340 CHAPTER 9 Financial Statements, Cash Flow, and Taxes“cash equivalents,” and they are included with cash. Other types of marketable
securities have a longer time until maturity ,and their market values are less pre-
dictable. These securities are classified as “short-term investments.” Receivables
are bills others owe MicroDrive ,while inventories show the dollars the company
has invested in raw materials ,work-in-process ,and finished goods available for
sale. Finally ,net plant and equipment reflect the amount of money MicroDrive
paid for its fixed assets when it acquired those assets in the past ,less accumulated
depreciation.
With $10 million of cash, MicroDrive can write checks for a total of $10 mil-
lion (versus current liabilities of $310 million due within a year). The noncash
assets should produce cash over time, but they do not represent cash in hand, and
the amount of cash they would bring if they were sold today could be higher or
lower than the values at which they are carried on the books.
2.Liabilities versus stockholders’ equity.The claims against assets are of two
types—liabilities (or money the company owes) and the stockholders’ ownership
position.^2 The common stockholders’ equity,or net worth,is a residual. For ex-
ample, at the end of 2002,Suppose assets decline in value; for example, suppose some of the accounts receiv-
able are written off as bad debts. Liabilities and preferred stock remain constant, so
the value of the common stockholders’ equity must decline. Therefore, the risk of
asset value fluctuations is borne primarily by the common stockholders. Note,
however, that if asset values rise (perhaps because of inflation), these benefits will
accrue exclusively to the common stockholders.
3.Preferred versus common stock.Preferred stock is a hybrid, or a cross between
common stock and debt. In the event of bankruptcy, preferred stock ranks below
debt but above common stock. Also, the preferred dividend is fixed, so preferred
stockholders do not benefit if the company’s earnings grow. Finally, many firms do
not use any preferred stock, and those that do generally do not use much of it.
Therefore, when the term “equity” is used in finance, we generally mean “common
equity” unless the word “total” is included.
4.Breakdown of the common equity accounts.The common equity section is di-
vided into two accounts—“common stock” and “retained earnings.” The retained
earningsaccount is built up over time as the firm “saves” a part of its earnings
rather than paying all earnings out as dividends. The common stock account arises
from the issuance of stock to raise capital, as discussed in Chapter 5.
The breakdown of the common equity accounts is important for some purposes
but not for others. For example, a potential stockholder would want to know
whether the company actually earned the funds reported in its equity accounts or
whether the funds came mainly from selling stock. A potential creditor, on the
other hand, would be more interested in the total equity the owners have in the
firm and would be less concerned with the source of the equity. In the remainder of
this chapter, we generally aggregate the two common equity accounts and call this
sum equity, common equity,or net worth.$2,000,000,000$1,064,000,000 P$40,000,000 sto$896,000,000.$2,0Assets $1,Liabilities Preferred stock
Common
stockholders’ equity.(^2) One could divide liabilities into (1) debts owed to someone and (2) other items, such as deferred taxes, re-
serves, and so on. Because we do not make this distinction, the terms debtand liabilitiesare often used syn-
onymously.