Chapter 2 Flashcards
The difference between a firm’s current assets and its current liabilities is called ____ ___________ ____________.
net working capital
_________ refers to the speed and ease at which an asset can be converted to cash.
Liquidity
T or F: Equity holders in a company are only entitled to residual value of a company, after creditors are paid.
True
What is book value and why is it important?
Book value is the historical cost of an asset (whatever it was purchased for).
Assets are recorded at book value on the balance sheet and the fact that there is no connection between book value and fair market value.
What is financial leverage?
It is the use of debt within a firm’s capital structure.
What is important to note about timing and the income statement?
GAAP allows revenue recorded even if cash hasn’t come in. So sometimes cash flows and revenue recognition timings can differ.
What is the matching principle?
Matching revenues and costs associated with producing them.
What item on the income statement is the primary reason that accounting income differs from cash flow?
noncash items (depreciations etc)
In practice, accountants tend to classify costs as either _________ or _________ costs.
product
period
_________ costs are those that include raw materials, direct labor expense, or manufacturing overhead. They can be easily allocated to a cost object.
product
Define a “period cost”.
Costs which are incurred during a particular time period - typically reported as selling, G&A expense.
T or F: Both product and period costs can be fixed or variable.
True.
After the Tax Cuts and Jobs Act of 2017, the federal corporate tax rate was _______, but other forms of businesses did not have a flat rate.
21%
Average tax rate is calculated by…
Dividing your tax bill by your taxable income.
Marginal tax rate is the…
rate of the extra tax you would pay if you earned one more dollar.
Why is marginal tax rate important?
Because new cash flows for you/your business will be taxed at that rate.
What does the cash flow identity state?
Cash flow from a firm’s assets is equal to cash flow paid to suppliers of capital to the firm.
Cash flow from assets = cash flow to creditors + cash flow to stockholders
List the three components of cash flow from assets.
1) operating cash flow
2) capital spending
3) change in net working capital
What is operating cash flow?
Cash flow from day-to-day activities of producing and selling.
Define capital spending.
The spending of money on fixed assets (or sale of fixed assets)
How is a change in net working capital calculated?
Net change in current assets relative to current liabilities.
Why is operating cash flow important?
Because it tells whether a firm’s inflows from its primary operations are sufficient to cover its everyday outflows.
How is the accounting definition of operating cash flow different than the finance definition?
In accounting, interest is deducted from NI.
T or F: Capital spending is also called CAPEX, short for capital expenditures.
True
What is another name for cash flows from assets?
free cash flow - refers to cash that the firm is free to distribute to creditors/stockholders.
What is the formula for cash flow from assets?
Operating Cash Flow
- Net Capital Spending
- Change in net capital
What is the formula for operating cash flow?
Earnings before interest and taxes
+ Depreciation
- Taxes
What is the formula for net capital spending?
Ending fixed assets
- Beg. fixed assets
+ Depreciation
What is the formula for change in NWC?
Ending NWC
- Beg. NWC
