Chapter 3 Financial Statements, Cash Flow, and Taxes 59- Working capital. Current assets are often called working capital because these
assets “turn over”; that is, they are used and then replaced throughout the year.^4 - Net working capital. When Allied buys inventory items on credit, its suppliers, in
effect, lend it the money used to! nance the inventory items. Allied could have
borrowed from its bank or sold stock to obtain the money, but it received the funds
from its suppliers. These loans are shown as accounts payable, and they typically
are “free” in the sense that they do not bear interest. Similarly, Allied pays its
workers every two weeks and it pays taxes quarterly; so Allied’s labor force and
tax authorities provide it with loans equal to its accrued wages and taxes. If we
Working Capital
Current assets.Working Capital
Current assets.Tabl e 3 - 1 Allied Food Products: December 31 Balance Sheets (Millions of Dollars)2008 2007
Assets
Current assets:
Cash and equivalents $ 10 $ 80
Accounts receivable 375 315
Inventories 615 415
Total current assets $1,000 $ 810
Net fixed assets:
Net plant and equipment (cost minus depreciation) 1,000 870
Other assets expected to last more than a year 0 0
Total assets $2,000 $1,680
Liabilities and Equity
Current liabilities:
Accounts payable $ 60 $ 30
Accruals 140 130
Notes payable 110 60
Total current liabilities $ 310 $ 220
Long-term bonds 750 580
Total debt $1,060 $ 800
Common equity:
Common stock (50,000,000 shares) $ 130 $ 130
Retained earnings 810 750
Total common equity $ 940 $ 880
Total liabilities and equity $2,000 $1,680
Notes:
(^1) Inventories can be valued by several different methods, and the method chosen can affect both the
balance sheet value and the cost of goods sold, and thus net income, as reported on the income
statement. Similarly, companies can use different depreciation methods. The methods used must be
reported in the notes to the financial statements, and security analysts can make adjustments when they
compare companies if they think the differences are material.
(^2) Book value per share! Total common equity/Shares outstanding! $940/50! $18.80.
(^3) Also note that a relatively few firms use preferred stock, which we discuss in Chapter 9. Preferred stock
can take several different forms, but it is generally like debt because it pays a fixed amount each year.
However, it is like common stock because a failure to pay the preferred dividend does not expose the firm
to bankruptcy. If a firm does use preferred stock, it is shown on the balance sheet between Total debt and
Common stock. There is no set rule on how preferred stock should be treated when financial ratios are
calculated—it could be considered as debt or as equity. Bondholders often think of it as equity, while
stockholders think of it as debt because it is a fixed charge. In truth, it is a hybrid, somewhere between
debt and common equity.
(^4) Any current assets not used in normal operations, such as excess cash held to pay for a plant under construc-
tion, are deducted and thus not included in working capital. Allied requires all of its current assets for operations.