Chapter 2: Financial Statements, Taxes, and Cash Flows

Question 1

balance sheet

Answer 1

a snapshot of the financial health of a firm, or of the firm’s accounting value on a particular date

Question 2

net working capital

Answer 2

current assets less current liabilities. usually positive for a healthy firm

Question 3

liquidity

Answer 3

refers to the speed and ease with which an asset can be converted to cash. gold is a relatively liquid asset; a sumo manufacturing facility is not

liquidity really has two dimensions: ease of conversion versus loss of value. any asset can be converted to cash quickly if we cut the price enough. a highly liquid asset, therefore, is one that can be converted to cash without a substantial price reduction

Question 4

the more liquid a business is…

Answer 4

the less likely it will be effected in times of financial distress

Question 5

market value

Answer 5

the true value of any asset, which is simply the amount of cash we would get if we actually sold it on the open market

Question 6

book values

Answer 6

values shown on the balance sheet for the firm’s assets and generally are not what the assets are actually worth

assets are generally carried on the books at historical cost, or what the firm paid for them (minus accumulated depreciation)

Question 7

income statement

Answer 7

measures performance over some period of time, usually a quarter or a year

Question 8

GAAP and the income statement

Answer 8

the matching principle reigns supreme: revenues have costs associated with them, and those are presented on the income statement

Question 9

non cash items

Answer 9

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

Question 10

fixed vs variable costs

Answer 10

fixed costs must be paid no matter what. other costs, such as wages to laborers and payments to suppliers, are still variable

accountants tend to clarify costs as either period costs or product costs

Question 11

period costs

Answer 11

incurred during a particular time period and might be reported as selling, general, and administrative expenses

Question 12

product costs

Answer 12

include such things as raw materials, direct labor expense, and manufacturing overhead. these are reported on the income statement as costs of goods sold, but they include both fixed and variable costs

Question 13

earnings management

Answer 13

the way that firms are required by GAAP to report financial results is supposed to be objective and precise, but in reality, there is plenty of wiggle room, and, as a result, companies have significant discretion over their reported earnings

Question 14

corporate tax rates

Answer 14

there are only four original corporate rates: 15, 25, 34, and 35 percent

Question 15

average tax rate

Answer 15

total taxes paid divided by total taxable income

Question 16

marginal tax rate

Answer 16

amount of tax payable on the net dollar earned

Question 17

flat tax rate

Answer 17

there is only one tax rate for all incomes, and as it stands now, the US is based on a modified flat tax rate, which becomes a true flat rate for the highest incomes

the average flat tax rate for large corporations is 35%

Question 18

what is the cash flow identity?

Answer 18

cash flow from assets = cash flow to creditors + cash flow to stockholders

Question 19

cash flow from assets

Answer 19

total of cash flow to creditors and cash flow to stockholders, consisting of the following three components: 1) operating cash flow 2) capital spending, and 3) change in net working capital

Question 20

operating cash flow

Answer 20

cash generate from a firm’s normal business activities

to calculate, take revenues and subtract costs (don’t include depreciation and don’t include interest)

earnings before interest and taxes + depreciation - taxes = operating cash flow

this is an important number because it tells us, on a very basic level, whether or not a firm’s cash inflows from its business operations are sufficient to cover its everyday cash outflows

Question 21

capital spending

Answer 21

spending on fixed assets less money received from the sale of fixed assets

ending fixed assets - beginning fixed assets + depreciation = net investments in fixed assets

this can be negative, which would happen if the firm sold off more assets than it purchased

Question 22

change in net working capital

Answer 22

difference between the beginning and ending net working capital figures