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Chapter 3 - Accounting and Finance.docx

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York University
FINE 2000
Mehdi Beyaghi

Chapter 3: Accounting and Finance The Balance sheet  represents a snapshot of the firm's assets and source of the money that was used to buy those assets  Most liquid assets listed first (cash and equivalents, accounts receivables, inventories, other current assets)  Goodwill and other intangibles: Paying more for assets than the value shown in the other firms' account  Shareholder's equity: amount leftover after liabilities have been paid off  Minority interest: book value of a company's equity not owned by the company in question  Items in the balance sheet valued according to GAAP - historical cost adjusted for depreciation OR book value, "backward looking" measures of value  The market values of assets and liabilities do not generally equal their book values. Market values measure current values of assets and liabilities  The difference is likely greatest for shareholder's equity. Shareholders are concerned with the market value of their shares, not book value  The difference between the market values of assets and liabilities is the market value of the shareholder's equity claim. The stock price is simply the market value of shareholder's equity divided by the number of outstanding shares.  Market value balance sheet lists assets at its current market value rather than at historical cost less depreciation  For example, Jupiter has invested $10 billion in a new plant, borrowed $4 billion and raised remaining funds by issuing 100 million shares at stock price of $75. Book value indicates assets worth $10 billion, debt worth $4 billion and SE worth $6 billion (10 - 4)  Market value balance sheet would adjust shareholder's equity by $1.5 billion ($75 x 100 million outstanding shares = $7.5 billion) and assets would be $11.5 billion and not $10 billion Income Statement  Financial statement that shows the revenues, expenses, and net income of a firm over a period of time  EBITDA = earnings before interest, taxes, depreciation and amortization  EBIT = earnings before interest, taxes Profit Versus Cash Flow 1. To calculate the cash produced by the business it is necessary to add back the depreciation charge (which is not a cash payment) and to subtract the expenditure on new capital equipment (which is a cash payment) 2. The cash that the company receives is equal to the sales shown in the income statement less the increase in unpaid bills - If a sale is made in period 1, but cash is not received until period 2, there is no cash transaction in the first period. Cash received = sales - change in receivables 3. The cash outflow is equal to the cost of goods sold, which is shown in the income statement, plus the change in inventories. - Cash paid out = cost of goods sold - change in inventories Statement of Cash Flows Firm's cash flow can be different from net income because: 1. income statement does not recognize capital expenditures as expenses in the year capital goods are paid for, instead those expenses are spread over time as depreciation 2. income statement uses accrual method of accounting, which means revenues and expenses recognized as they are incurred  statement of cash flows shows firm's cash inflows and outflows from operations as well as from investme
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