Finance Week 2

Question 1

What are financial statements?

Answer 1

Publicly traded companies have to report annual audited financial statements about the business to the government and shareholders.

Question 2

Why do shareholders want financial statements?

Answer 2

Shareholders need regular info to help monitor performance of corporation and make decisions on investments.

Question 3

What is included in financial statements?

Answer 3

Balance sheet, income statement, cashflow statement and additional material info.

Question 4

What is 10-K and 10-Q

Answer 4

10-K is the annual financial statement and 10-Q is the quarterly financial statement

Question 5

What is a balance sheet and what does it show?

Answer 5

A balance sheet shows a firms assets and liabilities at a point in time. Values for these calculated according to GAAP.

Question 6

What is on the left side of a balance sheet and how is it sorted?

Answer 6

Assets- result of investment decisions (uses of funds) sorted from most liquid (cash, AR) to least (machines, property, intangible assets)

Question 7

What is on the right side of a balance sheet and how is it sorted?

Answer 7

Liabilities and shareholders equity. Result of financing decisions (sources of funds). Sorted from shortest maturities (AP) to longest (long term debt).

Question 8

What is shareholders equity?

Answer 8

It is the value owned by a firms shareholders- this is calculated as a firms assets - a firms liabilities. A = L +E

Question 9

What are examples of assets?

Answer 9

Cash and securities, receivables, inventories

Question 10

What are examples of liabilities?

Answer 10

Payable, short term debt, long term debt

Question 11

Why in the shareholders equity are the book value vs market value different?

Answer 11

Book value of companies equity’s is value according to GAAP. Market value is value according to price which investors are trading the firm on market. Difference- book is backward looking and reflects transactions of past. Market value- forward looking as it reflects investors future expectations.

Question 12

What value does book value of shareholders equity not account for?

Answer 12

Internally created intangible assets- not accounted for e.g. user data, cloud servers.

Question 13

What is the income statement and what does it report?

Answer 13

Income statement reports a companies revenues, expenses and net income over a period of time

Question 14

What does income statement show?

Answer 14

How profitable a firm is during a financial year and the net income a firm earned

Question 15

Where is the net income on an income statement?

Answer 15

It is the bottom line

Question 16

How is an income statement organized?

Answer 16

Revenues - cost of goods sold - selling, gen, admin expenses - depreciation = EBIT

Question 17

What is EBIT?

Answer 17

Earnings before interest and income tax

Question 18

How do you calculate EBIT?

Answer 18

Revenues - cost of goods sold - selling, gen, admin expenses - depreciation

Question 19

What happens when you deduct a firms interest and taxes from the EBIT value?

Answer 19

You get the firms net income

Question 20

What does a firm do with its net income?

Answer 20

It is either paid out to shareholders as dividends or it is retained (added to stockholders book equity)

Question 21

How do you find a companies equity?

Answer 21

equity = last years equity + net income - dividends paid

Question 22

Why are a companies net income and cash company generates different?

Answer 22

1- If company has capital expenditure (e.g. buy machine) It has to pay in cash, this does not show on IS in current year but as a depreciation charge over years. 2- Accrual accounting- revenues and costs are matched at the time when new good is sold. If firm bought materials last year, produced and sold this year and customer pays next year- net income of current year reflects these. 3- change in debt- if company raises cash by issuing debt then company receives borrowed cash but net income unchanged

Question 23

What is the cashflow statement?

Answer 23

A company’s cash receipts and cash payments over a period of time.

Question 24

What does a cashflow statement show?

Answer 24

How a company’s available cash changes

Question 25

What are 4 parts of cashflow statement?

Answer 25

CF from operations/normal business activities, cashflow from investing (investment activities), cash flow from financing- from financing activities like issuing new debt/ equity, and total cash flows which is total from all 3

Question 26

How can you calculate cashflow from operations?

Answer 26

It is the net income + depreciation + change in NWC (networking capital: Current assets - current liabilities)

Question 27

How can you calculate cashflow from investing?

Answer 27

From investment decisions, it is the change in capital expenditure (buying and selling machines)

Question 28

How can you calculate cashflow from financing?

Answer 28

= change in debt + change in equity - dividends

Question 29

What is accounting malpractice and why does it arise?

Answer 29

FM pressure to perform well so tempted to cook the numbers and make net income look good. Want to keep jobs and make more money.

Question 30

Why is accounting fraud difficult to prove?

Answer 30

Due to flexibility of GAAP rules, e.g.: revenue recognition- manager may call customer to increase orders at end of year then return and refund, depreciation method- adjust how it is calculate to increase net income. Cutting R & D- expenses to increase NI. Cut marketing expenses

Question 31

What are corporate taxes and what is the corporate tax rate?

Answer 31

Companies have to pay taxes to the government and the corporate tax rate is 21%

Question 32

What do taxes have to be paid on?

Answer 32

Taxes have to be paid on taxable income which is the EBIT - interest

Question 33

How do you calculate taxes?

Answer 33

Taxes = (EBIT - interest) * tax rate. Net income = (EBIT - interest ) - taxes.

Question 34

Why is interest paid to debt holders tax deductible?

Answer 34

This is because it is the cost of doing business. Dividends, however, is taxable as it is what owners of business earn. Losses can be carried over to offset future taxable earnings.