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20 Cards in this Set
- Front
- Back
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Describe the 3 principle things a cash flow cycle tells you:
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1. Describes the flow of cash through a company.
2. Illustrates that profits and cash flow are not the same. 3. Reminds a manager she must be at least as concerned with cash flows as with profits. |
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Describe the 4 principle things a balance sheet tells you:
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1. Its a snapshot at a point in time of what a company owns and what it owes.
2. Rests on the fundamental accounting equation: assets = liabilities + owner's equity. 3. Lists assets and liabilities with maturities of less than a year as current. 4. Show shareholders' equity on the liability side of the balance sheet as the accounting value of owners' claims against existing assets. |
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Describe the 5 principle things an income statement tells you:
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1. It divides changes in owners' equity occurring over a period of time into revenues and expenses, where revenues are increases in equity and expenses are reductions.
2. Defines net income, or earnings, as the difference between revenues and expenses. 3. Identifies revenues generated during the period and matches the corresponding costs incurred in generating the revenue. 4. Embodies the accrual principle, which records revenues and expenses when there is reasonable certainty payments will be made, not when cash is received or disbursed. 5. Records depreciation as the allocation of past expenditures for long-lived assets to future time periods to match revenues and expenses. |
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Describe the 2 principle things a cash flow statement tells you:
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1. It focuses on solvency, having enough cash to pay bills as they come due.
2. It is an elaboration of a simple sources and uses statement according to which increases in asset accounts and reductions in liability accounts are uses of cash, while opposite changes in assets and liabilities are sources of cash. |
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Describe the 3 components of the value problem:
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1. Many accounting values are transactions based and hence backward looking, while market values are forward looking.
2. Accounting often creates a false dichotomy between realized and unrealized income. 3. Accountants refuse to assign a cost to equity capital, thereby suggesting to lay observers that positive accounting profit means financial health. |
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Describe how one might reduce the impact of the value problem.
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The value problem can be diminished by the use of fair value accounting according to which the value of widely traded assets and liabilities appear at market price rather than historical cost but at the potential cost of distortions, volatility, complexity and subjectivity.
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Ch1, Problem #1:
Why do you suppose financial statement are constructed on an accrual basis rather than a cash basis when cash accounting is so much easier to understand? |
Because the accountant's primary goal is to measure earning, not cash generated. She see earning as a fundamental indicator of viability, not cash generation. A more balanced perspective is that over the long run successful companies must be both profitable and sovent, that is, they must be profitable and have cash in the bank to pay their bills when due. This means that you should pay attention to both earning and cash flows.
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Ch1, Problem #7:
You are responsible for labor relations in your company. During heated labor negotiations, the General Secretary of your largest union exclaims, "Look, this company has $15 billion in assets, $7.5 billion in equity, and made a profit last year of $300 million - due largely, I might add, to the effort of union employees. So don't tell me you can't afford our wage demands." How would you reply? |
The General Secretary has confused accounting profits with economic profits. Earning $300 million on a $7.5 billion equity investment is a return of only 4%. This is poor performance and is too low for the company to continue attracting new investment necessary for growth. The company is certainly not covering it's cost of equity.
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Ch1, Problem #13:
Epic Record's equity has a market value of $5 million with 500,000 shares outstanding. The book value of its equity is $1,750,000. a. What is Epic's stock price per share? What is its book value per share? b. If the company repurchases 20% of its shares in the stock market, how will this affect the book value of equity if all else remains the same? c. If there are no taxes or transaction costs, and investors do not change their perceptions of the firm, what should the market value of the firm be after the repurchase? d. Instead of a share repurchase, the company decides to raise money by selling an additional 15% of its shares on the market. If it can issue these additional shares at the current market price, how will this affect the book value of equity if all else remains the same? e. IF there are no taxes or transaction costs, and investors do not change their perception of the firm, what should the market value of the firm be after this stock issuance? |
a. Stock Price per share = $10/share
Book value per share = $3.50/share b. Epic Records will pay $10/share for the 100,000 shares it re-purchases. This reduces the book value by $1,000,000. Assuming all else remains the same, the new book value should be $750,000. c. Since nothing else changed, the market value should fall by exactly the amount of the cash paid in the transaction. The new market value should be $4,000,000. This is because the re-purchase will reduce cash (increase liability) by $1,000,000, assuming the company finances the purchase with debt. With 400,000 shares outstanding after the re-purchase, the price per share remains $10 ($4M/400,000 shares). However, in practice share repurchases often have a positive price effect at the time of the announcement. d. A sale of 15% additional shares is 75,000 shares. At $10/share, Epic Records would raise $750,000 in this equity offering. Assuming all else remains the same, the new book value of equity should be $2,500,000. e. Due to the same reasoning as (c), the market value should rise by $750,000. In essence the sale raises company cash by $750,000, increasing the value of the fimr by just that amount. The new market value should be $5,750,000. In practice, such equity sales often cause investors to be less optimistic about the firm's future and generates negative price effects. |
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What is the balance sheet equation?
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Assets = Liabilities + Shareholder equity
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Net income (also known as earnings) can be described as the difference between what?
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Revenues and expenses.
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A cash flow statement segregates changes in cash into what 3 categories?
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1. Cash flows from Operating activities.
2. Cash flows from Investing activities. 3. Cash flows from Financing activities. |
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The focus of the cash flow statement is what? (one word)
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Solvency!
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What side of the balance sheet is Shareholder Equity listed on and why?
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Shareholder Equity is listed on the liability side. This is because it represents the owners claims against the company's assets.
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Define Net Income.
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Net Income (aka earnings, or profits) records the extent to which net sales generated during the reporting period exceeded the expense incurred to produce those sales.
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Define the Accrual Principle.
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Under the Accrual Principle revenue is recognized as soon as "the effort required to generate the sale is substantially complete and there is a reasonable certainty that payment will be received."
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Describe how one makes a Sources and Uses Statement. How does a company generate cash? How does it use cash?
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To make a Sources and Uses statement place two balance sheets for different dates sided by side and note all the changes in accounts that occurred. Then segregate those changes into Sources (cash generated ) and Uses (cash consumed).
A company generates cash by reducing an asset or by increasing a liability. A company uses cash by increasing an asset account or by reducing a liability account. *NOTE*: Sources MUST equal Uses. |
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Why might net cash provided by operating activities on a cash flow statement be a more reliable indicator of financial health than net income?
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Net Income can *theoretically* be manipulated by an unscrupulous manager. Net Cash provided by Operating Activities show the actual movement of cash into and out of a company.
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Describe the difference between Accounting Earnings and Economic Earnings?
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Accounting earning only records realized income and does not include the Cost of Equity.
Economic earnings does consider unrealized income and includes the Cost of Equity. |
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A Balance Sheet can be divided into two catagories:
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Assets and Liabilities.
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