621. Indeed, many of the most valuable assets a firm might have—good management, a good reputation, talented employees—don’t appear on the balance sheet at all.622. As a result of the way revenues and expenses are realized, the figures shown on the income statement may not be at all representative of the actual cash inflows and outflows that occurred during a particular period.623. The reason is that, in practice, accountants tend to classify costs as either product costs or period costs.624. In reality, the tax code is much more complex and is riddled with various tax deductions and loopholes allowed for certain industries.625. Operating cash flow is an important number because it tells us, on a very basic level, whether a firm’s cash inflows from its business operations are sufficient to cover its everyday cash outflows.626. A good working knowledge of financial statements is desirable simply because such statements, and numbers derived from those statements, are the primary means of communicating financial information both within the firm and outside the firm.627. So, loosely speaking, an increase in an asset account means the firm, on a net basis, bought some assets—a use of cash.628. To get started, a useful way of standardizing financial statements is to express each item on the balance sheet as a percentage of assets and to express each item on the income statement as a percentage of sales.629. What they are intended to describe is how efficiently or intensively a firm uses its assets to generate sales.630. Because the PE ratio measures how much investors are willing to pay per dollar of current earnings, higher PEs are often taken to mean the firm has significant prospects for future growth.631. As we will see, historical financial statement information is useful for generating projections about the future and for checking the realism of assumptions made in those projections.632. A key lesson to be learned from this chapter is that a firm’s investment and financing policies interact and thus cannot truly be considered in isolation from one another.633. Because a company is likely to spend a lot of time examining the different scenarios that will become the basis for its financial plan, it seems reasonable to ask what the planning process will accomplish.634. The financial plan allows the firm to develop, analyze, and compare many different scenarios in a consistent way.635. In particular, it should address what actions the firm will take ifthings go seriously wrong or, more generally, if assumptions made today about the future are seriously in error.636. In other words, financial planning is a way of verifying that the goals and plans made for specific areas of a firm’s operations are feasible and internally consistent.637. For example, with the scenario we have just examined, we would surely want to examine the current ratio and the total debt ratio to see if we were comfortable with the new projected debt levels.638. These alternative scenarios illustrate that it is inappropriate to blindly manipulate financial statement information in the planning process.639. An increase in profit margin will increase the firm’s ability to generate funds internally and thereby increase its sustainable growth.640. Because of this, financial planning models sometimes do not produce meaningful clues about what strategies will lead to increases in value.
