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Unformatted text preview: A2-1 1APPENDIX 2 FINANCIAL STATEMENTS Financial statements provide the fundamental information that we use to analyze and answer valuation questions. Therefore, it is important that we understand the principles governing these statements by looking at three questions: •How valuable are the assets of a firm? Assets can come in several forms: those with long lives, such as land and buildings; those with shorter lives, such inventory; and intangible assets that still produce revenues for the firm, such as patents and trademarks. •How did the firm raise the funds to finance these assets? In acquiring them, firms can use the funds of the owners (equity) or borrowed money (debt), and the mix is likely to change as the assets age. •How profitable are these assets? A good investment, we argued, is one that makes a return greater than the hurdle rate. To evaluate whether the investments that a firm has already made are good, we need to estimate the returns being made on these investments. We will look at the way accountants would answer these questions and why the answers might be different when doing financial analysis. Some of these differences can be traced to the differences in objectives—accountants try to measure the current standing and immediate past performance of a firm, whereas financial analysis is much more forward-looking. The Basic Accounting Statements There are three basic accounting statements that summarize information about a firm. The first is the balance sheet, shown in Figure A2.1, which summarizes the assets owned by a firm, the value of these assets, and the mix of financing, debt, and equity used to finance these assets at a point in time. A2-2 2AssetsLiabilitiesFixed AssetsDebtEquityShort-term liabilities of the firmIntangible AssetsLong Lived Real AssetsAssets which are not physical,like patents & trademarksCurrent AssetsFinancial InvestmentsInvestments in securities &assets of other firmsShort-lived AssetsEquity investment in firmDebt obligations of firmCurrent LiabiltiesOther LiabilitiesOther long-term obligationsFigure A2.1: The Balance SheetThe next is the income statement, shown in Figure A2.2, which provides information on the revenues and expenses of the firm and the resulting income made during a period. The period can be a quarter (if it is a quarterly income statement) or a year (if it is an annual report). A2-3 3Figure A2.2: Income StatementRevenuesGross revenues from sale of products or services- Operating ExpensesExpenses associates withgenerating revenues= Operating IncomeOperating income for theperiod- Financial ExpensesExpenses associated withborrowing and other financing- TaxesTaxes due on taxable income= Net Income before extraordinary itemsEarnings to Common & Preferred Equity forCurrent Period- (+) Extraordinary Losses (Profits)Profits and Losses notassociated with operations- Income Changes Associated with Accounting ChangesProfits or losses associatedwith changes in accountingrules- Preferred Dividends...
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This note was uploaded on 10/06/2011 for the course FIN 413 taught by Professor Irfansafdar during the Summer '11 term at Rochester.

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