What information is contained in the balance sheet,income statement, and statement of cash flows?Investors and other stakeholders in the firm need regularfinancial information to help them monitor the firm’sprogress. Accountants summarize this information in a balancesheet, income statement, and statement of cash flows.The balance sheet provides a snapshot of the firm’sassets and liabilities. The assets consist of current assetsthat can be rapidly turned into cash and long-term assets,which may be fixed assets such as plant and machinery.The liabilities consist of current liabilities that are due forpayment shortly and long-term debts. The differencebetween the assets and the liabilities represents theamount of the shareholders’ equity.The income statement measures the profitability ofthe company during the year. It shows the differencebetween revenues and expenses.The statement of cash flows measures the sources anduses of cash during the year. The change in the company’scash balance is the difference between the sources and uses.
What is the difference between market and book value?It is important to distinguish between the book values thatare shown in the company accounts and the market valuesof the assets and liabilities. Book values are historicalmeasures based on the original cost of an asset. For example,the assets in the balance sheet are shown at their historicalcost less an allowance for depreciation. Similarly,the figure for shareholders’ equity measures the cash thatshareholders have contributed in the past or that the companyhas contributed on their behalf.
Why does accounting income differ from cash flow?Income is not the same as cash flow. There are two reasonsfor this: (1) investment in fixed assets is not deductedimmediately from income but is instead spread overthe expected life of the equipment, and (2) the accountantrecords revenues when a sale is made rather than whenthe customer actually pays the bill, and at the same time,deducts the production costs even though those costs mayhave been incurred earlier.
What are a firm’s cash flows?Cash flow from assets measures the cash generated throughoperating activities and after making necessary investmentsin net working capital and fixed assets. This cash flow iseither distributed to the firm’s investors, creditors, and shareholders,or held in reserve by the firm as cash and marketablesecurities. We call this the financing flow of thefirm. Cash flow from assets must equal the financial flows.
What are the essential features of the taxation of corporateand personal income?For large companies the marginal rate of tax on income isaround 36 percent and around 18 percent for small businesses.In calculating taxable income the company deductsan allowance for depreciation and interest payments. It cannotdeduct dividend payments to the shareholders.Individuals are also taxed on their income, whichincludes dividends and interest on their investments.Dividends are taxed at lower rates than interest andemployment income. Capital gains are taxed at one-halfthe personal tax rate, but only when the investment is soldand the gain realized.
