This document contains all the crucial information described in Chapter 2 of the Corporate Finance: A focused approach book. These notes contain all the information to prepare yourself for the exam with the information of this chapter.
Chapter 2: Financial Statements, Cash Flows, and Taxes
Apple generated an operating cash flow of almost $64 billion in 2017!
It returned over $46 billion to stockholders by paying $13 billion in dividends and by
repurchasing $33 billion of its own stock.
Google generated over $36 billion but returned relatively little to stockholders, paying no
dividends and repurchasing only $4 billion of its stock. Instead, Google spent $10 billion on
capital expenditures (mostly technology infrastructure). Google also put about $18 billion into
short-term investments (such as Treasury securities), saving for a rainy day.
The stream of cash flows a firm is expected to generate in the future determines its fundamental
value
annual report
A report issued annually by a corporation to its stockholders. It contains basic financial
statements as well as management’s opinion of the past year’s operations and the firm’s future
prospects.
The annual report also presents four basic financial statements—the balance sheet, the income
statement, the statement of stockholders’ equity, and the statement of cash flows.
book values may be very different from market values , which are the current values as
determined in the marketplace.
marketable securities
Can be converted to cash on very short notice and provide at least a modest return. Such
securities are called cash equivalents and are included with cash.
We will always distinguish between the cash that is used to support operations and the cash, cash
equivalents, and marketable securities that are held for other purposes.
FIFO (first-in, first-out)
The first-in, first-out inventory accounting method that estimates production costs and the value
of remaining inventory by assuming that the first items placed in inventory are the first ones used
in production.
LIFO (last-in, first-out) method assumes that the items most recently placed in inventory are the
first ones used in production.
Because MicroDrive uses FIFO and because inflation has been occurring:
(1)
Its balance sheet inventories are higher than they would have been had it used LIFO.
(2)
, Its cost of goods sold is lower than it would have been under LIFO.
(3)
Its reported profits are therefore higher.
depreciation expense
A noncash charge against tangible assets, such as buildings or machines. It is taken for the
purpose of showing an asset’s estimated dollar cost of the capital equipment used up in the
production process.
Most companies use the Accrual Accounting Method, which attempts to match revenues to the
periods in which they are earned and expenses to the periods in which the effort to generate
income occurred. For example, companies don’t pay employees’ wages daily, and the amount
owed on these items at any point in time usually is reported as a current liability in an account
such as “Accrued Wages Payable.” Most companies have more than one type of accrued
liability, but we combine all such accruals into a single account for MicroDrive to avoid
unnecessary complexity.
Preferred stock is a hybrid, or a cross between common stock and debt. In the event of
bankruptcy, preferred stock ranks below debt but above common stock. Also, the preferred
dividend is fixed, so preferred stockholders do not benefit if the company’s earnings grow. Most
firms do not use much, if any, preferred stock, so “equity” usually means “common equity”
unless the words “total” or “preferred” are included.
common stock account
Cumulative proceeds reported on a company’s financial statement due to sales of common stock.
It is the sum of the par value and paid-in capital.
Retained earnings
The portion of the firm’s earnings that have been saved rather than paid out as dividends.
The sum of common stock and retained earnings is called common equity , or just equity.
Unlike the balance sheet, which is a snapshot of a firm at a point in time, the income statement
reflects performance during the period.
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