Chapter no 2

Annual Report
A report issued annually by a corporation to its stockholders. It contains basic financial statements, as
well as management's analysis of the past year's operations and opinions about the firm's future prospects.

Balance Sheet
A statement of the firm's financial position at a specific point in time.

Common Stockholders' Equity

(Net Worth)
The capital supplied by common stockholders — common stock, paid-in capital, retained earnings, and,
occasionally, certain reserves. Total equity is common equity plus preferred stock.

Retained Earnings
That portion of the firm's earnings that has been saved rather than paid out as dividends.

Income Statement
A statement summarizing the firm's revenues and expenses over an accounting period, generally a quarter or
a year.
Depreciation
The charge to reflect the cost of assets used up in the production process. Depreciation is not a cash outlay.
Tangible Assets
Physical assets such as plant and equipment.
Amortization
A noncash charge similar to depreciation except that it is used to write off the costs of intangible assets.
Intangible Assets
Assets such as patents, copyrights, trademarks, and goodwill.
EBITDA
Earnings before interest, taxes, depreciation, and amortization.

Cash Flow
The actual net cash, as opposed to accounting net income, that a firm generates during some specified
period.

Accounting Profit
A firm's net income as reported on
its income statement.

Statement of Cash Flows

A statement reporting the impact of a firm's operating, investing, and financing activities on cash flows over
an accounting period.

Operating Assets
The cash and marketable securities, accounts receivable, inventories, and fixed assets necessary to operate
the business.
Nonoperating Assets
Cash and marketable securities above the level required for normal operations, investments in subsidiaries,
land held for future use, and other nonessential assets.

Operating Working Capital

Current assets used in operations.
Net Operating Working Capital
Operating working capital less accounts payable and accruals. It is the working capital acquired with
investor-supplied funds

Net Operating Profit After

Taxes (NOPAT)
The profit a company would generate if it had no debt and held no non operating assets.

Free Cash Flow

The cash flow actually available for distribution to all investors (stockholders and debtholders) after the
company has made all the investments in fixed assets, new products, and working capital necessary to sustain
ongoing operations

Operating Cash Flow

Equal to NOPAT plus any non cash adjustments, calculated on an after-tax basis.

Market Value Added (MVA)

The difference between the market value of the firm's stock and the amount of equity capital investors have
supplied.

Economic Value Added (EVA)

Value added to shareholders by management during a given year.

Progressive Tax
A tax system where the tax rate is higher on higher incomes. The personal income tax in the United States,
which goes from 0 percent on the lowest increments of income to 39.6 percent, is progressive.
Taxable Income
Gross income minus exemptions and allowable deductions as set forth in the Tax Code.

Marginal Tax Rate

The tax rate applicable to the last unit of a person's income.

Average Tax Rate

Taxes paid divided by taxable income.

Bracket Creep
A situation that occurs when progressive tax rates combine with inflation to cause a greater portion of each
taxpayer's real income to be paid as taxes.

Capital Gain or Loss

The profit (loss) from the sale of a capital asset for more (less) than its purchase price.

The four basic statements contained in the annual report are the balance sheet, the income statement, the
statement of retained earnings, and the statement of cash flows. Investors use the information provided
in these statements to form expectations about the future levels of earnings and dividends, and about
the firm's riskiness.

The balance sheet shows assets on the left-hand side and liabilities and equity, or claims against
assets, on the right-hand side. The balance sheet may be thought of as a snapshot of the firm's
financial position at a particular point in time.
The income statement reports the results of operations over a period of time, and it shows earnings per
hare as its "bottom line."

The statement of retained earnings shows the change in retained earnings between the balance sheet dates.
Retained earnings represent a claim against assets, not assets per se.

The statement of cash flows reports the impact of operating, investing, and financing activities on
cash flows over an accounting period.

Net cash flow differs from accounting profit because some of the revenues and expenses reflected in
accounting profits may not have been received or paid out in cash during the year. Depreciation is
typically the largest non cash item, so net cash flow is often expressed as net income plus depreciation.
Investors are at least as interested in a firm's projected net cash flow as in reported earnings because it
is cash, not paper profit, that is paid out as dividends and plowed back into the business to produce growth.

Net operating working capital is defined as the difference between the current assets necessary to
operate the business and those current liabilities on which no interest is charged (generally, accounts
payable and accruals). Thus, net operating working capital is the working capital acquired with investor-
supplied funds.

Operating assets are the cash and marketable securities, accounts receivable, inventories, and fixed assets
necessary to operate the business.

NOPAT is net operating profit after taxes. It is the after-tax profit a company would have if it had no debt
and no investments in non operating assets. Since it excludes the effects of financial decisions, it is a
better measure of operating performance than is net income.

Operating cash flow arises from normal operations, and it is the difference between cash revenues
and cash costs, including taxes on operating income. Operating cash flow differs from net cash flow
because operating cash flow does not include either interest income or interest expense. It is equal to NOPAT
plus any non cash adjustments.

Free cash flow (FCF) is the amount of cash flow remaining after a company makes the asset investments
necessary to support operations. In other words, FCF is the amount of cash flow available for distribution
to investors, so the value of a company is directly related to its ability to generate free cash flow.

Market Value Added (MVA) represents the difference between the market value of a firm's stock and the
amount of equity its investors have supplied.

Economic Value Added (EVA) is the difference between after-tax operating profit and the total cost of
capital, including the cost of equity capital. EVA is an estimate of the value created by management
during the year, and it differs substantially from accounting profit because no charge for the use of
equity capital is reflected in accounting profit.