TKM_Chapter_03

TKM_Chapter_03 - CHAPTER 3 UNDERSTANDING FINANCIAL...

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CHAPTER 3 UNDERSTANDING FINANCIAL STATEMENTS, TAXES, AND CASH FLOWS This chapter focuses on accounting and financial statements. Understanding the financial health of a business by reviewing its financial statements is an important function of financial management. The accounting and regulatory authorities mandate the following four types of financial statements: income statement, balance sheet, cash flow statement, and statement of shareholders’ equity. Financial statement analysis is important for a number of reasons. First, the study of these accounting statements aids in assessing the financial condition of a business. Second, financial statements are a tool for managers to use in monitoring and controlling the firm’s operations. Third, financial planning and forecasting often is done through the medium of financial statements. Learning Objectives 3-1. Describe the content of the four basic financial statements and discuss the importance of financial statement analysis to the financial manager. 3-2. Evaluate firm profitability using the income statement. 3-3. Estimate a firm’s tax liability using the corporate tax schedule and distinguish between the average and marginal tax rate. 3-4. Use the balance sheet to describe a firm’s investments in assets and the way it has financed them. 3-5. Identify the sources and uses of cash flow for a firm using the firm’s cash flow statement. CHAPTER ORGANIZATION 3.1 An Overview of the Firm’s Financial Statements A. The four basic financial statements are: income statement, balance sheet, cash flow statement, and statement of shareholders’ equity. B. Accountants use three fundamental principles when preparing a firm’s financial statements: 1
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1. The revenue recognition principle states that the revenue should be included in the firm’s income statement for the period in which: Its goods and services were exchanged for cash or accounts receivable; or The firm has completed what it must do to be entitled to the cash. 2. The matching principle states that the revenue should be included in the firm’s income statement for the period in which: Its goods and services were exchanged for cash or accounts receivable; or The firm has completed what it must do to be entitled to the cash. 3. The historical cost principle provides the basis for determining the dollar values the firm reports in its balance sheet. Most assets and liabilities are reported in the firm’s financial statements at historical cost, i.e., the price the firm paid to acquire them. The historical cost generally does not equal the current market value of the assets or liabilities. 3.2
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This note was uploaded on 09/17/2011 for the course FIN 3403 taught by Professor Keys during the Spring '08 term at FIU.

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TKM_Chapter_03 - CHAPTER 3 UNDERSTANDING FINANCIAL...

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