FIN305 Exam 2 Review Guide: Financial Statements,
Valuation & Ratios|2026 Latest Update with
Complete Solution
Content
Financial Statements, Taxes, Cash Flow, Ratio Analysis (Chapter 2)
Project Valuation (Chapter 11)
Risk & Return (Chapter 13)
Formulas
Financial Statements, Taxes, Cash Flows, & Ratio Analysis
The Balance Sheet
❖ Shows “snapshot” at a given point
❖ BS equation
➢ Assets= liabilities + owner’s equity
❖ Asset side
➢ Current assets
■ Convert to cash within a year
■ Cash, inventory, accounts receivable (amount of goods or services
delivered or used but not yet paid for by customers)
➢ Fixed assets (> 1 year)
■ Tangible, intangible (intellectual properties like trademark, patent,
copyright)
❖ Liabilities side
➢ Current liabilities (< 1 year)
■ Short-term debt, accounts payable (amount of goods or services
delivered to the company by suppliers, but not yet paid by the company)
➢ Long-term liabilities (> 1 year)
■ Long-term bonds, loans
➢ Shareholder’s equity
■ Common stock
■ Retained earnings
❖ Net working capital (NWC) and liquidity
➢ Liquidity
■ Ability to convert to cash quickly but without a significant loss in value
■ Assets listed in order of decreasing liquidity: cash > inventory > fixed
assets (don’t convert to cash in normal business activity)
➢ Net Working Capital
■ NWC= current assets - current liabilities
■ Positive if cash to be received > to be paid out, in the next 12 months
■ Usually positive in a healthy, liquid firm
➢ Tradeoff
, ■ More liquid assets: financial distress less likely
■ But liquid assets: a lower return
❖ Debt vs equity
➢ Equity: only entitled to the residual value (after debt is paid out)
➢ Debt/total asset: financial leverage
➢ Higher leverage:
■ higher reward to equity, higher tax shield, higher risk of financial distress
❖ Market value vs book value
➢ Values on the balance sheets are book values
■ Market values of assets/equity/debt are NOT directly on the balance
sheet
■ Need discounted cash flow model (use financial statement
information)/market prices
➢ Book value of assets: historical costs of acquisition
■ Irrelevant to the current market value
■ E.g. a railroad acquires a land a century ago
● Book value of the land << current market value of the land
➢ Book value of debt/equity
■ Book value of debt: how much you still owe (original loan amount –
reduction in principal)
■ Book value of common stock: how much you have raised at the time of
issuance
■ Could be very different from the market value
The Income Statement
❖ Measures performance over some period of time
❖ Income= revenue - expenses
❖ Using GAAP shows revenue when it accrues and expenses using matching principle
➢ May not be representative of actual cash flows
❖ Non cash items
➢ Expenses that don’t affect cash flow
➢ Ex- depreciation
❖ Sample statement
Sales revenue
-cost of goods sold
=gross profit
-depreciation
=earnings before interest and taxes
-interest paid
=taxable income
-taxes
Valuation & Ratios|2026 Latest Update with
Complete Solution
Content
Financial Statements, Taxes, Cash Flow, Ratio Analysis (Chapter 2)
Project Valuation (Chapter 11)
Risk & Return (Chapter 13)
Formulas
Financial Statements, Taxes, Cash Flows, & Ratio Analysis
The Balance Sheet
❖ Shows “snapshot” at a given point
❖ BS equation
➢ Assets= liabilities + owner’s equity
❖ Asset side
➢ Current assets
■ Convert to cash within a year
■ Cash, inventory, accounts receivable (amount of goods or services
delivered or used but not yet paid for by customers)
➢ Fixed assets (> 1 year)
■ Tangible, intangible (intellectual properties like trademark, patent,
copyright)
❖ Liabilities side
➢ Current liabilities (< 1 year)
■ Short-term debt, accounts payable (amount of goods or services
delivered to the company by suppliers, but not yet paid by the company)
➢ Long-term liabilities (> 1 year)
■ Long-term bonds, loans
➢ Shareholder’s equity
■ Common stock
■ Retained earnings
❖ Net working capital (NWC) and liquidity
➢ Liquidity
■ Ability to convert to cash quickly but without a significant loss in value
■ Assets listed in order of decreasing liquidity: cash > inventory > fixed
assets (don’t convert to cash in normal business activity)
➢ Net Working Capital
■ NWC= current assets - current liabilities
■ Positive if cash to be received > to be paid out, in the next 12 months
■ Usually positive in a healthy, liquid firm
➢ Tradeoff
, ■ More liquid assets: financial distress less likely
■ But liquid assets: a lower return
❖ Debt vs equity
➢ Equity: only entitled to the residual value (after debt is paid out)
➢ Debt/total asset: financial leverage
➢ Higher leverage:
■ higher reward to equity, higher tax shield, higher risk of financial distress
❖ Market value vs book value
➢ Values on the balance sheets are book values
■ Market values of assets/equity/debt are NOT directly on the balance
sheet
■ Need discounted cash flow model (use financial statement
information)/market prices
➢ Book value of assets: historical costs of acquisition
■ Irrelevant to the current market value
■ E.g. a railroad acquires a land a century ago
● Book value of the land << current market value of the land
➢ Book value of debt/equity
■ Book value of debt: how much you still owe (original loan amount –
reduction in principal)
■ Book value of common stock: how much you have raised at the time of
issuance
■ Could be very different from the market value
The Income Statement
❖ Measures performance over some period of time
❖ Income= revenue - expenses
❖ Using GAAP shows revenue when it accrues and expenses using matching principle
➢ May not be representative of actual cash flows
❖ Non cash items
➢ Expenses that don’t affect cash flow
➢ Ex- depreciation
❖ Sample statement
Sales revenue
-cost of goods sold
=gross profit
-depreciation
=earnings before interest and taxes
-interest paid
=taxable income
-taxes
