Chapter 2: Financial Statements, Cash flow, and Taxes

Question 1

Statement of financial position (balance sheets)–>

Answer 1

financial statement showing a firm’s accounting value on particular date.

Question 2

Net Working Capital

Answer 2

• The difference between a firm’s current assets and its current liabilities

○ Current assets - current liabilities= net working capital
Means that the cash available

Question 3

Liquidity

Answer 3

• Refers to the speed and ease with which an asset can be converted into cash.
Ease of conversion vs. loss of value. –> highly liquid asset is one that can be converted into cash without any los of value. An illiquid asset is one that cannot be converted quickly without substantial price reduction.

Question 4

Financial leverage-

Answer 4

the use of debt in a firm’s capital structure. The more debt, the greater the degree of financial leverage.

Question 5

Carrying value or book value

Answer 5

the accounting value of a firm’s assets

Question 6

Revaluation method

Answer 6

allows companies to revalue assets at specific periods in time

Question 7

Market value

Answer 7

is the price at which willing buyers and sellers trade the assets.

Question 8

State of comprehensive income

Answer 8

measures performance over some period of time, usually a year. Also know as the income statement.

Revenues-expenses= income.

Question 9

EPS(earnings per share)

Answer 9

= Net income/# of shares outstanding

Question 10

International Financial reporting standard (IFRS)

Answer 10

• Revenue is recognized on the statement when it is probable that any future economic benefit associated with the item of review will flow to the firm and the amount of revenue can be measure, no when cash flow occurred.

–Revenues must match expense– earned when accrued (even if sold for credit)

Question 11

Non-cash items-

Answer 11

expenses charged against revenues that do not directly affect cash flow, such as depreciation.

Question 12

Product costs

Answer 12

include things such as raw materials, direct labour expense, and manufacturing overhead (reported as cost of goods sold on income statement)

Question 13

Period costs-

Answer 13

costs incurred during a particular time period and are reported as selling, general, and administrative expenses

Question 14

Cash Flow from assets

Answer 14

Cash-flow from assets = cash flow to bondholders+ cash flow to shareholders

Three Components :

Cash flow from assets= operating cash flow - capital spending - additions to net working capital

Question 15

Operating cash flow

Answer 15

Refers to the cash flow that results from the firm’s day-to-day activities of producing and selling.

=Revenues-expenses ( no depreciation or interest)(include taxes)

Question 16

Capital spending

Answer 16

–Refers to the net spending on fixed assets (purchases of fixed assets less sales of fixed assets

Question 17

Additions to net working capital

Answer 17

Is the amount spent on net working capital. It is measured as the change in net working capital over the period being examined and represents the net increase in current assets over current liabilities.

Question 18

Free cash flow (another name for cash flow from assets)

Answer 18

refers to cash that the firm is free to distribute to credits and shareholders because it is not needed for working capital or fixed asset investment.

=cash flow - any reinvestment required to maintain the competitive advantage

Question 19

Cash flow to creditors

Answer 19

a firms interest payments to creditors less net new borrowings

Question 20

Cash flow to shareholders–>

Answer 20

dividends paid out by a firm less net new equity

Question 21

Taxes

Answer 21

Determined through tax laws and regulations in the annual budgets of the federal government and provincial government.

Question 22

Ideal tax system has three features

Answer 22

a. Distribute the tax burden equitably– “fair share”
b. Should not change the efficient allocation of resources by markers
c. Should be easy to administer.

Question 23

Average tax rate

Answer 23

is you tax bill divided by your taxable income; the percentage of you income that goes to taxes

Question 24

Marginal Tax Rate

Answer 24

is the extra tax you would pay if you earned one more dollar.

Question 25

Progressive taxation

Answer 25

> with higher incomes, there are higher tax rates

Question 26

Flat rate tax-

Answer 26

there is only one taxes rate, and this rate is the same for all income levels

Question 27

Dividend tax credit

Answer 27

tax formula that reduces the effective tax rate on dividends.

Question 28

Capital gains

Answer 28

the increase in value of an investment over its purchase price.

Question 29

Realized capital gains

Answer 29

the increase in value of an investment when converted to cash

Question 30

loss-carry back

Answer 30

Using a year’s capital losses to offset capital gains of previous years.

Question 31

Loss carry-forward

Answer 31

Using a year’s capital losses to offset capital gains of future years.

Question 32

N.W.C. Equation

Answer 32

= CA – CL

Question 33

Capital Structure Equation

Answer 33

D+E = 1

Question 34

Cash Flow from Assets Equation

Answer 34

= (+) Operating Cash Flow - Net Capital Spending - Net Working Capital

Cash Flow from Assets = Cash Flow to Bondholders + Cash Flow to Shareholders

Question 35

.) Operating Cash Flow Equation

Answer 35

= EBIT + Depreciation, Amort, Dep. – Taxes

Question 36

Net Capital Spending Equation

Answer 36

= Ending Fixed Assets – Beginning Fixed Assets + Depreciation, Amort, Dep.

Question 37

Change in Net Working Capital Equation

Answer 37

= End N.W.C – Beginning N.W.C

= End (C.A – C.L) – Begin (C.A – C.L)

Question 38

Cash Flow to Bondholders

Answer 38

= Interest – Net new borrowing (End L.T Debt – Begin L.T.D)

Question 39

Cash Flow to Shareholders

Answer 39

= Dividends – Net new equity ((Beg – End)Com Stock + Pref. Stock)