Chapter 2 Balance Sheet Flashcards
Net Worth - Individual
Balance Sheet Equation
The difference between what you have and what you owe.
Total assets less liabilities
A - L = NW
Balance Sheet Equation
Lenders Relationship
Creditors have a claim on listed assets, they are in a less risky position
A = L + NW
Balance Sheet Equation
Shareholder Relationship
Shareholders (those that purchase ownership shares in the business) have the last claim on the corporate assets listed on the balance sheet.
A = L + SE
Financing Decision
Some companies borrow sparingly and thus are financed principally by shareholders. Other companies borrow extensively (referred to as leveraged)
The relative mix of funding between shareholders and lenders can have a dramatic effect on a firms financial performance.
Asset
An economic resource that is expected to generate future benefits for a business
Liability
An obligation to make future payments
Off-Balance Sheet liabilities
Liabilities that are often not reported on the balance sheet
Shareholders Equity
Residual value of a business - Value of any assets remaining after all liabilities have been satisfied
CS + RE = SE
Common Stock (CS)
Value of the shareholders direct investment in a business
Retained Earnings (RE)
Amount of any profits retained in the business to support future operations
Issuing Shares
The number of shares issued by a company and their related value. The amount of money given for a set of shares becomes the basis for the starting equity value
Entity Principle
This principle stipulates that the financial affairs of a business must be maintained separate and distinct from the affairs of the owners of the business
Accrual Basis of accounting
Any interest owed but not paid will be recorded as necessary at future balance sheet dates with an appropriate charge to earnings and retained earnings
Tangible Assets
Most recorded assets such as buildings have an actual physical presence
Intangible Assets
Include such items as patents, copyrights and brand names
Forecasted Financial Statement
Financial statements prepared on an “as if” bases using assumptions about what might happen in the future
Opportunity Cost
Extending credit to customers. Equal to the cost of borrowing over the time period during which the purchase price remains unpaid
Historical Cost Principle
Stipulates that all assets should initially be recorded at their historical acquisition cost
Relation between Revenues and Expenses
Revenues - which increase net income also increase retained earnings
Expenses - Decrease net income and also decreases retained earnings
We include income statement accounts as subcomponents of retained earnings
Revenue Recognition Principle
Recognizing revenue is a wealth-increasing event for a business and its shareholders and this is reflects by an increase in shareholders equity (through the retained earnings account).
Expenses
Represent the using up of goods and services associated with the production of revenues by a business. Expenses reduce assets or increase liabilities, expenses are a wealth-reducing event
Matching Concept
Within a given accounting period, a business is able to convey its accomplishments (revenue) with its efforts (expenses)
Contra Accounts (CA)
Balance Sheet accounts that are subtracted from other accounts (such as accumulated depreciation)
Net Book Value
The difference between the cost of an asset (eg equipment) and its accumulated depreciation
Depreciation
Refers to the systematic expensing of an asset as a consequence of the passage of time
Asset = Accumulated Depreciation
Shareholder Equity = Depreciation
Amortization
The write-off of the purchased brand name
-Just estimates, and as such, can be quite imprecise
Additional Shares
The issuance of additional common shares increase SE. As a consequence of selling shares to the outside investor, the owners must share control of the business and its profits with the investor who has become co-owner
Income Tax
cost of doing business. This expense must be matched with the company’s revenue
Balance Sheet Includes…
The income statement accounts
Ex. Revenues, COGS, Wages and Salaries, Selling and Administrative, Depreciation, Amortization, Interest expense, income tax, dividends all under Retained Earnings
Preparing the Financial Statements
Summing up the various values in each of the rows. These final balances are entered in the final column labeled “ending balance”.
Current Assets
Those assets that are expected to be converted into cash or used to support operations during the next 12 months
Noncurrent Assets
Those assets expected to be available to support the coninuing operations of a business beyond 12 months
Current Liabilities
those liabilities that are expected to require payment within the next 12 months
Noncurrent Liabilities
Obligations that not expected to require payment for more than one year. The phrase “long-term” is often used instead of “noncurrent”.
Revenue
Measure the inflow of cash and other assets (such as accounts receivable) from a firms primary business activity.
Gross Profit
Measures the amount of cash and assets remaining after deducting the cost of sales (COGS)
Operating Income
Refers to a firms net income before deducting such items as interest expense and income taxes
Net Income
The firms bottom-line performance - the company’s net income after all expenses are deducted, both operating and nonoperating, recurring or non-recurring
Recurring Operations
core business of producing and selling product
Evaluating Firm Profitability
To evaluate the profitability of a business, it is often useful to consider various performance indicators from the financial statement’s
Return on Sales (ROS)
One profitability measure that considers relative firm size.
AKA Net income divided by sales revenue
Return on Assets (ROA)
Another measure of profitability that considers relative firm size.
Net income plus after tax interest expense divided by total assets
Tax Shield
Positive impact of interest expense on a firms income tax expense.
The amount of interest added back to net income should be reduced by the amount of the tax shield which is already reflected in a firms income tax provision
