Wall Street Prep Study Questions And Answers Verified

Assets - resources a company uses to operate its business includes cash, A/R, PP&E Liabilities - represents the company's contractual obligations and includes A/P, debt, accrued expenses Shareholder's equity - is the residual the value of the business available to the owners (shareholders) after debts have been paid off Income statement - illustrates the profitability of the company over a specified period of time broad sense: shows revenue-expenses Balance sheet - snapshot of the company economic resources and funding for those resources at a given point in time (A = L + SE) Revenue - "top-line" represents the sale of goods and services it is recorded when earned (even though cash might not have been received at the time of transaction) Expenses - netted against revenue to arrive at net income COGS (directly associate with good production), SG&A (indirectly associated with production), interest expense (expense related to paying debt holders periodic payments), taxes, depreciation expense (non-cash expense accounting for the use of PP&E, often imbedded within COGS and SG&A) Net income - "bottom-line" revenue-expenses the profitability available to common shareholder's after debt payments have been made (interest expense) EPS (earnings per share) - portion of a company's profit allocated to each outstanding share of common stock EPS = (net income - dividends on preferred stock)/weighted average shares outstanding Cash flow statement - While cash is not necessarily received when a sale occurs, the income statement still records the sale. As a result, the income statement captures all the economic transactions of the business. The cash flow statement is needed because the income statement uses what is called accrual accounting. In accrual accounting, revenues are recorded when earned regardless of when cash is received (revenue includes sales using cash and made on credit A/R) Since we also want to have a clear understanding of the cash position of a company, we need the statement of cash flows to reconcile the income statement to cash inflows and outflows. "cash position of the company" cash from operating activities, cash from investing activities, and cash from financing activities Cash from operating activities - mostly indirect method starts with net income and includes the cash effects of transactions involved in calculating net income. reconciliation of net income. Net income (income statement) + non-cash expenses - non-cash gains - period on period increases in working capital assets + period on period increases in working capital liability = CF from operations *for stable, mature, plain vanilla companies, a positive cash flow from operating activities is desirable Cash from investing activities - cash related to investments in the business (additional capex or sales of assets) for stable, mature, plain vanilla a negative cash flow from investing activities is desirable as this indicates that the company is trying to grow by buying assets Cash from financing activities - cash related to capital raising and payment of dividends if the company issues more preferred stock, we will see such an increase in cash in this section if the company pays out dividends, we will see a cash outflow for stable, mature plain vanilla companies, there is not a preference for positive or negative cash flow in this section Net change in cash over period = - cash from operating activities plus cash from investing activities plus cash from financing activities Why do capex increase assets (PP&E) while other cash outflows, like paying salary, taxes, etc do not create any asset, and instead create an expense on the income statement that reduces equity via retained earnings? - Capital expenditures are capitalized because of the timing of their estimated benefits - the lemonade stand will benefit the firm for may years. The employee's work, on the other hand, benefits the period in which the wages are generated and only should be expensed then. This is what differentiates an asset from an expense. Walk through a cash flow statement. - Start with net income, go line by line through major adjustments (depreciation, changes in working capital, and deferred taxes) to arrive at cash flow from operating activities Mention capex, asset sales, purchase of intangible assets, and purchase/sale of investment securities to arrive at cash flow from investing activities Mention repurchase/issuance of debt and equity and paying out dividends to arrive at cash flow from financing activities Adding cash flow from ops, investments and financing gets you total change in cash beginning of period cash balance plus change in cash allows you to arrive at end of period cash balance What is working capital? - Working capital is defined as current assets minus current liabilities; it tells the financial statement user how much cash is tied up in the business through items such as receivables and inventories and also how much cash is going to be needed to pay off short term obligations in the next 12 months.