43 the primary source of funding for banks such as

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43.The primary source of funding for banks such as Bank of America is through depositsgathered from its diverse customer base. Banks do not present classified balancesheets, but most deposits are relatively short-term (current). Borrowings are a secondarysource of funding, and are not as great as the deposit liability. Banks are highlyleveraged, i.e., shareholders’ equity represents a smaller portion of total assets (usuallyless than 10%). 44.A deficit in retained earnings means that Amazon.com has not been profitable on acumulative basis since its inception, net of any distributions to shareholders. This is notan uncommon situation for young companies, especially those in Internet relatedbusinesses.47.Cost of goods sold represents the original cost of inventory items sold by manufacturers,wholesalers, and retailers. This inventory cost is reported separately from otheroperating expenses. Service businesses such as H & R Block provide services and donot sell inventory, thus there is no cost of goods to report.47.If the profits were the result of expense reductions, and continued expense reductionswere in doubt, continued profits would be doubtful as well.48.An excess of other (non-operating) expenses over other (non-operating) revenues wouldcause net income to be lower than net income from operating activities. Investors wouldbe more concerned about net income from operating activities which would be expectedto recur while (significant) other revenues and expenses tend to be one-time items. Themarket reaction to the news suggests that the market now believes that TXU stock hadbeen previously undervalued.48.Dividends are reported in the statement of shareholders’ equity as a reduction in retainedearnings. Net income is reported as an increase in retained earnings in the statement ofshareholders’ equity. Retained earnings represent the portion of net income not paid toshareholders as dividends. The difference–60% to 70% of net income in the case ofJohnson & Johnson–represents the portion of earnings normally reinvested in thebusiness.49.Cash flows from operating activities generally are usually be expected to continue,whereas cash flows from investing activities are understood to vary considerably fromyear to year. Furthermore, cash flows from operating activities are more closely tied toprofitability than are investing cash flows, which tend to be negative when a company ishealthy and growing. Reclassifying cash outflows from operating to investing wouldmake the company’s continuing operations appear more profitable while the increase
Chapter 2Page 8 cash outflows for investing would make the company appear to be enjoying positivegrowth.51.Cash flow from (or used) in operations is shown in the first section of the statement ofcash flows under the caption “operating activities”. Analysts do not necessarily reactnegatively to negative cash flows from operations for emerging businesses. Negativecash flows during the introductory phase of a company’s life cycle are not uncommon. Afavorable trend in cash flows, and prospects for positive cash flows as the businessgrows, would be important to the analyst.

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