ch 3 - Chapter 3 Income Statement (c) Mikhail B. Pevzner...

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(c) Mikhail B. Pevzner and George Mason University Chapter 3 Income Statement (c) Mikhail B. Pevzner and George Mason University Financial Statements and Business Activities • For a firm to stay in business, it must generate value over a long-term. • That value must manifest itself in tangible, productive, and liquid assets (i.e. these assets must be easily convertible to cash). (c) Mikhail B. Pevzner and George Mason University Operating cycle • The time period which it takes the firm to generate cash from its productive activities is called operating cycle. Operating cycle lasts through the time when a firm sells the product, collects cash, and uses the cash to pay for any cash it borrowed to produce the product. Firms want to have shortest operating cycle possible.
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(c) Mikhail B. Pevzner and George Mason University Time period over which the changes in firm value are measured • Firms need to assume some period, called accounting period (year, quarter, month), over which changes in firm value are measured. • The last end of fiscal year/quarter/month is called fiscal year/quarter/month end; GAAP refers to a concept of time- period measurement as a time-period assumption. (c) Mikhail B. Pevzner and George Mason University Income Statement • Income Statement reflects the details of how a firm generates or destroys its value over a fiscal period. • The process of creating firm value involves spending money on creating, and then selling, assets, or services, and making sure that a firm gets paid for it. • For example, when GM sells a car for a profit of $20K, it generates value of $20K. (c) Mikhail B. Pevzner and George Mason University Revenues Revenues is what firm gets for selling products and services. Revenues are either increases in firms’ assets or reductions in liabilities in a normal course of business.
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(c) Mikhail B. Pevzner and George Mason University Expenses • GM also needs to spend some money on building a car. If it cost $10K GM to build a car it sold, then its Expense or Cost of Goods Sold is $10K. Expenses are either reductions in assets or increases in liabilities in a normal course of business. (c) Mikhail B. Pevzner and George Mason University Net Income • GM makes $10K profit on a car. This is GM’s Net Income before Taxes. • If GM pays $3K in taxes to the IRS, its Net Income is $7K. $3K is Income Tax Expense Net Income=Revenues-Expenses+Gains- Losses (c) Mikhail B. Pevzner and George Mason University Earnings Per Share • It is useful to have an idea of how much value is created or destroyed for each shareholder. • For example, if GM made $1 billion in net income, what does it mean for me, Mikhail Pevzner? I (hypothetically) own 1,000 shares of GM stock. Altogether, there are 500 million shares outstanding (i.e. held by other shareholders like me) during the entire year.
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(c) Mikhail B. Pevzner and George Mason University Earnings per share Earnings per share (EPS) shows how
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ch 3 - Chapter 3 Income Statement (c) Mikhail B. Pevzner...

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