Chapter 2: Financial Accounting Concepts

1
Chapter 2Financial Accounting Concepts
2
Cash vs. Accrual

• Cash Accounting- all entries are related to a
  specific cash inflow or outflow
• Accrual Accounting- entries are made regardless
  of when the cash flow takes place

3
Accrual Accounting

• Income recognition-
• Revenue is recorded when sales are made
• This makes a noticeable difference on the
  balance sheet

4
Financial Statements

• Income Statement- revenues minus expenses
• Statement of Retained Earnings- how a certain
  periods net income was used
• Balance Sheet- assets equal liabilities plus
  equity ( A LE)
• Statement of Cash Flows- consists of three
  sections Operating, Investing, Financing

5
Financial Structure

• Debt- loans, commercial paper, notes, or bonds
• Equity- ownership of the firm

6
Why Finance With Debt?

• Tax Savings- interest is tax deductible
• Dilution of ownership- new equity decreases the
  proportion of existing shareholders ownership

7
WACC

• Weighted Average Cost of Capital-
• function of the cost of debt, cost of equity,
  tax rate, and the weights of debt and equity
  respectively

8
Why is Liquidity Needed?

• Transactions Requirement- day-to-day cash flows
  are unsynchronized
• Precautionary Requirement- cash flows are
  somewhat unpredictable
• Speculative Requirement- ability to take
  advantage of high-return opportunities

9
Sources of Liquidity

• Net Cashflow from Operations
• Cash and Short-Term Investments
• Unused Borrowing Capacity

10
Insufficient Liquidity

• Cost of Delayed Payments- interest charges,
  foregone discounts
• Cost of Lost Opportunities- opportunity cost
• Additional Interest Costs- unanticipated
  borrowing
• Transaction Costs- brokerage costs

11
Too Much Liquidity?

• Excess liquidity can result in opportunity costs
  due to lower return rates.