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Chap002 and 003 - Chapters 2 and 3 Financial Statements...

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Chapters 2 and 3 Financial Statements, Taxes and Cash Flows
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The Balance Sheet - Figure 2.1 The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time Balance Sheet Identity: Assets = Liabilities + Stockholders’ Equity
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Balance Sheet: Assets Assets are listed in order of liquidity Current assets (<1 year) more liquid than fixed (long-term) assets Liquidity means ease of conversion to cash without significant loss of value Examples of current assets: cash, marketable securities, inventory, accounts receivable Examples of fixed assets: PP&E, patents, long- term investment in securities Assets can be tangible (truck, machine), or intangible (patents)
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Balance Sheet: Liabilities and Owners’ Equity Liabilities are either current (<1yr.) or long-term. Examples of current liabilities: notes, long-term debt payable within one year, accounts payable, taxes payable, salaries payable, etc. Long-term liabilities and owners’ equity are a firm’s long-term sources of funds Bonds (debt) and stocks (equity)
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Balance Sheet (cont’d) Net Working Capital Current Assets – Current Liabilities Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out Usually positive in a healthy firm Three things to keep in mind with examining a balance sheet: liquidity, debt versus equity, and market value versus book value
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Liquidity Ability to convert to cash quickly without a significant loss in value Liquid firms are less likely to experience financial distress But liquid assets earn a lower return Trade-off to find balance between liquid and illiquid assets; to put it another way, a balance between risk and return.
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Market Vs. Book Value The balance sheet provides the book value of the assets, liabilities and equity. Book value is typically the historical cost, less accumulated depreciation. The market value may be much different. Current assets may have very similar book and market values. For long-term assets, book and market values may differ greatly. Land owned by Union Pacific, e.g. Focus on market values
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Income Statement The income statement is more like a video of the firm’s operations for a specified period of time. You generally report revenues first and then deduct any expenses for the period. Matching principle – GAAP say to show revenue when it accrues and match the expenses required to generate the revenue. This principle includes depreciation and other non-cash deductions. This is why NI does not equal CF.
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Income Statement (cont’d) GAAP shows revenue when it accrues, usually at the time of sale. Expenses are then matched to the revenue.
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