Business Finance Chapter 2

Balance Sheet
1. Balance sheet illustrates the firm’s assets and liabilities at one time.
2. Sequence of recording of balance sheet is based on liquidity. Assets at the top are
usually have the highest liquidity, such as cash etc. While inventories which will take
some time to convert into cash are usually one of the last since it has low liquidity.
3. Current assets are usually listed first since they are the most liquid.
4. Liquidity is the ability of converting an item into cash without losing significant value.
5. We may try to convert items to cash quickly by lowering its price, but it does not
mean it is liquid.
6. Too liquid can also lead to overall lower returns.
7. Assets = Liabilities + Stockholder’s equity
8. Asset is the use of cash while debt and equity are the source of cash

9. Tangible fixed assets consist of fixed assets like land, machinery, and buildings and
current assets like inventory.
10. Intangible fixed assets consist of nonphysical items like copyrights and trademarks.
11. Both tangible and intangible are generally not liquid, hence they are being placed last.
12. Investment decisions can also consist of investments in financial assets.
13. Current assets – Current liabilities = Net working capital
14. Net working capital is positive when current assets exceed current liabilities. This
means cash will be available for the next 12 months exceeding the cash that will be
paid over the same period of time.
15. Balance sheet does not reflect some valuable assets like firms’ workers.

Market Value vs Book Value

1. Book value only reflects the original price of the items based on recorded historical
cost/ acquisition cost. It does not represent the market value.
2. Acquisition cost is the cost of an asset after deducted the discounts but before sales
taxes.
3. Market value is based on supply and demand of an asset.
4. Financial managers should consider the market value of assets than the book value.
5. Market-to-book ratio is used to compare the market value of equity to book value
of equity. If the ratio approaches 1.00 or less than 1.00, it is a bad sign.

Income Statement
1. Matching principle – GAAP states that revenue must be shown when it’s accrued to
match the expense to generate the revenue.

Taxes
1. Make sure to always keep updated to the change in taxes. The taxes that we study
now is federal tax. Marginal tax rate vs average tax rate.

Cash Flow
1. Cash flow from assets = Cash flow to creditors + Cash flow to stockholders.
2. Cash flow of assets = Operating cash flow (OCF) – Net capital spending (NCS) –
Change in net working capital (NWC)
3. Negative cash flow of assets may mean that the firm is buying profitable assets.
4. Operating cash flow = Earnings before interest and taxes (EBIT) + Depreciation – Commented [CT1]: Refers to the cash flow that results
Taxes from day-to-day activities of producing and selling.
5. Net capital spending = Ending net fixed assets – Beginning net fixed assets +
Depreciation
6. Change in Net Working Capital (NWC) = Ending Net Working Capital – Beginning
Net Working Capital
7. Negative net working capital means firm is managing inventory or receivables or
payables more efficiently.
8. Cash flow to creditors = Interest paid – Net new borrowing
9. Cash flow to stockholders = Dividends paid – Net new equity raised
10. Negative cash flow to stockholders means that firm issued an amount of new stock
which is more than dividends paid.
11. Cash flow statement reconciles the difference between net income and actual cash
generated.
To find CFFA, must find OCF, NWC and NCS first!!!!!!!!!!!!!!!!!!!!!! Commented [CT2]:
IMPORTANT