Financial Economics

WEB-APPENDIX E*

FINANCIAL STATEMENTS

Acorporation's financial statements are summaries of the decisions made by management and are the subject of this appendix. These decisions include operating, financing, and investment decisions. Throughout this book we have primarily focused on the financing decision (i.e., capital structure decision) and investment decision (i.e., capital budgeting decision). The financial statements should furnish information that can be utilized by the suppliers of capital to be able to forecast future cash flows and the riskiness associated with those forecasts.

There are four basic financial statements: the balance sheet, the income statement, the statement of cash flows, and the statement of shareholders’ equity. We describe each in this appendix.¹ The tools for financial analysis that suppliers of capital can use to assess a firm's performance are the subjects of Web-Appendix F.

E.1 ACCOUNTING PRINCIPLES

The accounting data in financial statements are prepared by the firm's management according to a set of standards, referred to as generally accepted accounting principles (GAAP). Generally accepted accounting principles are not one set of standards, but rather a hierarchy of accounting principles that are promulgated from a number of sources.

The financial statements are prepared using several assumptions that affect how suppliers of capital use and interpret the financial data. Following are the key assumptions:

1. Transactions are recorded at historical ...