AFM273 Chapter Notes - Chapter 2: Net Income, Gross Profit, Asset Turnover

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Sept 13 Lecture 2 1
C2: Introduction to FS Analysis
Disclosure of Financial Information
Public firms are required to issue a variety of financial statements with past performance
information
Must be prepared in accordance to GAAP/IFRS, checked by independent auditor
o Statement of financial position
o Statement of comprehensive income
o Statement of cash flows
o Statement of changes in equity
o Notes including accounting policies
Provides useful info to firms internal management, outside investors, creditors, and other
interested parties
o Govt needs to regulate the firms
The Balance Sheet
Provides a picture of the firm's financial situation at a point in time
Both assets and liabilities are divided into current and long-term components
o Current: Within 1 year
o Fixed: > 1 year
Low or negative NWC may indicate that a firm could face a shortage of funds
2.3 Balance Sheet Analysis
Liquidation value: value that would be left if the company's assets were sold and liabilities were paid
Shareholder's Equity (book value of equity)
Can be negative (if Liabilities > Assets)
Book value of equity does not accurately reflect what investors are willing to pay for the firm's
equity
1. Assets are valued based on historical cost, not current worth
House worth 10M last year, worth 1B in 10 years
2. "intangibles"
Reputation
Relationship with customers
Expertise of employees
Market value of equity:
Cannot be negative because share price > $0, # of shares >0
Market capitalization: the total market value of a firm's equity
Market value of a stock does not depend on the historical cost of the firm's assets -> depends on
what investors expect those assets to produce in the future
Market to Book Ratio (price to book P/B):
Successful firms substantially >1, indicating the value of the firm's assets when put to use exceeds
their historical cost (liquidation value)
High ratio means that the company can generate more cash flows
Higher number is better assessment of a firm's future performance
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