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Unformatted text preview: CHAPTER SEVEN Business Activities and Financial Statements Stephen H. Penman The web page for Chapter Seven runs under the following headings: What this Chapter is Doing: Focusing the Lens on the Business Links to Chapter Two Links to Chapter Four The Dynamics of the Financial Statements How Dividends are Generated Free Cash Flow is a Dividend The BYOAP feature on the web site Kimberly-Clark Corporation: 10-K for 2004 What this Chapter is Doing: Focusing the Lens on the Business Chapter 1 describes the financial statements as the lens on the business: We understand the business through the financial statements. Chapter 2 enlarges on this theme: the form of the financial statements sketches the picture and the content the measurements within the statement -- color the picture. However, the financial statements prepared under Generally Accepted Accounting Principles (GAAP) dont give a clear picture. Chapter 7 brings a sharper focus to the financial statements. Chapter 7 describes what is involved in business activities. Building on Figure 1.1 in Chapter 1, it shows that business activities involve Raising cash from and disbursing cash to claimants (financing activities) Investing cash raised in operating assets (investing activities) Employing operating assets to trade with customers (operating activities) Because investing activities are investment in operations, is it is usual to refer to investing and operating activities under one term, operating activities. So the firm is said to have operating and financing activities. The distinction between financing and operating activities is important to the equity analyst for, typically, the financing activities do not add value but the operating activities do. Unfortunately, GAAP does not make a clear distinction, so the analyst cannot get a clear picture of the value generation on the business. The reformulation of the financial statements outlined in Chapter 7 rectifies the problem. The Chapter provides only a template; the practical matter of doing the reformulations is in Chapters 8 10. Chapter 7 first draws a picture of the business in your mind, then applies that picture to the financial statements. The picture is quite skeletal at this stage, to be filled out as the book proceeds. Figure 7.3 gives the complete picture. Make sure that this picture is imprinted in your mind. This is perhaps the most important figure in the book. Links to Chapter Two Chapter 2 described the form of GAAP financial statements with a set of accounting relations that hold the component parts together. Box 21. gives a summary. Reformulated statements also are dictated by a set of accounting relations but, as the component parts differ from the GAAP statements, the accounting relations differ from those in Chapter 2....
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This note was uploaded on 10/07/2010 for the course ECTCS ec12947322 taught by Professor Johnathayeri during the Spring '10 term at Life.
- Spring '10