Chapter 2: A Closer Look at the Financial Statements

Question 1

business plan

Answer 1

a document designed to show investors that your idea can turn a profit - that is, sell goods and services at a price that exceeds the expenses of the operation

Question 2

contributed capital

Answer 2

money contributed directly to your business

Question 3

debt capital

Answer 3

money you owe to investors or a bank, a liability, for starting a business (comes with a maturity date, a covenant, and interest payments)

Question 4

producing assets

Answer 4

assets used to support the generation of revenue (more fishing equipment, bait, tackle, and food)

Question 5

operating assets

Answer 5

they too help generate revenues, but unlike producing assets, they will be used up quickly and will have to be replaced often (boats)

Question 6

what are the three major activities of a business?

Answer 6

operating, investing, and financing.

Question 7

cash flows from operating activities

Answer 7

include cash collections from customers and clients, who bought products and services, reduced by cash payments to purchase operating assets (inventories) and pay expenses (wages, utilities, repairs), including interest paid on the bank loan

Question 8

cash flows from investing activities

Answer 8

include cash payments to purchase producing assets (land, structures, assets for rent), plus any cash receipts from selling these assets

Question 9

cash flows from financing activities

Answer 9

cash inflows from borrowings and contributions from shareholders and cash outflows associated with payments to creditors (excluding interest) and shareholders in the form of dividends or share buybacks

Question 10

retained earnings

Answer 10

reinvested earnings that go back into the business

Question 11

balance sheet contains?

Answer 11

the assets, the liabilities, and the shareholders equity all laid out in a document. It is a snapshot of the company’s financial condition

Question 12

liquidity on the balance sheet

Answer 12

how quickly you can liquify an asset is how quickly you can return it to its cash form. The assets near the top of the balance sheet and at the top of each category are expected to be converted into cash within a shorter period of time than those listed towards the bottom

Question 13

current assets

Answer 13

assets categorized as current are expected to be realized in the near future, usually within a year. They include cash, short-term investments, accounts receivable, inventory, and prepaid expenses

Question 14

cash

Answer 14

currency the company has access to as of the balance sheet date (petty cash on site, in a savings account or checking account)

Question 15

short term investments

Answer 15

include stocks (equity investments in other companies), bonds (debt investments in the government or other companies), and similar investments. These securities are both readily marketable (able to be sold immediately) and intended by management to be sold within a short period of time, usually less than one year

Question 16

accounts receivable

Answer 16

represents the amount of money a company expects to collect from its customers. such receivables arise from sales of products or services for which customers have not yet paid. These sales are often referred to as credit sales or sales on account

Question 17

inventory

Answer 17

represents items or products on hand that a company intends to sell to its customers. The balance sheet value of inventory is the cost of acquiring it or the cost of replacing it. Supplies inventory is another kind that is used to support the company’s operation

Question 18

prepaid expenses

Answer 18

expenses that have been paid by a company before the corresponding services or rights are actually used. Insurance premiums, for example, are normally paid prior to coverage. Rent is usually paid before the rental period. Therefore, prepaid expenses are considered an asset because it represents a benefit to be enjoyed by the company in the future

Question 19

long term investments

Answer 19

acquired by companies to provide benefits for periods of time extending beyond one year

Question 20

promissory note

Answer 20

a formal, legally binding document that states the face value of the receivable, the date when the face value is due, and the periodic interest payments to be made while the note is outstanding

Question 21

long lived assets

Answer 21

include property, plant, and equipment and intangible assets. This section of the balance sheet includes assets acquired for use in the day-to-day operations of the business, and they are called long-lived because they are expected to support the generation of revenues for a period of time before the current one

Question 22

property account

Answer 22

represents the physical structures that a company owns and uses in its operations. it is carried on the balance sheet at the original cost of the land, which is not adjusted as the value of the property appreciates (this IS NOT a long term investment on the balance sheet)

Question 23

plant and equipment account

Answer 23

this will include the accumulated depreciation on the balance sheet, or the amount that loosely approximates the asset’s lost usefulness over time

Question 24

intangible assets

Answer 24

they have no physical substance. they usually represent legal rights to the use or sale of valuable names, items, processes, or information. Patents are under this category. Goodwill might be the most common, which represents the cost of purchasing another company over and above the total market price of that company’s individual assets and liabilities.

Question 25

current liabilities

Answer 25

are obligations expected to be paid (or services expected to be performed) with the use of current assets listed in the current assets section of the balance sheet (accounts payable, wages payable, interest payable, short-term notes payable, income taxes payable, current maturities of long-term debts, and unearned revenues).

Question 26

accounts payable

Answer 26

usually obligations to a company’s suppliers for merchandise purchases made on an account. Salaries and wages payable are obligations to a company’s employees for earned but unpaid salaries and wages of the balance sheet date.

Question 27

current maturities of long term debts

Answer 27

portions of long term liabilities that are due in the current period

Question 28

long term liabilities

Answer 28

obligations expected to require payment over a period of time beyond the current year. these are usually evidenced by formal contracts that state their principal amounts, the period interest payments, and maturity dates

Question 29

notes payable

Answer 29

refer to obligations on loans that are normally due more than one year beyond the balance sheet date

Question 30

bonds payable

Answer 30

represent notes that have been issued for cash to a large number of debt investors (called bondholders)

Question 31

shareholder equity

Answer 31

this section of the balance sheet consists of common stock, retained earnings, and treasury stock.

Question 32

retained earnings

Answer 32

represent investments made by the owners by not exercising their right to withdraw via dividends prior net income amounts, allowing these profits to remain in the company

Question 33

the income statement

Answer 33

sometimes called the statement of operations, measures operating performance over a particular period. Most investors agree that the net income is the most important number disclosed on the financial statements because it represents the company’s ability to sell its products and services for more than it costs to provide them

Question 34

operating revenues

Answer 34

represent the inflow of assets (or decrease in liabilities) die to a company’s operating activities over time. This includes the sales and services revenues. the ability to produce operating revenues is often viewed as one of the important keys to success for a company

Question 35

sales or sales revenue

Answer 35

perhaps the most common revenue account. it represents a measure of asset increases (usually in the form of cash or accounts receivable) due to selling a company’s products or inventories

Question 36

operating expenses

Answer 36

represent the periodic and usual outflow of assets (or creation of liabilities) required to generate operating revenues. Examples are costs of goods sold and expenses related to wages, rent, selling, depreciation, and amortization

Question 37

classified balance sheet

Answer 37

balance sheet where the asset and liability accounts are grouped into classifications: current assets, long term investments, long lived assets, current liabilities, and long term liabilities

Question 38

depreciation (amortization)

Answer 38

represents an estimate of the extent to which plant and equipment (depreciation) and intangible assets (amortization) are being used up each year. depreciation ad amortization expense reflect that cost on the income statement

Question 39

non operating revenues

Answer 39

usually contains revenues and expenses from activities not central to the company’s operations; therefore, the dollar amount of this category is also usually small. include interest on bank accounts, rent collected on the rental of excess warehouse space, and book gains recognized when assets are sold for amounts that exceed the costs

Question 40

the statement of cash flows (summary of cash account)

Answer 40

summary of the activity in a company’s cash account over a period of time. understanding it is simply a matter of recognizing that certain transactions entered into by a company during a given period increase the cash account, while others decrease it. made up of operating activities, investing activities, and financing activities

Question 41

cash flows from operating activities

Answer 41

includes those cash inflows and outflows associated with the acquisition and sale of a company’s products and services (closely related to revenue/expenses because both measure inflow/outflow of cash).

Question 42

cash flows from investing activities

Answer 42

include cash inflows and outflows associated with the purchase and sale of a company’s producing assets, including investments and long lived assets

Question 43

cash flows from financing activities

Answer 43

include the cash inflows and outflows associated with a company’s two sources of outside capital: liabilities and owner investment. cash proceeds from and cash principal payments on short and long term liabilities are reflected in this section

Question 44

corporation

Answer 44

a legal entity that is separate and distinct from its owner. it can be taxed or sued, and the owners, called shareholders or stockholders, are legally liable only for the amount of their original contributions to the corporation

Question 45

partnership or proprietorship

Answer 45

not a legal entity. it can neither be taxed nor sued, ad the legal liability of the owners, called partners, is not limited to the original contributions