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Part 2 Fundamental Concepts in Financial Management

Table 3-1

Allied Food Products: December 31 Balance Sheets (Millions of Dollars)

2008 Assets Current assets: Cash and equivalents Accounts receivable Inventories Total current assets Net fixed assets: Net plant and equipment (cost minus depreciation) Other assets expected to last more than a year Total assets Liabilities and Equity Current liabilities: Accounts payable Accruals Notes payable Total current liabilities Long-term bonds Total debt Common equity: Common stock (50,000,000 shares) Retained earnings Total common equity Total liabilities and equity 2007

10 375 615 $1,000 1,000 0 $2,000

80 315 415 $ 810 870 0 $1,680

60 140 110 $ 310 750 $1,060 $ 130 810 $ 940 $2,000

30 130 60 $ 220 580 $ 800 $ 130 750 $ 880 $1,680

Notes: 1. Inventories can be valued by several different methods, and the method chosen can affect both the balance sheet value and the cost of goods sold, and thus net income, as reported on the income statement. Similarly, companies can use different depreciation methods. The methods used must be reported in the notes to the financial statements, and security analysts can make adjustments when they compare companies if they think the differences are material. 2. Book value per share: Total common equity/Shares outstanding $940/50 $18.80. 3. Also note that a relatively few firms use preferred stock, which we discuss in Chapter 9. Preferred stock can take several different forms, but it is generally like debt because it pays a fixed amount each year. However, it is like common stock because a failure to pay the preferred dividend does not expose the firm to bankruptcy. If a firm does use preferred stock, it is shown on the balance sheet between Total debt and Common stock. There is no set rule on how preferred stock should be treated when financial ratios are calculatedit could be considered as debt or as equity. Bondholders often think of it as equity, while stockholders think of it as debt because it is a fixed charge. In truth, it is a hybrid, somewhere between debt and common equity.

Working Capital Current assets.

2. 3.

Working capital. Current assets are often called working capital because these assets turn over; that is, they are used and then replaced throughout the year.4 Net working capital. When Allied buys inventory items on credit, its suppliers, in effect, lend it the money used to finance the inventory items. Allied could have borrowed from its bank or sold stock to obtain the money, but it received the funds from its suppliers. These loans are shown as accounts payable, and they typically are free in the sense that they do not bear interest. Similarly, Allied pays its workers every two weeks and it pays taxes quarterly; so

4 Any current assets not used in normal operations, such as excess cash held to pay for a plant under construction, are deducted and thus not included in working capital. Allied requires all of its current assets for operations.