Chapters 1 and 2

Question 1

What are assets

Answer 1

What the company owns

Question 2

What are liabilities?

Answer 2

What the company owes

Question 3

What is equity?

Answer 3

What company owes to shareholders

Question 4

Elements of equity

Answer 4

1. Share capital: invested by shareholders
2. Retained earnings: profits not paid out to shareholders
3. Reserves: funds used in less profitable times as safety buffers

Question 5

Elements of a cash flow statement

Answer 5

1. Operating cash flow: activities you make profits with
2. Investing cash flow: Transactions regarding long-term assets
3. Financing cash flow: Transactions related to raising capital

Question 6

Elements of income statement

Answer 6

1. Operating income (income generated from primary activity of the business
2. Financing (interest expenses)
3. Tax expenses

Question 7

What is accounting?

Answer 7

Accounting is the process of identifying, measuring and communicating financial information

Question 8

Types of accounting

Answer 8

1. Financial accounting (for external parties)
2. Managerial accounting (for internal purposes)

Question 9

Who uses accounting information

Answer 9

1. (potential) shareholders
2. Creditors and suppliers
3. Managers and directors
4. Financial analysts
5. Other users such as unions, and government (tax) agencies

Question 10

Why do (potential) shareholders use accounting information?

Answer 10

Shareholders rely on financial information to assess manager performance. They can invest capital in the business and need an accurate picture of business performance. Financial information reduces uncertainty about future and thus raises stock price.

Question 11

Why do creditors and suppliers use financial information?

Answer 11

Creditors use financial information to assess the default risk of the company they want to lend money to in order to decide whether to lend money or not.

Suppliers use FI to establish credit terms and their commitment to the relationship

Question 12

Why do managers and directors use financial information?

Answer 12

They use it for performance benchmarks tied to their compensation packages.

Question 13

Why do financial analysts use financial information?

Answer 13

Financial analysts are professionals who analyze FI for clients.

Question 14

What is disclosure?

Answer 14

Disclosure is the practice of releasing financial information.
This is necessary for loans but giving away too much information can create competitive disadvantage.

Always comply with minimum reporting standards.

Question 15

What types of business activities are there in accounting?

Answer 15

1. Planning activities
2. Investing activities
3. Financing activities
4. Operating activities

Question 16

What are planning activities?

Answer 16

These are the company’s goals and the methods of achieving those. This requires constant consideration of market condition. This is proprietary information.

Question 17

What are investing activities?

Answer 17

The buying and selling of resources to produce and sell (assets)
These can be long-term and short-term assets. Differs per company

Question 18

What are financing activities?

Answer 18

Methods of funding investments. Can be done through:
1. Equity financing= raising capital through share sales
2. Debt financing = raising capital by taking on liabilities.

Question 19

What are operating activities?

Answer 19

The production, promotion and selling of goods. Consists of input and output markets

Question 20

Input markets

Answer 20

Markets in which goods required to produce products are exchanged. Transactions create operating expense

Question 21

Output markets

Answer 21

Markets in which company’s products are sold to customer and creates revenue

Question 22

Wat are the main financial statements

Answer 22

1. Balance sheet
2. Income statement
3. Statement of cash flows
4. Statement of changes in equity

Question 23

What does a balance sheet do

Answer 23

A balance sheet reports financial position at a certain point in time (mostly the end of the reporting period). Divides financial position in assets, liabilities and equity.

Question 24

What does an inome statement show

Answer 24

Reports changes in equity value over time. It breaks done revenue (increase in equity value) and expenses (decrease in equity value).
Net income is the increase in equity value

Question 25

What does a statement of cash flow show

Answer 25

Give insight in the cash that actually came in to and got out of the business.

Question 26

What does a statement of changes in equity show

Answer 26

It reports changes in the total equity value through changes in: 1. contributed capital (through share issues) 2. Retained earnings (net profit -dividends) 3. other equity

Question 27

What are the 3 key linkages in the financial statements

Answer 27

1. Cash flow statement links Cash on beginning balance sheet to cash on ending balance sheet 2. Income statement links beginning and ending retained earnings in statement of changes in equity 3. Statement of changes in equity links beginning and ending equity on balance sheet.

Question 28

What is GAAP

Answer 28

GAAP stands for Generally Accepted Accounting Principles Set of standards and practices based on underlying principles in order to create financial statements. They vary per country

Question 29

What is IFRS

Answer 29

IFRS stands for International Financial Reporting Standards. To improve comparability between companies in different countries, this reporting standard was created. Most countries have adopted IFRS (but not US and Canada) Audition is mandaated to ensure reliability of financial information

Question 30

How do you calculate Return on Equity (ROE) and what is it used for

Answer 30

It is calculated: Net income/ Average total equity It is used to calculate the return generated for shareholders.

Question 31

What are the considerations using ROE

Answer 31

1. Only compare ROE to company in same industry. 2. Window-dressing 3. Differences in fiscal year (different operating cycles) 4. customer/supplier demographics

Question 32

How do you calculate the Debt-to-equity ratio?

Answer 32

Total liabilities / Total equity

Question 33

What does the Debt-to-equity ratio show?

Answer 33

It shows the ratio of debt over equity to determine credit risk. The lower the ratio the safer

Question 34

When are assets reported?

Answer 34

Assets are reported when they fit two requirements: 1. Likely has future economic benefits for the company 2. Cost/value can be reliably measured

Question 35

How are assets measured?

Answer 35

Most assets are measured by historical cost because of its objectivity Some assets like securities are reported at fair/current value for relevance.

Question 36

When are liabilities reported

Answer 36

Liabilities are reported when: 1. Economic sacrifice is probable 2. Obligation amount is relatively certain.

Question 37

What are executory contracts?Contri

Answer 37

Contract fulfilling criteria when transaction that caused the debt has not yet occurred. The transaction will occur on a later date.

Question 38

What is contributed capital

Answer 38

Contributed capital is the nominal value of issued shares - nominal value of repurchased shares.

Question 39

What is earned capital

Answer 39

Retained earnings- acc. other comprehensive income/loss

Question 40

How is gross profit calculated

Answer 40

Revenue - cost of goods sold

Question 41

How is net working capital calculated

Answer 41

Current assets - current liabilities

Question 42

What are considerations about the net working capital

Answer 42

It doesn't take into account the size of the company. $1 million in NWC for Microsoft is bad, but good for VG.

Question 43

What is the cash operating cycle

Answer 43

1. Cash 2. Cash is used to purchase inventories 3. Those are sould and earned on accounts receivables 4. Those are paid to return cash to the company 5. Cash is used to pay accounts payable.

Question 44

How is the current ratio calculated and what does it do?

Answer 44

Current ratio = current assets - current liabilities. should be 1

Question 45

How is quick ratio calculated?

Answer 45

QR = (cash + short-term securities + Acc. Receivable)/current liabilities

Question 46

Quick ratio characteristic and considerations

Answer 46

QR is more selective than CR 2. One should take into account different operating cycles 3. There could be differences in inventory, receivables and payables management efficiency.

Question 47

What is the difference between operating and nonoperating expenses.

Answer 47

Operating expenses are expenses incurred in support of the company's main activities Nonoperating expenses come from financing and investing activities.