Chapter 2: Financial Statements, Cash Flow, and Taxes Flashcards
(123 cards)
1
Q
Cash flow
A
we simply mean the difference between the number of dollars that come in and the number that go out
2
Q
Statement of Financial Position (AKA Balance Sheet)
A
Financial statement showing a firm’s accounting value on a particular date.
3
Q
Assets
A
What the firm owns!
4
Q
Liabilities
A
What the firm owes!
5
Q
Firm equity
A
The difference between a firms assets and liabilities
6
Q
International financial reporting standards (IFRS)
A
Accounting standards to provide a common global language for business affairs so that company accounts are understandable and comparable across countries.
7
Q
Generally Accepted Accounting Principles (GAAP)
A
A framework for a common set of principles, rules, and procedures of accounting.
8
Q
Total value of the Firm to Investors (Figure 2.1)
A
- It’s current liabilities
- It’s Long-term debt
- Shareholder’s equity
9
Q
Two types of fixed assets
A
1) Tangible fixed assets (like a truck, computer)
2) Intangible fixed assets (Like a trademark or patent)
10
Q
Fixed asset
A
Has a relatively long life
11
Q
Two types of assets:
A
1) Current assets
2) Fixed assets
12
Q
Current asset has a life of less than ________, meaning the asset will convert into cash within _______ months
A
1 year
12 Months
13
Q
Examples of a current asset
A
Inventory - as it is normally bought and sold within 1 year
Cash can be a current asset
Accounts receivable (money owed to the firm by its customers)
14
Q
The firm’s liabilities are the first thing listed on the right-hand side of the ______________
A
statement of financial position (balance sheet)
15
Q
Two types of liabilties
A
1) Current
2) Long-term
16
Q
Current liabilities
A
have a life of less than one year (meaning they must be paid within the year) and are listed before long-term liabilities.
17
Q
Accounts payable
A
money the firm owes to its suppliers
18
Q
Example of current liability
A
Accounts payable
19
Q
Long-term liability
A
A debt that is not due in the coming year
20
Q
Example of long-term liability
A
A loan that the firm will pay off in five years
21
Q
Terms for long-term creditors and long-term debt
A
Bond
Bondholders
22
Q
Shareholder’s equity
A
By definition, the difference between the total value of the assets (current and fixed) and the total value of the liabilities (current and long term)
23
Q
Assets =
Balance sheet equation
Statement of financial position identity
A
Liabilities + Shareholders’ equity
24
Q
Net working capital
A
The difference between a firm’s current assets and its current liabilities
25
Net working capital is ___________ when current assets exceed current liabilities
positive
Based on the definitions of current assets and current liabilities, this means that the cash available over the next 12 months exceeds the cash that must be paid over that same period
26
In a healthy firm, __________ should be positive
Net working capital
27
The liabilities side of the statement of financial position primarily reflects
managerial decisions about capital structure and the use of short-term debt.
28
Three particularly important things to keep in mind when examining a statement of financial position are:
1) liquidity,
2) debt versus equity,
3) market value versus book value
29
1) liquidity,
refers to the speed and ease with which an asset can be converted to cash
30
What is liquid vs what isnt?
The common stock of a large publicly traded company is relatively liquid asset
A custom manufacturing facility is not very liquid
31
Any asset can be converted to cash quickly if we cut the price enough. A highly liquid asset is therefore one that can be quickly sold without significant ____________________
loss of value
32
illiquid asset
one that cannot be quickly converted to cash without a substantial price reduction.
33
Assets are normally listed on the statement of financial position in order of decreasing liquidity, meaning that the most liquid assets are listed _____
first
34
______ are relatively liquid and include cash and those assets that we expect to convert to cash over the next 12 months
Current assets
35
Inventory is probably the ____________ of the current assets, at least for many businesses.
least liquid
36
________ are, for the most part, relatively illiquid.
Fixed assets
37
Are trademarks liquid or naw?
They are rather illiquid
38
Cash holdings are the __________ of all investments, but they sometimes earn no return at all—they just sit there
most liquid
39
Shareholders' equity value =
Assets - Liabilities
40
Shareholders' equity is just the __________
residual portion
41
Financial leverage
The use of debt in a firm’s capital structure
42
The more debt a firm has (as a percentage of assets), the ________ is its degree of financial leverage
greater
43
__________ increases the potential reward to shareholders, but it also increases the potential for financial distress and business failure.
Financial leverage
44
Carrying value or the book value
The accounting value of a firm’s assets
45
IFRS allows companies to use the ___________ method; it also allows use of the __________ (fair value) method
historical cost
revaluation
46
When a company adopts the ____________, all items in a class of assets should be revalued simultaneously, and the revaluation should be performed with enough regularity to ensure that at the statement of financial position date the carrying amount is not materially different from the fair value amount
revaluation method
47
Market value
the price at which willing buyers and sellers trade the assets
48
A fundamental difference between Canadian GAAP and IFRS is that __________ accounting plays a more important role under IFRS
fair value
49
Impairment losses
The amount by which the carrying value of an asset or cash-generating unit exceeds its recoverable amount.
50
Although the adoption of IFRS in 2011 allowed Canadian companies to improve comparability worldwide with companies from more than ______ IFRS-adopted countries, it reduced Canadian companies’ comparability with ________.
130
U.S. companies
51
Statement of Comprehensive Income (Income Statement)
Financial statement summarizing a firm’s performance over a period of time
52
Under IFRS, a company has the flexibility to present either a single statement of comprehensive income or separate it into two statements:
the income statement presenting revenues and expenses, and the other comprehensive income statement presenting unrealized gains and losses
53
Income statement equation
Revenues - Expenses = Income
54
Net income is often expressed on a per-share basis and called ____________________
earnings per share (EPS).
55
Are taxes reported on the income statement?
No sir, on a separate statement
56
When looking at the statement of comprehensive income, the financial manager needs to keep three things in mind:
1) IFRS,
2) cash versus non-cash items,
3) and time and costs.
57
Revenue is recognized on the statement of ___________ when it is probable that any future economic benefit associated with the item of revenue will flow to the firm and the amount of revenue can be reliably measured, not when cash inflow occurred
comprehensive income
58
Thus, income is reported when it is earned or accrued, even though no cash flow has necessarily occurred.
For example, when goods are sold for credit, sales and profits are reported.
59
A primary reason that accounting income differs from cash flow is that a statement of comprehensive income contains _________
non-cash items
60
Non-cash items
Expenses charged against revenues that do not directly affect cash flow, such as depreciation.
61
What is the most important non-cash item?
Depreciation!!!
62
Two parts of the future
1) The short run
| 2) The long run
63
In the _________, all business costs are _______. Given sufficient time, assets can be sold, debts can be paid, and so on.
long run
variable
64
Accountants tend to classify costs as either _______ costs or _______ costs.
product
period
65
Product costs
include things such as raw materials, direct labour expense, and manufacturing overhead
66
______________________ are reported on the statement of comprehensive income as _______________________, but they include both fixed and variable costs
Product costs
Costs of goods sold (COGS)
67
Period costs
Costs that are incurred during a particular time period and are reported as selling, general, and administrative expenses.
68
Cash flows from assets =
| Cash flow identity
Cash flow to bondholders (or creditors) + Cash flows to shareholders (or owners)
69
Cash flow identity explained
The cash flow from the firms assets is equal to the cash flow paid to suppliers of capital to the firm
70
Cash Flow from Assets
The total of cash flow to bondholders and cash flow to shareholders, consisting of operating cash flow, capital spending, and additions to net working capital.
71
Cash Flow from Assets contains 3 components, what are they?
1) Operating cash flow
2) Capital spending
3) Additions to net working capital
72
Operating cash flow
refers to the cash flow that results from the firm’s day-to-day activities of producing and selling
It should usually be positive; a firm is in trouble if operating cash flow is negative for a long time because the firm is not generating enough cash to pay operating costs
73
Capital spending
refers to the net spending on fixed assets (purchases of fixed assets less sales of fixed assets)
74
Additions to net working capital
the amount spent on net working capital
It is measured as the change in net working capital over the period being examined and represents the net increase in current assets over current liabilities
75
OPERATING CASH FLOW definition
Cash generated from a firm’s normal business activities.
76
How to calculate operating cash flow equation
EBIT + Depreciation - Taxes = Operating cash flows
Revenue - Costs
**Important: do not include depreciation or interest!! - it is not a cash outflow, and interest is a financing
expense
**Include taxes**
77
EBIT
Earnings before interest and taxes
78
How to calculate Net capital spending equation
Ending fixed assets - beginning fixed assets + depreciation = net investment in fixed assets
is just money spent on fixed assets less money received from the sale of fixed assets
79
Could net capital spending be negative?
Yes - This would happen if the firm sold more assets than it purchased
80
NWC
Net working capital
81
Ending NWC - Beginning NWC = Change in NWC
Net working capital equation
82
Cash flow from assets equation
Operating cash flow - Net capital spending - Changes in NWC = Cash flow from assets
83
Free cash flow
Another name for cash flow from assets.
Cash that the firm is free to distribute to creditors and shareholders because it is not needed for working capital or fixed asset investment
84
Cash Flow to Creditors
A firm’s interest payments to creditors less net new borrowings.
85
Cash flow to Shareholders
Dividends paid out by a firm less net new equity raised.
86
Cash flow to creditors equation
AKA
cash flow to bondholders equation
Interest paid - Net new borrowing = Cash flow to creditors
87
Cash flow to shareholders equation
Dividends paid - Net new equity = cash flow to shareholders
This account tells us how many shares the company has sold
88
Total cash flow of the firm
includes capital spending and additions to net working capital
This will frequently be negative
89
Net income is not _______
Cash flow
90
The size of the tax bill is determined through tax laws and regulations in the annual budgets of the_________ (administered by Canada Revenue Agency (CRA)) and ____________
federal government
provincial governments
91
According to economic theory, an ideal tax system has three features
1) it should distribute the tax burden equitably, with each taxpayer shouldering a “fair share.”
2) the tax system should not change the efficient allocation of resources by markets
3) the system should be easy to administer.
92
Investment income is also taxable
Interest income is taxed at the same rates as employment income, but special provisions reduce the taxes payable on dividends and capital gains
93
Individual income tax rates—2017
5. 06% Up to $38,898
7. 70% 38,899–77,797
10. 50% 77,798–89,320
12. 29% 89,301–108,460
14. 70% 108,461 and over
94
Average tax rate
Total taxes paid divided by total taxable income.
Other words: the percentage of your income that goes to pay taxes
95
Marginal tax rate
Amount of tax payable on the next dollar earned.
96
Flat rate tax
The same tax rate for all incomes
97
The treatment of dividends in Canada is at least a partial exception because there are two clear goals
1) First, corporations pay dividends from after-tax income so tax laws shelter dividends from full tax in the hands of shareholders
2) Second, the dividend tax credit applies only to dividends paid by Canadian corporations
98
Dividend tax credit
Tax formula that reduces the effective tax rate on dividends.
99
TABLE 2.6
| Combined Top Marginal Tax Rates for Individuals—2018
BC Numbers:
49. 80% - Interest and Regular income
24. 90% - Capital Gains
34. 20% - Eligible Dividends
43. 73% - Non-eligible Dividends
100
Capital gains
The increase in value of an investment over its purchase price
101
Realized capital gains
The increase in value of an investment, when converted to cash
102
___________, like individuals, are subject to taxes levied by the federal and provincial governments.
Canadian corporations
103
In general, a taxable firm must earn _____________________ in additional EBIT for each extra dollar of dividends
1/(1 − Tax rate)
104
Dividends on common shares received from other Canadian corporations qualify for a ___% exemption and are received tax free
100
105
_____ does not have a tiered capital gains tax system.
Canada
106
When a firm disposes of an asset for more than it paid originally, the difference is a ________
Capital gain
107
At the time of writing, capital gains received by corporations are taxed at_______% of the marginal tax rate.
50
108
loss carry-back
Using a year’s capital losses to offset capital gains of previous years.
109
loss carry-forward
Using a year’s capital losses to offset capital gains of future years.
110
Non-capital losses can be carried back _______
three years
111
Capital cost allowance (CCA)
Depreciation for tax purposes, not necessarily the same as depreciation under IFRS; depreciation method under Canadian tax law allowing for the accelerated write-off of property under various classifications.
112
_________ calculation begins by assigning every capital asset to a particular class
CCA
113
_________ assets like leasehold improvements follow straight-line depreciation for CCA
Intangible
114
For all other assets, CCA follows the declining _______________.
balance method
115
How to calculate CCA (equation?)
Undepreciated capital cost (UCC) x Appropriate rate
116
Accelerated Cost Recovery System (ACRS)
System used in the USA - Canada's version is the capital cost allowance (CCA)
117
Half-year rule
CRA’s requirement to figure CCA on only one-half of an asset’s installed cost for its first year of use.
118
Adjusted cost of disposal
When an asset is sold, the UCC in its asset class (or pool) is reduced by what is realized on the asset or by its original cost, whichever is less
119
Net acquisitions
Total installed cost of capital acquisitions minus adjusted cost of any disposals within an asset pool.
120
How to calculate net acquisitions costs (equatio)
From the total installed cost of all acquisitions, we subtract the adjusted cost of disposal of all assets in the pool
The result is net acquisitions for the asset class
If net acquisitions are positive, we apply the half-year rule and calculate CCA as we did earlier. If net acquisitions is negative, there is no adjustment for the half-year rule.
121
Terminal loss
The difference between UCC and adjusted cost of disposal when the UCC is greater.
122
Recaptured depreciation
The taxable difference between adjusted cost of disposal and UCC when UCC is smaller.
123
The goal of financial management is to maximize the __________ of the stock, not its ________
market value
book value
