Chapter 2

Financial statements are used as reliable information about the corporation, a

snapshot of the firms assets, etc. An overview of short-term and long-term financial
condition of a business.
Generally Accepted Accounting Princip (GAAP) Set by FASB to provide a common
set of rules and a standard format for public companies reports
Corporations must hire an auditor to:
-

Check financial statements for accuracy

Ensure they are prepared according to GAAP
Provide evidence that the information is reliable

Balance Sheet (Statement of Financial Position)

-

List of firms assets and liabilities

A snapshot of the firms financial position at a given point in time
Two sides must balance. Assets must equal liabilities plus SE because SE is
the difference between the assets and liabilits
Assets = Liabilities + Stockholders Equity
o Or Assets Liabilities = SE
Current Assets
o Cash and other marketable securities
o Accounts Receivables
o Inventories
o Other current assets such as prepaid expenses
Long-Term Assets
o Produce benefits for more than one year
o Reduced through a yearly deduction called depreciation
Depreciation is not an actual cash expense
Liabilities
o Current Liabilities
AP
NP and Short-term debt
Accrual Items
o Net working capital Capital available in the short term to run the
business
If negative, company does not have funds to meet their
obligations
o Long-term Liabilities
Loan or debt obligations maturing in more than a year
Stockholders Equity
o Components include Common Stock, paid-in surplus, and retained
earnings
o Companys assets are not likely profitable if market value is less
than book value
o Market Value
Market price per share X number of shares

Does not depend on historical cost of assets

Value
Net worth from an accounting perspective
Assets Liabilities = Equity
True value of assets may be different from book value
Can find the book value of equity at the bottom of the right
side of its balance sheet
o Sources of Value (Value assets that are not taken into account on
the balance sheet)
Opportunities for growth
Quality of management team
Relationships with suppliers and customers
o Market to Book Ratio
Firms market capitalization to the book value of
stockholders equity
Formula: Market Value of Equity / Book Value of Equity
Also known as Price-to-book ratio
o Enterprise Value
Underlying business assets, unencumbered by debt and
separate from any cash and marketable securities
Formula: Market Value of Equity + Debt Cash
Income Statement
o List the firms revenues and expenses
o The last or bottom line of te income
o Measure profitability and refer to as firms earnings
o Calculations
Gross Profit
Revenues (Net Sales) - Cost of Sales = Gross Profit
Operating Expenses
Gross Profit Operating Expenses = Operating Income
Earnings Before Interest and Taxes (EBIT)
Operating Income +/- Other Income = Earnings Before
Interest and Taxes
Pretax and Net Income
EBIT +/- Interest income (Expense) = Pretax Income
Pretax Income Taxes = Net Income
Earnings Per Share = Net income reported on a per-share
basis
Net Income / Shares Outstanding
Cash Flow
o Needs information from the income statement and balance sheet to
determine: 1) how much cash the firm has generated; 2) how that
cash has been allocated during a set period
o Divided into three sections
Operating
Investment
Financing
o

Book

Payout Ratio: Dividends / Net Income

Retained Earnings = Net Income Dividends

Market Debt-Equity Ratio (Used to measure the financial health of a fir)

o Debt / (market price per share X shares outstanding) = Ratio
Market Capitalization
o Share price x Shares Outstanding
Book Value
o Market Cap / Market-to-Book Ratio
Enterprise Value
o Market cap + Debt Cash
Quick Ratio
o Current Assets Inventories / Current Liabilities