstanding (increasing the company’s diluted share count)).

SBC is an I/S expense that reduces Operating Income, Pre-Tax Income, and Net Income, and like depreciation, it is a non-cash expense that’s added back on the CFS. However, similar to Impairments and Write-Downs, it is not deductible for Cash-Tax purposes when it is first issued to employees. It only becomes deductible later on once employees exercise their options and receive their shares. It links back into CSE on the B/S.

Some benefits of SBC are that it reduces cash operating expenses (i.e.: lower employee salaries, bonuses, etc.) and incentivizes performance and employees to stay for the long-term.

Question 45

What is Diluted Share Count?

Answer 45

A metric that includes outstanding shares and ones that may be created from sources like employee stock options.

Question 46

True or False: Because SBC reduces the value to existing investors, you often treat it as a normal cash expense in Valuations.

Answer 46

True.

Question 47

True or False: Initial issuances of SBC do not affect Cash balance.

Answer 47

True. Net Income goes down, but then non-cash adjustment on CFS adjusted for Deferred Income Taxes usually results in no cash changes.

Question 48

What are Other Intangible Assets?

Answer 48

Identifiable Assets such as Contracts, Patents, Trademarks, Customer Relationships, and Brand Value. They do not have a physical substance and are not financial assets.

Most Intangible Assets amortize over time (except for indefinite-lived intangibles such as land and brand). The amortization reduces Pre-Tax Income and Net Income and is not cash-tax deductible.

Question 49

What is Goodwill?

Answer 49

Purchase Price - FMV. Item to plug the gap and make the Balance Sheet Balance.

Goodwill does not amortize. Instead, the company reviews it each year and records an impairment if its value has decreased. The impairment reduces Pre-Tax Income and Net Income and is not deductible for cash-tax purposes.

Question 50

What does IFRS stand for?

Answer 50

International Financial Reporting Standards.

Question 51

What is the Income Statement?

Answer 51

The income statement shows a company’s revenue, expenses, and taxes over a period of time.

It starts with Revenue at the top and goes all the way to after-tax profits or Net Income to Common at the bottom.

More succinct: The income statement shows the company’s revenue, expenses, and taxes over a period and ends with Net Income, which represents the company’s after-tax profits.

Question 52

What is Depreciation and Amortization?

Answer 52

Non-cash expenses representing the allocation of capital purchases, such as spending on factories, equipment, patents, or anything else that will be useful for more than one year.

Method for allocating the cost of tangible and intangible assets over their useful lives.

Question 53

What is Other Income and Expenses?

Answer 53

Items such as Interest Income, Interest Expense, Gains and Losses, Write-Downs, and Impairments. As well as any income from “side activities” that aren’t part of its core business.

Question 54

What is the Balance Sheet?

Answer 54

The B/S shows the company’s resources (assets) and how it paid for those resources (liabilities and equity) on a specific date/at a specific point in time.

Assets must always equal Liabilities + Equity

Question 55

What are the components of Common Shareholder’s Equity?

Answer 55

1. Common Stock: Par Value of Shares Issued * Number of Shares Issued Over Time
2. Additional Paid-In Capital: (Market Value - Par Value) * Number of Shares in Each Issuance; value does not change as share price changes - based on share price at time of issuance
3. Retained Earnings: Company’s saved up, after-tax earnings. R/E = R/E (t-1) + Net Income - Dividends
4. Treasury Stock: Cumulative market value of shares the company has repurchased from shareholders; value does not change as share price changes - based on share price at time of repurchase
5. Accumulated Other Comprehensive Income: miscellaneous saved-up income (i.e.: effects of foreign currency exchange rate changes, unrealized gains and losses on certain securities, from hedging transactions, etc.)

Question 56

What is the Cash Flow Statement?

Answer 56

The CFS begins with Net Income, adjusts for Non-Cash items and changes in operating assets and liabilities (aka working capital) and then shows the companies CFI and CFF activities. The last line shows the net change in cash and the company’s ending cash balance.

The Cash Flow statement shows changes over time and exists for two main reasons:

1. The company may have recorded non-cash revenue, expenses, and taxes on the I/S (and adjustments need to be made to reflect the actual amount of cash received/paid)
2. Capture additional cash inflows and outflows that did not appear on the I/S (such as CapEx and Dividends)

Question 57

What is Cash Flow from Operations?

Answer 57

Begins with Net Income and then adjusts for non-cash items and then factors in changes in operational Balance Sheet changes in the period.

Rough Proxy for Current Assets - Liabilities (but not exactly since Cash, Investments, and Debt do not show up as they are non-operational; also changes in lease assets and liabilities (both long-term) show up).

Question 58

What is Cash Flow from Investing (CFI)?

Answer 58

Items related to financial investments, acquisitions, and PPE.

Rough Proxy: Long-Term Assets (but not exactly because changes to operating lease assets do not appear here and financial investments could be part of current assets)

Question 59

What is Cash Flow from Financing (CFF)?

Answer 59

Items related to Debt, Dividends, and Issuing or Repurchasing Shares

Rough Proxy: Corresponds to Long-Term Liabilities and Equity (but again not exactly because some long-term items such as Deferred Tax Liabilities are affected by changes in CFO or CSE by Net Income and SBC by changes in CFO and Long-Term Lease Liabilities appear in CFO)

Question 60

How do the three Financial Statements Link together?

Answer 60

IBC Recommended Answer: Net Income from the Income Statement flows is the top line of the CFS. The cash at the bottom of the CFS becomes the Cash on the B/S. Net Income from I/S also flows into CSE via Retained Earnings.

–

Changes in operational items on the B/S are reflected in CFO section of CFS

Links between CFS and B/S

• Cash at bottom of CFS (ending cash) becomes Cash on B/S
• Net Income, Stock Repurchases/Issuances, SBC, and Dividends link into CSE
• Debt Issuances/Repayments link into Total Debt
• CapEx and Depreciation link into Net PPE
• Deferred Taxes link into Net DTL or Net DTA

Question 61

What is Discretionary Cash Flow?

Answer 61

Cash Flow after the company pays for what it needs to run its business and avoid being shut down by external parties such as lenders and the government.

aka Free Cash Flow

Free Cash Flow = Cash Flow from Operations - Capital Expenditures (because not optional because companies need buildings, factories, equipment to house employees, manufacture products, and sell them to customers)

FCF allows us to quickly and easily assess a company’s ability to generate cash flow from its business

Question 61

What does a negative FCF indicate?

Answer 61

The company is not running a sustainable business by itself - it is relaying on outside financing to stay afloat

Question 62

What is Working Capital? What do changes in WC matter?

Answer 62

Current (Operational) Assets - Current (Operational) Liabilities
^ excludes cash, financial investments and debt

Changes in WC tells you how much FCF is likely to differ from Net Income and in which direction. If it’s positive (common for retailers because have to purchase inventory upfront), it reduces CF, reducing the company’s valuation. If it’s negative (common for subscription companies that collect cash upfront), it increases CF, increasing the company’s valuation.

Evaluate the impact of Changes in WC by looking at it as a percentage of revenue.

Question 63

True or False: Financial Metrics and Ratios allow you to analyze a company’s performance in more detail.

Answer 63

True. Metrics and Ratios allow you to compare a company’s financial performance to past performance and that of other similar companies.

Question 64

True or False: Companies that use their capital more efficiently, are not overly dependent on Debt, and that have the best cash-flow management should be valued more highly than companies that are worse at all of those.

Answer 64

True.

Question 65

What are the four primary groups of financial metrics for analyzing and valuing companies?

Answer 65

1. Cash Flow Proxy Metrics: EBIT, EBITDA, etc.
2. Credit Metrics: Leverage Ratio (Total Debt/EBITDA) and Interest Coverage Ratio (EBITDA/Interest Expense)
3. Return-Based Metrics: ROE, ROA, and ROIC
4. Cash Conversion Metrics - DSO, DIO, DPO, and CCC

Question 66

True or False: EBIT is the same as Operating Income which is the same as Operating Profit.

Answer 66

True. EBIT = Operating Income adjusted for any non-recurring or one-time changes (such as impairments or write-downs)

Question 67

Why is EBIT a proxy for FCF?

Answer 67

Both metrics reflect some or all of the impact of Capital Expenditures (recall: FCF = CFO - CapEx and EBIT = EBITDA - D&A)

Question 68

What is EBIT?

Answer 68

Reflects a company’s core, recurring business profitability before the impact of capital structures and taxes

Question 69

What is EBITDA and what is it a proxy for?

Answer 69

EBITDA gives you a company’s core, recurring business cash flow from operations before the impact of capital structure and taxes.

Therefore, it is a proxy for CFO.

Question 70

What is the Leverage Ratio and what does it tell you?

Answer 70

Total Debt / EBITDA

The ratio tells you how much Debt a company has relative to its ability to repay that Debt. Higher numbers are riskier and lower numbers are less risky

Question 71

What is the Interest Coverage Ratio and what does it tell you?

Answer 71

EBITDA / Interest Expense

The ICR tells you how easily the company could pay for its current interest expense on Debt. Higher numbers are better because they indicate there is more of a buffer in case the business suffers and profits fall.

Question 72

What do Return-Based Metrics Measure?

Answer 72

How efficiently a company is using its capital or assets to generate income.

Question 73

What does capital refer to with respect to Return-Based Metrics?

Answer 73

Funding Sources (i.e.: equity, equity + debt, equity + debt + preferred stock + other funding sources, etc.)

Question 74

True or False: Equity may be generated both internally or externally, but Debt and Preferred Stock must be generated externally.

Answer 74

True.

Question 75

What is the formula for ROE?

Answer 75

Net Income to Common / Average CSE

Question 76

What is the formula for ROA?

Answer 76

Net Income to Common / Average Total Assets

Question 77

What is the formula for ROIC?

Answer 77

NOPAT / Average Invested Capital

where NOPAT = EBIT * (1 - Tax Rate)

Question 78

What do Cash Conversion Metrics tell you?

Answer 78

Measure how quickly it takes a company to collect receivables, sell inventory, or pay the amounts owed to suppliers.

Question 79

What is the formula for DSO?

Answer 79

Days Sales Outstanding = A/R / Revenue * Days in the Year

Question 80

What is the formula for DIO?

Answer 80

Days Inventory Outstanding = Inventory / COGS * Days in the Year

Question 81

What is the formula for DPO?

Answer 81

Days Payable Outstanding = A/P / COGS * Days in the Year

Question 82

What is the formula for CCC? What does it tell you?

Answer 82

Cash Conversion Cycle = DIO + DSO - DPO

CCC tells you how long it takes a company to convert its inventory and other short-term operational assets (such as A/R) into cash flows. Lower numbers are better because they mean the company is selling its inventor and collecting cash from customers more quickly.

Question 83

When answering questions related to how a change affects the three financial statements, what order should you use?

Answer 83

1. Explain how the Income Statement changes
2. Explain how the CFS changes
3. Explain how the B/S changes and why it still balances

Question 84

What is the most important financial statement?

Answer 84

Cash flow statement because it tells you how much cash a company is generating and valuations are based on cash flow.

Conversely, the I/S includes non-cash revenue, expenses and taxes and excludes cash spending on major items such as CapEx so it does not accurately represent a company’s cash flow.

Question 85

Could you use only two financial statements to construct the third one? If not, why not?

Answer 85

Depends on which two statements.

For example, you can use the Starting and Ending B/S and I/S to construct the CF statement, but there will be some ambiguity (i.e.: you know how Net PPE changes, but not sure of the CapEx vs. Depreciation split).

Could also use the I/S and CFS to move from the starting B/S to ending B/S.

Nearly impossible to construct I/S with only the B/S and CFS because not enough direct links.

Question 86

True or False: Amortization of Other Intangible Assets, Goodwill Impairments and Asset Write-Downs are not deductible for Cash-Tax Purposes. Therefore changes in these items create DTAs and cash does not change.

Answer 86

True