The Key Financial Statements

Question 1

The Key Financial Statements

Answer 1

1) The Balance Sheet
2) The Income Statement
3) The Cash Flow Statement

Question 2

The Balance Sheet

Answer 2

The balance sheet shows what the company owns (its assets), waht it owes (its liabilities), and its book value, or net worth (also called owners’ equity, or shareholders’ equity).

Question 3

Assets

Answer 3

Comprise all the physical resources a company can put to work in the service of the business. This category includes cash and financial instruments (such as stocks and bonds), inventories of raw materials and finished goods, land, buildings, and equipment, plus the firm’s accounts receivable – funds owed by customers for goods or services purchased.

Question 4

Liabilities

Answer 4

Are debts to suppliers and other creditors. If a firm borrows money from a bank, that’s a liability.

Question 5

Owners’ equity

Answer 5

Is what’s left after you subtract total liabilities from total assets. A company with $3 million in total assets and $2 million in liabilities has $1 million in owners’ equity.

Question 6

What balance sheet shows?

Answer 6

The balance sheet shows assets on one side of the ledger, liabilities and owners’ equity on the other. It’s called a balance sheet because the two sides must always balance. If the company were to borrow $100 000 from a bank, the cash infusion would increase both its assets and its liabilities by $100 000.
Balance sheet data are most helpful when compared with the same information from one or more previous years.

Question 7

Assets

Answer 7

1) current assets

2) fixed assets

Question 8

Current assets

Answer 8

cash on hand and marketable securities, receivable, and inventory. Generally current assets can be converted into cash within one year.

Question 9

Fixed assets

Answer 9

are harder to turn into cash – the biggest category of fixed assets is usually property, plant, and equipment; for some companies, it’s the only category.
Since fixed assets other than land don’t last forever, the company must charge a portion of their cost against revenue over their estimated useful life. This is called depreciation, and the balance sheet shows the accumulated depreciation for all of the company’s fixed assets.

Question 10

How the Balance Sheet Relates to You

Answer 10

1) Working capital
2) Financial leverage
3) Financial structure of the firm

Question 11

Working capital

Answer 11

Subtracting current liabilities from current assets gives you the company’s net working capital, or the amount of money tied up in current operations.

Question 12

Working capital importance

Answer 12

Financial managers give substantial attention to the level of working capital, which typically expands and contracts with the level of sales. Too little working capital can put a company in a bad position: It may be unable to pay its bills or take advantage of profitable opportunities. But too much working capital reduces profitability since that capital must be financed is some way, usually through interest-bearing loans.

Question 13

A component of working capital that directly affects many nonfinancial managers?

Answer 13

Inventory. As with working capital in general, there’s a tension between having too much and too little. On the one hand, plenty of inventory solves business problems. The company can fill customer orders without delay, and the inventory provides a buffer against potential production stoppages or interruptions in the flow of raw materials or parts. On the other hand, every piece of inventory must be financed, and the market value of the inventory itself mey decline while it sits on the shelf.

Question 14

Financial leverage

Answer 14

1) Financial leverage

2) Operating leverage

Question 15

Financial leverage

Answer 15

The use of borrowed money to acquire an asset. Company is highly leveraged when the percentage of debt on its balance sheet is high relative to the capital invested by the owners.

Question 16

Operating leverage

Answer 16

Refers to the extent to which a company’s operating costs are fixed rather than variable. For example, a company that relies on heavy investments in machinery and very few workers to produce its goods has a high operating leverage.

Question 17

What Financial leverage can give to company?

Answer 17

Can increase returns on an investment, but it also increases risk. For example, suppose that you paid $400 000 for an asset, using $100 000 of your own money and $300 000 in borrowed funds. For simplicity, we’ll ignore loan payments, taxes, and any cash flow you might get from the investment. Four years go by, and your asset has appreciated to $500 000. Now you decide to sell. After paying off the $300 000 loan, you end up with $200 000 in your pocket – your original $100 000 plus a $100 000 profit. That’s a gain of 100% on your personal capital, even though the asset increased in value by only 25%. Financial leverage made this possible. If you had financed the purchase entirely with you own funds ($400 000), you would have ended up with only a 25% gain.

Question 18

Financial structure of the firm

Answer 18

The negative potential of financial leverage is what keeps CEO’s, their financial executives, and board members from maximizing their companies’ debt financing. Instead, they seek a financial structure that creates a realistic balance between debt and equity on the balance sheet.
When creditors and investors examine corporate balance sheets, therefore, they look carefully at the debt-to-equity ratio.

Question 19

The Income Statement

Answer 19

Unlike the balance sheet, which is a snapshot of a company’s position at one point in time, the income statement shows cumulative business results within a defined time frame, such as a quarter or a year. It tells you whether the company is making a profit or a loss – that is, whether it has positive or negative net income (net earnings) – and how much.

Question 20

Income statement is often referred to as…?

Answer 20

Profit-and-loss statement, or P&L.

Question 21

The income statement also tells you…?

Answer 21

company’s revenues and expenses during the time period it covers. Knowing the revenues and the profit enables you to determine the company’s profit margin.

Question 22

An income statement starts with the company’s…

Answer 22

1) sales, or revenues

Question 23

Sales, or revenues

Answer 23

This is primarily the value of the goods or services delivered to customers, but you may have revenues from other sources as well. If a company delivers $1 million worth of goods in December 2010 and sends out an invoice at the end of the month, for example, that $1 million in sales counts as revenue for the year 2010 even though the customer hasn’t yet paid the bill.

Question 24

Various expenses

Answer 24

The costs of making and storing a company’s goods, administrative costs, depreciation of plant and equipment, interest expense, and taxes – are then deducted from revenues.

Question 25

The bottom line

Answer 25

what’s left over – is the net income (or net profit, or net earnings) for the period covered by the statement.

Question 26

The cost of goods, or COGS

Answer 26

represents the direct costs of manufacturing goods. That figure covers raw materials, and everything needed to turn those materials into finished goods, such as labor.

Question 27

Gross profit

Answer 27

Subtracting cost of goods sold from revenues gives us gross profit – an important measure of a company’s financial performance.

Question 28

Operating expenses

Answer 28

include the salaries of administrative employees, office rents, sales and marketing costs, and other costs not directly related to making a product or delivering a service.

Question 29

Where Depreciation appears?

Answer 29

on the income statement as an expense, even though it involves no out-of-pocket payment. As described earlier, it’s a way of allocating the cost of an asset over the asset’s estimated useful life.

Question 30

Operating earnings, or operating profit (earnings before interest and taxes, or EBIT)

Answer 30

Subtracting operating expenses and depreciation from gross profit gives you a company’s operating earnings, or operating profit.