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income statement

What information is contained in the balance sheet, income statement, and statement of cash flows?

Investors and other stakeholders in the firm need regular financial information to help them monitor the firm`s progress. Accountants summarize this information in a balance sheet, income statement, and statement of cash flows.

The balance sheet provides a snapshot of the firm`s assets and liabilities. The assets consist of current assets that can be rapidly turned into cash and fixed assets such as plant and machinery. The liabilities consist of current liabilities that are due for payment shortly and long-term debts. The difference between the assets and the liabilities represents the amount of the shareholders` equity.

The income statement measures the profitability of the company during the year. It shows the difference between revenues and expenses. The statement of cash flows measures the sources and uses of cash during the year. The change in the company`s cash balance is the difference between sources and uses.

What is the difference between market and book value?

It is important to distinguish between the book values that are shown in the company accounts and the market values of the assets and liabilities. Book values are historical measures based on the original cost of an asset. For example, the assets in the balance sheet are shown at their historical cost less an allowance for depreciation. Similarly, the figure for shareholders` equity measures the cash that shareholders have contributed in the past or that the company has contributed on their behalf.

Why does accounting income differ from cash flow?

Income is not the same as cash flow. There are two reasons for this: (1) investment in fixed assets is not deducted immediately from income but is instead spread over the expected life of the equipment, and (2) the accountant records revenues when the sale is made rather than when the customer actually pays the bill, and at the same time deducts the production costs even though those costs may have been incurred earlier.

What are the essential features of the taxation of corporate and personal income?

For large companies the marginal rate of tax on income is 35 percent. In calculating taxable income the company deducts an allowance for depreciation and interest payments. It cannot deduct dividend payments to the shareholders. Individuals are also taxed on their income, which includes dividends and interest on their investments. Capital gains are taxed, but only when the investment is sold and the gain realized.

1. Balance Sheet. Construct a balance sheet for Sophie`s Sofas given the following data. What

is shareholders` equity?

Cash balances = $10,000

Inventory of sofas = $200,000

Store and property = $100,000

Accounts receivable = $22,000

Accounts payable = $17,000

Long-term debt = $170,000

2. Financial Statements. Earlier, we characterized the balance sheet as providing a snapshot of the firm at one point in time and the income statement as providing a video. What did we mean by this? Is the statement of cash flow more like a snapshot or a video?

3. Income versus Cash Flow. Explain why accounting revenue generally will differ from a firm`s cash inflows.

4. Working Capital. QuickGrow is in an expanding market, and its sales are increasing by 25 percent per year. Would you expect its net working capital to be increasing or decreasing?

5. Tax Rates. Using Table 2.6, calculate the marginal and average tax rates for a single taxpayer with the following incomes:

a. $20,000

b. $50,000

c. $300,000

d. $3,000,000

6. Tax Rates. What would be the marginal and average tax rates for a corporation with an income level of $100,000?

7. Taxes. A married couple earned $95,000 in 1999. How much did they pay in taxes? What were their marginal and average tax brackets?

8. Cash Flows. What impact will the following actions have on the firm`s cash balance?

a. The firm sells some goods from inventory.

b. The firm sells some machinery to a bank and leases it back for a period of 20 years.

c. The firm buys back 1 million shares of stock from existing shareholders.