Chapter 1 - Financial Accounting for MBAs

Question 1

The main objective of financial reporting

Answer 1

to provide users w/ information that supports investment and management decisions

Question 2

Main user groups of financial statements (3)

Answer 2

1. Investors and equity analysts
2. Lenders and credit analysts
3. Company managers

Question 3

Ongoing basic business activities (4 types)

Answer 3

1. Planning
2. Operating
3. Investing
4. Financing

Question 4

Business forces (3 types)

Answer 4

1. Market conditions
2. Competitive pressures
3. Regulations

Question 5

Demand for Information - (7 classes)

Answer 5

1. Managers and employees
2. Investment analysts and information intermediaries
3. Creditors and suppliers
4. Stockholders and directors
5. Customers and strategic partners
6. Regulators and tax agencies
7. Voters and their representitives

Question 6

Supply of information (2 main; SEC)

Answer 6

1. 10-K (audited annual report)
2. 10-Q (unaudited quarterly report)

Datasets are scrubbed and formatted

Question 7

Costs of disclosure (4)

Answer 7

1. Preparation and dissemination
2. Competitive disadvantages
3. Litigation
4. Political

Question 8

Benefits of disclosure ((4)

Answer 8

1. Capital markets
2. Labor markets
3. Input markets
4. Output markets

Question 9

International Accounting Standards

Answer 9

1. International Financial Reporting Standards (IFRS)
2. International Accounting Standards Board (IASB)

Both IASB & FASB use accrual accounting

Question 10

Financial Statements (4)

Answer 10

1. Balance sheet
2. Income sheet
3. Statement of stockholders’ equity
4. Statement of cash flows

Question 11

Breaking down the Balance Sheet

Answer 11

Reports a company’s financial position at a point in time. “Permanent Accounts”

Reports 3 components of that financial position

1. Resources (asset)
2. Investing
   
   1. Owner financing (equity)
   2. Non-owner financing (liability)
3. Broken down into the accounting equation

Investing = Financing (sources)

Investing = Non-owner Financing + Owner Financing

ASSETS = LIABILITIES + EQUITY

Question 12

Investing Activities

Answer 12

• Prepared at a point in time
• Represented by a company’s Assets
• Financed by a combination of nonowner financing (Liabilities) and owner financing (Equity)

Listed on the balance sheet in order of nearness to cash

• Current assets (short-term) - expected to generate cash in w/in 1 yr from the BS date
  
  • Large investments in short-term assets
    
    • e.g. Best Buy, Starbucks, Nordstrom’s.
    • e.g. Alphabet, Cisco
• Long-term assets - Land, building, and equipment (PPE - property, plant, and equipment) will generate cash over a long period of time
  
  • Larger investments in PPE, long-term inventory, & accounts receivable
    
    • e.g. 3M, J&J, & Colgate-Palmolive

Question 13

Financing Activities

Answer 13

To pay for Assets

1. Equity (Owner financing)
   
   • Resources contributed by owners (two types; mostly cash, sometimes noncash assets)
   • Profits retained by the company
2. Liabilities (Nonowner financing)
   
   • Borrowed Money

Stable cash flows equate to the ability to operate with higer debt (e.g. Caterpillar, GM, Starbucks)

Higher levels of risk equate to requiring more cash (e.g. Alphabet & Intel)

Question 14

Breaking down the Income Statement

Definition. Equation. 2 kinds of operating expenses

Answer 14

Reports on a company’s performance over a period of time and lists amounts for top line revenues (also called sales) and its expenses.

Revenues - expenses = net income (or profit or earnings)

(Note: net income represents the profit to the company’s shareholders for the period)

2 basic kinds of operating expenses

1. Cost of goods sold (COGS, also called cost of sales)
   
   • Amt paid to purchase or manufacture a good
   • Revenue less COGS = gross profit (which is profit available to cover all other costs)
2. Selling, general, and administrative expenses (SG&A)
   
   • Includes salaries, marketing costs, occupancy costs, HR & IT costs, and all the other operating expenses

Question 15

Relative profitability (what is…)

Answer 15

Net income as a percent of sales

Net income ÷ sales = relative profitability

Question 16

Breaking down the Statement of Stockholders’ Equity

Definition. 3 Components.

Answer 16

Reports on year-over-year changes in the equity accounts that are reported on the balance sheet

3 Components of an Equity Statement

1. Beginning balance
2. Summary of activity in the account during the year
3. Ending balance

Question 17

Three categories of changes to an Equity Statement

List & Define

Answer 17

1. Contributed capital
2. Retained earnings
3. Other equity

Contributed capital: Represents the assets the company received from issuing stock to stockholders

Retained earnings: Represents the cumulative total amount of income the company has earned and that has been retained in the business (i.e not distributed to stockholders as dividends)

• Net income increases retained earnings
• Dividends decrease retained earnings

Question 18

Breaking down the Statement of Cash Flows

Answer 18

Reports the change (either increase or decrease) in a company’s cash balance over a period of time.

Reports cash inflows and outflows from operating, investing, and financing activites over a period of time

3 activites on the Statement of Cash Flows

1. Operating activities: generated profit or loss from the core business
2. Investing activities: purchase of property, PPE assets, and inflows/outflows of case for sales and purchases of marketable securities
3. Financing activities: Borrowing and repayment of debt, sales and repurchases of stock and the payment of dividends

Question 19

Return on Assets (What are…)

Answer 19

Defined as net income for that period divided by teh av erage total assets during that period

Question 20

Components of Return on Assets (2)

Answer 20

1. Profitability relates profit to sales. This ratio is called the profit margin (PM). Reflects the net income (profit after sales) earned on each sales dollar.
   
   • Net income ÷ sales
2. Productivity relats sales to assets. Asset turnover reflects sales generated by each dollar of assets.
   
   • Sales ÷ Average assets

Question 21

General observations on Return on Assets

Answer 21

1. High margin and Low turnover
   
   • e.g. Intel, Cisco, J&J, & Apple
2. Low margin and High turnover
   
   • e.g. Nordstrom, Target, Macy’s, & CVS
3. High performance
   
   • Intel, Apple, Colgate Palmolive, Starbucks, & Home Depot

Question 22

Return on Equity (What is…)

Answer 22

Net income divided. by average stockholders’ equity

(Beginning of year + end of year) ÷ 2 = average equity

ROE reflects the return to stockholders (which is different from the Return on Assets (ROA))

Question 23

EBITDA (What is…)

Answer 23

Earnings Befor Interest, Taxes, and amoritization Expense

Question 24

5 forces of the Competitive Environment

Answer 24

A.K.A. Porter’s 5 Forces

1. Industry competition
2. Bargaining power of buyers
3. Bargaining power of suppliers
4. Threat of substitution
5. Threat of entry

Question 25

How to Calculate Asset Turnover (AT)

Answer 25

Net sales (Net revenue) ÷ Average assets = Asset Turnover