How Companies Work: Checkpoint 1

Quick checkpoint - five questions on financial statements, financing, valuation and returning cash to shareholders.

Question 1 of 5 What does the balance sheet equation state?

Revenue equals profit Assets equal liabilities plus shareholders' equity Cash equals net income Debt equals equity

Every asset is funded either by borrowing or by the owners' stake.

Question 2 of 5 Why can a profitable company run out of cash?

Profit is always the same as cash Customers may pay late, and inventory and equipment purchases use cash before profits arrive Profitable companies cannot borrow Taxes take all the cash

Accrual accounting records sales when made, not when cash is received.

Question 3 of 5 What does leverage do to owners' returns?

It always reduces them It has no effect It magnifies both gains and losses It guarantees a profit

Borrowed money increases returns when the business does well and deepens losses when it does badly.

Question 4 of 5 A price-to-earnings ratio of 20 means:

The company earns 20 dollars per share Investors pay 20 dollars for each dollar of yearly profit per share The company has 20 shareholders The share price has risen 20 percent

The P/E ratio divides the share price by earnings per share.

Question 5 of 5 How does a share buyback affect earnings per share if total profit stays the same?

It lowers earnings per share It raises earnings per share because profits are spread over fewer shares It has no effect It turns profits into losses

Fewer shares outstanding means each share represents a bigger slice of profit.

← Back to Dividends and Share Buybacks Next lesson → Mergers and Acquisitions: Why Companies Buy Each Other

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