5.1: Usefullness of Statement of Financial Position and Cash flow from Business Perspective Flashcards
What is the purpose of the Statement of Financial Position (SFP)?
The SFP provides information about a company’s liquidity and solvency, helping users assess the risk of investing or increasing their investment in the company.
It also details the company’s financial structure, such as whether it is financed by debt or equity.
How do companies with more financial flexibility benefit from the Statement of Financial Position (SFP)?
Companies with more financial flexibility are typically better able to survive economic downturns and take advantage of opportunities to invest and expand.
Investors use the SFP and related notes to assess financial flexibility and the risk of business failure.
How is the Statement of Cash Flows used to assess earnings quality?
Financial analysts use the statement of cash flows to assess earnings quality by comparing net income with cash flow from operations.
A significant difference between the two may indicate poor earnings quality and requires further analysis.
What are some ways managers might manipulate earnings to improve their appearance?
Managers might manipulate earnings by reducing the allowance for expected credit losses or the provision for inventory obsolescence.
This can artificially increase earnings to meet targets such as bonuses or loan terms.
Why might financial statement users be concerned if a company relies heavily on financing activities?
If a company consistently uses issuing shares or other financing activities to offset repeated negative cash flow from operations, it may indicate underlying financial problems, signaling poor earnings quality.
How do creditors assess a company’s creditworthiness using the Statement of Financial Position (SFP)?
Creditors assess a company’s liquidity and ability to service debt by reviewing the company’s long-term debt and shareholders’ equity.
A high debt-to-assets ratio indicates a higher risk of bankruptcy, requiring strong cash flow from operations to cover interest and principal payments.
