L1: Introduction

Question 1

Why are financial statements useful?

Answer 1

• Provides information primarily to stakeholders outside the company.
• Info helpful in attracting capital from investors in equity and debt, suppliers, customers and employees, and making better decisions.
• Captures impact of business activities on profitability, financial strength and liquidity (cash flows).

Question 2

What is important for equity investors?

Answer 2

• Long-term earning power
• Growth potential
• Dividend payments

Question 3

What is important for creditors?

Answer 3

• Immediate liquidity
• Assurance of the payment of interest
• Share in downside risk

Question 4

What does the cash flow statement show?

Answer 4

How cash is generated and used during every period. Classifies different CFs into 3 categories, based on nature of the business cycle:

• Cash from operations
• Cash from investments
• Cash from financing

Question 5

What is included in financing cash flows?

Answer 5

• Capital contributions or withdrawals by shareholders
• New borrowings, repayment of existing borrowings
• Payment of dividends.

Question 6

What is included in investment cash flows?

Answer 6

• Purchases or disposals of property, plant and equipment
• Purchases or sales of financial assets (i.e. shares of other firms, treasury bills, etc.)
• Purchases or disposals of other firms (i.e. mergers and acquisitions).

Question 7

What is included in operating cash flows?

Answer 7

The remainder.

• Collections from customers
• Payments to suppliers and employees
• Payments to tax authorities
• Payments for operating expenses (i.e. rent, insurance, utilities, etc.).
• Interest paid is usually classified as operating CFs.

Question 8

What two methods can we use to find the operating cash flows?

Answer 8

• Direct method
• Indirect method

Question 9

What does Beaver (1968) and Ball & Brown (1968) show?

Answer 9

The value relevance of information from financial statements is the highest at the time the information is released –> taken into account immediately

Question 10

What have been shown to be determinants of future cash flows?

Answer 10

Statistically significant:
- Current cash flows
- Accruals (AR, AP, Inventory, Depreciation, others)

Question 11

What is the direct method for operating cash flows?

Answer 11

Adding up all cash payments made/received to get the sum of the operating cash flows

Question 12

What is the indirect method for operating cash flows?

Answer 12

Earnings = OCF +/- Accruals

Making adjustments to net income for:
- non-cash items
- changes in working capital