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Corporate Finance, Berk - Complete test bank - exam questions - quizzes (updated 2022)
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,Maria Gómez – IBE Corporate Finance 2022/2023CORPORATE FINANCE
CHAPTER 2: INTRODUCTION TO FINANCIAL STATEMENT ANALYSIS
Firms issue financial statements regularly to communicate financial information to the
investment community.
2.1 Firms’ Disclosure of Financial Information
Financial statements are accounting reports with past performance information that a
firm issues periodically (quarterly or annually). The firm also has to send an annual
report to their shareholders.
Financial statements are important tools through which investors, financial analysts, and
other interested outside parties (such as creditors) obtain information about a
corporation. They are also useful for managers within the firm as a source of
information for corporate financial decisions.
Preparation of financial statements
Reports about a company’s performance must be understandable and accurate.
Generally Accepted Accounting Principles (GAAP) provide a common set of rules and
a standard format. This standardization makes it easier to compare the financial results
of different firms. For those international companies, given that each country is ruled
according to their accounting principles, some decades ago the IFRS was created to
standardize the accounting principles internationally.
Types of Financial Statements
Every public company is required to produce four financial statements: the balance
sheet, the income statement, the statement of cash flows, and the statement of
stockholders’ equity.
2.2 The Balance Sheet
The balance sheet, or statement of financial position,1 lists the firm’s assets and
liabilities, providing a snapshot of the firm’s financial position at a given point in time.
It is divided into two parts: assets on the left
Assets=Liabilities+ Equity
side and liabilities on the right. The assets
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,Maria Gómez – IBE Corporate Finance 2022/2023
are what the firm owns (how the firm uses its capital: its investments), whereas the
liabilities are the firm’s obligations to creditors (how the firm raises capital for its
investments). On the right side there is also the equity, which is an accounting measure
of the firm’s net worth.
Assets
The left side of a firm’s balance sheet is also subdivided into two main groups:
Current Assets: which are those assets that will only be in the firm for 1 year.
o Cash and other marketable securities
o Accounts receivable: amounts owed to the firm by customers
o Inventories
o Other current assets, such as prepaid expenses
Non Current Assets: those are the assets that stay within the firm for more than 1
accounting year. These include assets such as real estate or machinery
that produce tangible benefits for more than one year.
An important thing to bear in mind is depreciation. The firm will have to reduce
the value recorded of some fixed asset by deduction a depreciation expense.
Hence, the accumulated depreciation is the total amount deducted over its life.
Depreciation is not considered a cash expense that the firm has to pay. The book
value of an asset, which is the value shown in the firm’s financial statements, is
equal to its acquisition cost less accumulated depreciation.
When a firm acquires another company, they can have purchase it for its book
value or for a higher value in comparison to the firm’s book value. This
difference will have to be noted in the firm’s balance sheet as goodwill. For
example, a firm pays $25 million for a firm whose tangible assets had a book
value of $5 million. The remaining $20 million will appear as goodwill. As a
matter of fact, goodwill is amortized and not depreciated.
Liabilities
They will be divided into 2 subgroups:
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, Maria Gómez – IBE Corporate Finance 2022/2023
Current Liabilities: debt which will mature within 1 year
o Accounts payable
o Short-term debt
o Other short-term liabilities
Net working capital=current assets−current liabilities
Non-current liabilities: debt that will mature in more than 1 year since now.
o Long-term debt
o Deferred taxed
o Capital leases
Stockholders’ Equity (book value of equity)
It is an accounting measure of the net worth of the firm. Ideally, the balance sheet would
provide us with an accurate assessment of the true value of the firm’s equity.
Unfortunately, this is unlikely to be the case. Why is this the case? A common
explanation to this is that many of the assets accounted in a firm’s balance sheet, are
valued as their historical cost net depreciation rather than their true value today. Another
reason could be that many of the firm’s valuable assets are not captured on the balance
sheet.
Market Value versus Book Value
The book value of equity is an inaccurate assessment of the actual value of the firm’s
equity. On the other hand, the market value of equity is often referred to as the
company’s market capitalization. It does not depend on the historical cost of the firm’s
assets because it depends on what investors expect those assets to produce in the future.
Market value of equity=Shares outstanding × Market price per share
Market-to-Book ratio (or price-to-book ratio)
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