Question 1

The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.

Accepted Answer

The opposite is true. The balance sheet shows the financial position of a company at a point in time, while the income statement shows the flow of funds over a period of time.

Question 2

Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the amounts at which the assets are carried on the books.

Accepted Answer

This statement is true because assets such as property, plant and equipment, and investments are expected to generate cash flows over the course of their useful lives. However, the amount of cash generated could be different than the carrying amount on the balance sheet due to factors such as changes in market conditions, technological advances, or unexpected events.

Question 3

Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes.

Accepted Answer

False

Question 4

The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance.

Accepted Answer

The statement is true. The value of an asset or a business is commonly determined by the present value of the cash flows it is expected to generate in the future, and free cash flow (FCF) is the cash available to a business for distribution to its investors after accounting for all operating expenses and capital expenditures. Therefore, FCF is an important metric in finance for assessing the value of a business.

Question 5

If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot.

Accepted Answer

The income statement shows a company's financial performance over a certain period of time, similar to a video that captures a sequence of events. Meanwhile, the balance sheet is a snapshot that provides a summary of a company's financial position at a particular point in time.

Question 6

On the balance sheet, total assets must always equal the sum of total liabilities plus equity.

Accepted Answer

This is a fundamental accounting principle known as the accounting equation, which states that assets must always equal liabilities plus equity on the balance sheet.

Question 7

EBITDA stands for earnings before interest, taxes, debt, and assets.

Accepted Answer

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, not debt and assets.

Question 8

Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.

Accepted Answer

This is the correct definition of free cash flow.

Question 9

EBIT stands for earnings before interest and taxes, and it is often called "operating income."

Accepted Answer

EBIT stands for earnings before interest and taxes and is also referred to as operating income.

Question 10

The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

Accepted Answer

The annual report provides important information about the firm's financial performance, position, and future prospects, which investors use to make informed decisions about whether to invest in the company or not. This includes information about the firm's historical financial performance, strategy, management, risks, and outlook, as well as financial statements, notes to the financial statements, and other disclosures. Investors also rely on the annual report to evaluate the firm's governance, corporate social responsibility, and other non-financial factors that may affect its long-term viability and reputation. Therefore, the annual report is a crucial tool for investors to assess the value and risk of their investment in the firm, and to make informed decisions about buying, holding, or selling its shares.

Question 11

Typically, the statement of stockholders' equity starts with retained earnings at the beginning of the year, adds net income, subtracts dividends paid, and ends up with retained earnings at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, and the series of annual retained earnings will result in a substantial amount of retained earnings as shown on the balance sheet.

Accepted Answer

This statement accurately describes the typical structure of the statement of stockholders' equity for a profitable company.

Question 12

Net working capital is equal to current assets minus accounts payable and accruals.

Accepted Answer

Net working capital is calculated by subtracting current liabilities (which include accounts payable and accruals) from current assets.

Question 13

If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.

Accepted Answer

Net income as reported on the income statement includes non-cash expenses such as depreciation and amortization, which are added back in the calculation of free cash flow. Additionally, other cash flows such as capital expenditures and changes in working capital are taken into account in the calculation of free cash flow. Therefore, net income and free cash flow are not necessarily equal.

Question 14

Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm either sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.

Accepted Answer

The firms may use different depreciation methods under GAAP, leading to different net fixed asset values on their balance sheets.

Question 15

Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000.

Accepted Answer

Retained earnings do not represent cash available for spending; they are part of shareholders' equity and may have been reinvested in the business or used for other purposes.

Question 16

The amount shown on the December 31, 2009 balance sheet as "retained earnings" is equal to the firm's net income for 2009 minus any dividends it paid.

Accepted Answer

Retained earnings is equal to the cumulative net income of a company minus any dividends paid to shareholders. The balance sheet only shows the ending balance of retained earnings, not the net income for the current year. A separate income statement would show the net income for the year.

Question 17

The income statement shows the difference between a firm's income and its costs--i.e., its profits--during a specified period of time. However, not all reported income comes in the form of cash, and reported costs likewise may not be consistent with cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.

Accepted Answer

The statement accurately describes the difference between reported profits and actual cash flow for a period of time.

Question 18

The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement, and statement of stockholders' equity.

Accepted Answer

The annual report typically includes these four basic financial statements.

Question 19

Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement.

Accepted Answer

Companies typically provide three basic financial statements: the income statement (which includes both fixed and current income), the balance sheet, and the cash flow statement.

Question 20

The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.

Accepted Answer

The answer of The fact that 70% of the interest...

Quiz 3: Financial Statements, Cash Flow, and Taxes