The balance sheet is a snapshot of a firm’s accounting value as of a particular date. Assets are listed on the left-hand side, and liabilities and owners’ equity on the right-hand side. (Note: Firm financial statement information is available via the SEC's EDGAR reporting system.)
Assets are things the firm owns – cash, marketable securities, machinery, etc. Assets can be tangible (e.g., machinery) or intangible (e.g., prepaid rent).
Liabilities and Owners’ Equity
Liabilities are amounts owed by the firm to others – notes payable, long-term debt, etc.
Owners’ equity (sometimes called “shareholders’ equity”) is the difference between total assets and total liabilities.
The Balance Sheet Equation: Total Assets = Total Liabilities + Owners’ Equity
Net Working Capital
Net working capital is the difference between the firm’s current assets and current liabilities.
Net working capital can be positive or negative, but is usually positive in a healthy firm, since a positive value indicates that more liquid assets are available than short-term liabilities are due over the next year.
Liquidity
The liquidity of an asset is measured by the speed with which it can be converted into cash without significant loss in value. There is a tradeoff between liquidity and foregone potential returns.
Debt versus Equity
Liabilities represent obligations to repay principal and interest to creditors at a specified time. Liabilities are generally fixed, contractual obligations of the firm.
Holders of equity securities possess only residual claims on cash flows and assets. (The residual is the amount remaining, if any, after all creditors’ claims are satisfied.)
The balance sheet values of a firm's assets (book values) generally do reflect the historical cost of an asset.
The current worth of an asset is its market value. Market value is the relevant value for financial decisions, because it is the market value of the firm that is reflected in share prices. True or False: Generally speaking, the balance sheet value of a firm's fixed assets is unlikely to be equal to the assets' market value. CONCEPT CHECK
The income statement measures the firm’s performance over a specified period of time.
The income statement equation is: Revenues – expenses = net income.
Net income divided by the number of shares outstanding is earnings per share (EPS).
GAAP and the Income Statement
Generally Accepted Accounting Principles (GAAP) require that revenue be recorded on the income statement when earned, or accrued, even if the actual cash inflow from payment has not occurred.
Costs on the income statement are determined according to the matching principle; that is, costs are matched with the revenues they produce.
Noncash items such as depreciation are reflected in expenses that are booked but for which no cash is actually paid out. This generally causes accounting income and cash flow to differ.
Time and Costs
In the long run, all costs are variable (i.e., they can be changed).
· In the short run, some costs are variable, and others are fixed (i.e., they can’t be changed without considerable expense and/or effort).
Corporate Taxes are reflected in Table 2.3
(60.0K)
.
Average versus Marginal Tax Rates
The average tax rate equals tax liability divided by taxable income.
The marginal tax rate equals the tax rate applied to the last dollar of taxable income.
Average tax rates are compared to marginal tax rates in Table 2.4 in the text.
The firm’s marginal tax rate is generally the relevant rate for financial decision-making.
Cash Flow
Cash flow generated by the firm’s assets must equal the sum of the cash flow paid to the firm’s creditors and to the firm’s equityholders.
Cash Flow from Assets
Operating Cash Flow is the cash flow resulting from a firm’s day-to-day operations and equals revenues minus costs, excluding depreciation and interest expense.
Capital Spending is the net amount spent on fixed assets, or the difference between cash out to purchase fixed assets and cash in from the sale of fixed assets.
The Change in Net Working Capital equals the change in current assets less the change in current liabilities.
Cash Flow from Assets
(54.0K)
equals: Operating Cash Flow less Net Capital Spending less Change in Net Working Capital.
Cash Flow to Creditors and Stockholders
Cash Flow to Creditors equals interest paid less net new borrowing.
Cash Flow to Stockholders is dividends paid less net new equity financing obtained. Cash flow from assets = _____ + _____. CONCEPT CHECK
(55.0K)