Chapter 3 Notes

Chapter 3 Notes - Chapter 3: Working with Financial...

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Chapter 3: Working with Financial Statements Cash Flow and Financial Statements: A Closer Look - At the most fundamental level, firms do two different things: o Generate cash o Spend cash - Cash is generated by selling a product, an asset, or a security o Selling a security involves either borrowing or selling an equity interest (shares of stock) in the firm Sources and Uses of Cash - Sources of cash - activities that bring in cash - Uses of cash - activities that involve spending cash - Table 3.1 - A firm uses cash by either buying assets or making payments - An increase in a left-side (asset) account or a decrease in a right-side (liability or equity) account is a use of cash - A decrease in an asset account or an increase in a liability or equity account is a source of cash - Net addition to cash is just the difference between sources and uses - Table 3.2 The Statement of Cash Flows - Statement of cash flows - a firm’s financial statement that summarizes its sources and uses of cash over a specified period of time - Table 3.3 - Group all changes into 3 categories: 1) Operating Activities
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2) Financing Activities 3) Investment Activities - Table 3.4 Standardized Financial Statements Common-Size Statements - Common-size statements - standardizing financial statements is to express each item on the balance sheet as a percentage of assets and to express each item on the income statement as a percentage of sales - Common-Size Balance Sheets o Express each item as a percentage of total assets o Forms are relatively easy to read and compare - Common-Size Income Statements o Useful way of standardizing the income statement is to express each item as a percentage of total sales o Table 3.6 o Tells us what happens to each dollar in sales - Common-Size Statements of Cash Flows o Table 3.4 o Each item can be presented as a percentage of total sources (or total uses) o Results can then be interpreted as the percentage of total sources of cash supplied or as the percentage of total uses of cash for a particular item Common-Base Year Financial Statements: Trend Analysis - Common-base year statements - useful way of standardizing financial statements in this case is to choose a base year and then express each item relative to the base amount - Table 3.7 ~ 2 ~
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Combined Common-Size and Base Year Analysis - Reason for doing this is that as total assets grow, most of the other accounts must grow as well - By first forming the common-size statements, we eliminate the effect of this overall growth Ratio Analysis - Financial ratios - relationships determined from a firm’s financial information and used for comparison purposes - Another way of avoiding the problems involved in comparing companies of different sizes is to calculate and compare financial ratios - Such ratios are ways of comparing and investigating the relationships between different pieces of financial information - Using ratios eliminates the size problem because the size effectively divides out and were then left with percentages, multiples, or time periods
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Chapter 3 Notes - Chapter 3: Working with Financial...

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