Assets
resources a company uses to operate its business
includes cash, A/R, PP&E
Liabilities
represents the company's contractual obligations a... [Show More] nd includes A/P, debt, accrued expenses
Shareholder's equity
is the residual
the value of the business available to the owners (shareholders) after debts have been paid off
Income statement
illustrates the profitability of the company over a specified period of time
broad sense: shows revenue-expenses
Balance sheet
snapshot of the company economic resources and funding for those resources at a given point in time (A = L + SE)
Revenue
"top-line"
represents the sale of goods and services
it is recorded when earned (even though cash might not have been received at the time of transaction)
Expenses
netted against revenue to arrive at net income
COGS (directly associate with good production), SG&A (indirectly associated with production), interest expense (expense related to paying debt holders periodic payments), taxes, depreciation expense (non-cash expense accounting for the use of PP&E, often imbedded within COGS and SG&A)
Net income
"bottom-line"
revenue-expenses
the profitability available to common shareholder's after debt payments have been made (interest expense)
EPS (earnings per share)
portion of a company's profit allocated to each outstanding share of common stock
EPS = (net income - dividends on preferred stock)/weighted average shares outstanding
Cash flow statement
While cash is not necessarily received when a sale occurs, the income statement still records the sale. As a result, the income statement captures all the economic transactions of the business.
The cash flow statement is needed because the income statement uses what is called accrual accounting. In accrual accounting, revenues are recorded when earned regardless of when cash is received (revenue includes sales using cash and made on credit A/R)
Since we also want to have a clear understanding of the cash position of a company, we need the statement of cash flows to reconcile the income statement to cash inflows and outflows.
"cash position of the company"
cash from operating activities, cash from investing activities, and cash from financing activities
Cash from operating activities
mostly indirect method
starts with net income and includes the cash effects of transactions involved in calculating net income. reconciliation of net income.
Net income (income statement)
+ non-cash expenses
- non-cash gains
- period on period increases in working capital assets
+ period on period increases in working capital liability
= CF from operations
*for stable, mature, plain vanilla companies, a positive cash flow from operating activities is desirable
Cash from investing activities
cash related to investments in the business (additional capex or sales of assets)
for stable, mature, plain vanilla a negative cash flow from investing activities is desirable as this indicates that the company is trying to grow by buying assets
Cash from financing activities
cash related to capital raising and payment of dividends
if the company issues more preferred stock, we will see such an increase in cash in this section
if the company pays out dividends, we will see a cash outflow
for stable, mature plain vanilla companies, there is not a preference for positive or negative cash flow in this section
Net change in cash over period =
cash from operating activities plus cash from investing activities plus cash from financing activities
Why do capex increase assets (PP&E) while other cash outflows, like paying salary, taxes, etc do not create any asset, and instead create an expense on the income statement that reduces equity via retained earnings?
Capital expenditures are capitalized because of the timing of their estimated benefits - the lemonade stand will benefit the firm for may years. The employee's work, on the other hand, benefits the period in which the wages are generated and only should be expensed then. This is what differentiates an asset from an expense.
Walk through a cash flow statement.
Start with net income, go line by line through major adjustments (depreciation, changes in working capital, and deferred taxes) to arrive at cash flow from operating activities
Mention capex, asset sales, purchase of intangible assets, and purchase/sale of investment securities to arrive at cash flow from investing activities
Mention repurchase/issuance of debt and equity and paying out dividends to arrive at cash flow from financing activities
Adding cash flow from ops, investments and financing gets you total change in cash
beginning of period cash balance plus change in cash allows you to arrive at end of period cash balance
What is working capital?
Working capital is defined as current assets minus current liabilities; it tells the financial statement user how much cash is tied up in the business through items such as receivables and inventories and also how much cash is going to be needed to pay off short term obligations in the next 12 months.
Is it possible for a company to show positive cash flows but be in grave trouble?
Absolutely. Two examples involve unsustainable improvements in working capital (a company is selling off inventory and delaying payables), and another example involves lack of revenues going forward.in the pipeline
How is it possible for a company to show positive net income but go bankrupt?
Two examples include deterioration of working capital (i.e. increasing accounts receivable, lowering accounts payable), and financial shenanigans.
I buy a piece of equipment, walk me through the impact on the 3 financial statements.
Initially, there is no impact (income statement); cash goes down, while PP&E goes up (balance sheet), and the purchase of PP&E is a cash outflow (cash flow statement)
Over the life of the asset: depreciation reduces net income (income statement); PP&E goes down by depreciation, while retained earnings go down (balance sheet); and depreciation is added back (because it is a non-cash expense that reduced net income) in the cash from operations section (cash flow statement).
Why are increases in accounts receivable a cash reduction on the cash flow statement?
Since our cash flow statement starts with net income, an increase in accounts receivable is an adjustment to net income to reflect the fact that the company never actually received those funds.
How is the income statement linked to the balance sheet?
Net income flows into retained earnings.
What is goodwill?
Goodwill is an asset that captures excess of the purchase price over fair market value of an acquired business. Let's walk through the following example: Acquirer buys Target for $500m in cash. Target has 1 asset: PPE with book value of $100, debt of $50m, and equity of $50m = book value (A-L) of $50m.
Acquirer records cash decline of $500 to finance acquisition
Acquirer's PP&E increases by $100m
Acquirer's debt increases by $50m
Acquirer records goodwill of $450m
What is a deferred tax liability and why might one be created?
Deferred tax liability is a tax expense amount reported on a company's income statement that is not actually paid to the IRS in that time period, but is expected to be paid in the future. It arises because when a company actually pays less in taxes to the IRS than they show as an expense on their income statement in a reporting period.
Differences in depreciation expense between book reporting (GAAP) and IRS reporting can lead to differences in income between the two, which ultimately leads to differences in tax expense reported in the financial statements and taxes payable to the IRS.
What is a deferred tax asset and why might one be created?
Deferred tax asset arises when a company [Show Less]
