Ch 5 Flashcards
Analysts use the balance sheet to assess three things about the company?
The company’s
1 liquidity
2 solvency
3 financial flexibility
Balance sheet AKA Statement of financial position
Reports assets, liabilities and stockholders equity
Of business enterprise on specific date
Liquidity
Amount of time expected to elapse until asset is
Realized or converted to cash
Or a liability has to be paid
Solvency
Ability of company to pay its debts as they mature
Financial flexibility
Measures ability of enterprise to take effective actions
To alter amounts and timing of cash flows
to respond to unexpected needs and opportunities
3 major limitations of balance sheet?
1 historical cost reporting
2 judgements and estimates used for reporting
3 omitting items of financial value
Historical cost limitation on balance sheet?
Because of historical cost principle fair value is not
Accounted for unless an asset is sold
Judgements and estimates, limitation on balance sheet?
Estimates can be inaccurate for useful life, depreciation,
Amount of receivables collected
4 Examples of “omits items that are of financial value” limitation on balance sheet?
Employees who are skilled and know how to develop
Computer chip can’t be recorded on the balance
Sheet but are company’s most valuable asset
Reputation, customer base, research superiority
Classified balance sheet
Balance sheets group together similar items to arrive
At significant subtotals
3 ways companies should separate items with different characteristics on the balance sheet?
1 type or expected function
2 different implications for companies financial flexibility
3 different general liquidity characteristics
Example of assets type or expected function classification?
IBM reports merchandise inventories separately
From property, plant and equipment
Assets and liabilities with different implications of company’s financial flexibility example?
Company that uses assets in operations Should report
those assets separately from asset’s Held for investments
And assets subject to restrictions such as leased equipment
Assets and liabilities with different general liquidity characteristics example?
Boeing reports cash separately from inventories
3 elements of balance sheet?
Assets
Liabilities
Equity
Assets
Probable future economic benefits obtained or controlled
By a particular entity as a result of past transactions or events
Liabilities
Probable future sacrifices of economic benefits arising
from present obligations of particular entity
to transfer Assets or provide services to other entities in the
Future as result of past transactions or events
Equity
Residual interest in the assets of an entity that remains after
Deducting its liabilities
Equity in a business enterprise
Equity is the ownership interest
Current assets
Cash and other assets a company expects to convert
Into cash, sell or consume in 1 year it operating cycle
Order of Operating cycle
Cash through inventory, production, receivables
And back to cash
How are current assets presented in the balance sheet
In order of liquidity
Cash equivalents
Short term highly liquid investments that mature in
3 months or less
3 separate portfolios for valuation and reporting purposes of short term investments of debt and equity securities?
1 Held to maturity
2 trading
3 available for sale
short term investments of debt and equity securities: held to maturity?
Debt securities that company has positive intent and
ability to hold to maturity
short term investments of debt and equity securities: trading?
Debt and equity securities bought and held primarily for
Sale in near term to generate income on short term price
Differences
short term investments of debt and equity securities: available-for-sale?
Debt and equity securities not classified as held to maturity
Or trading securities
Long term investments consist of one of four types?
1 investments in securities, such as bonds, common
stock, or Longterm notes
2 investments in tangible fixed assets not currently
Used in operations, such as land held for speculation
3 investments set aside in special funds, such as
sinking fund, pension fund or plant expansion fund
Includes cash surrender value of life insurance
4 investments in non consolidated subsidiaries
Or affiliated companies
Long term investments are usually called?
Investments
When are investments included in current assets?
If company intends to convert them to cash in short term
Property, plant and equipment, define, 6 general examples?
Tangible, Longterm assets used in regular operations
of business
Consist of land, buildings, machinery, furniture, tools, Wasting resources (timberland, minerals)
Intangible assets, 7 examples?
Lack physical substance and are not financial instruments
Patents, copyrights, franchises, goodwill, trademarks,
Trade names and customer lists
What is it called when you write off/ depreciate an intangible asset?
Amortize
Current liabilities
Obligations that a company expects to liquidate either
Though use of current assets or creation of other
Current liabilities
What’s included in current liabilities?
1 payables
2 unearned rent or revenue
3 long term debts whoes payments occur within a year
Working capital, equation, definition?
Working capital = total current assets - total current liabilities
Net amount of company’s relatively liquid resources
Longterm liabilities
Obligations that a company doesn’t expect to liquidate
During operating cycle
When do companies classify long term liabilities as
Current liabilities?
When Longterm liabilities mature within current operating
Cycle and require payment with current assets
3 types of Longterm liabilities
1 obligations arising from specific financing situations
Ex issuance of bonds, LT lease obligations, LT notes payable
2 obligations arising form ordinary operations of company
Ex pension obligations, deferred income tax liabilities
3 obligations that depend on occurrence or non occurrence
Of one or more future events to confirm amt payable, payee
Or date payable
Include product warranties and other contingencies
6 parts of stockholder’s equity section?
1 capital stock 2 additional paid in capital 3 retained earnings 4 accumulated other comprehensive income 5 treasury stock 6 noncontrolling interest (minority interest)
Stockholder’s equity section: capital stock
Par or stated value of shares issued
Stockholder’s equity section: additional paid in capital
Excess amounts paid over the par or stated value
Stockholder’s equity section: retained earnings
Corporation’s undistributed earnings
Stockholder’s equity section: accumulated and other comprehensive income
Aggregate amount of other comprehensive income items
Stockholder’s equity section: treasury stock
Generally amount of ordinary shares repurchased
Stockholder’s equity section: non controlling interest (minority interest)
Portion of the equity of subsidiaries not wholly owned
By the reporting company
Unappropriated retained earnings
Amount of RE available for dividend distribution
Restricted RE
Restricted from being paid as dividends from
bond indentures and other loan agreements
Account form of balance sheet
List of assets, by sections on the left side
And liabilities and stockholders equity section on
the right side
Report form of balance sheet
Lists assets above liabilities and stockholders equity on
same page
Primary purpose of statement of cash flows
Provide relevant information about cash receipts and
Cash payments of enterprise during period
What 4 areas do cash flow statements report?
1 cash effects of operations during period
2 investing transactions
3 financing transactions
4 net increase or decrease in cash during period
3 questions cash flow statement provides an answer to?
1 where did the cash come form during the period?
2 what was the cash used for during the period?
3 what was the Change in the cash balance during the period?
Statement of cash flows: Operating activities
Involve the cash effects of transactions that enter into
Determination of net income
Statement of cash flows: investing activities
Include making and collecting loans and acquiring
And disposing of investments (both debt and equity),
Property, plant and equipment
Statement of cash flows: financing activities
Involve liabilities and owners’ equity items
Include obtaining resources from owners and
providing them with return on their investment
Borrowing money from creditors and repaying amounts
borrowed
Statement of cash flows helps users evaluate?
Liquidity, solvency and financial flexibility
4 steps to preparing a statement of cash flows?
1 determine net cash provided by (or used in)
operating activities
2 determine the net cash provided by (or used in)
investing and financing activities
3 determine the change (increase or decrease) in cash
During the period
4 reconcile the change in cash with beginning and ending
Cash balances
4 examples of significant non cash activities?
1 issuance of common stock to purchase assets
2 conversion of bonds into common stock
3 issuance of debt to purchase assets
4 exchanges of long lived assets
Current cash debt coverage, equation, definition?
Current cash debt coverage =
(Net cash provided by operating activities)/(avg. current liabilities)
Indicates whether a company can pay off its current
Liabilities from operations in a given year
Indicates financial liquidity
Cash debt coverage equation, definition?
Cash debt coverage =
(net cash provided by operating activities)/(avg. total liabilities)
Higher the ratio the better
Measures financial flexibility
Indicates company’s ability to repay its liabilities from
Net cash provided by operating activities without
Having to liquidate assets employed in its operations
Free cash flow equation, it’s use?
Free cash flow =
(net cash provided by operating activities) - (capital expenditures)
- (dividends)
Examines company’s financial flexibility
3 questions cash flow analysis answers?
1 is the company able to pay its dividends without resorting
To external financing?
2 if business operations decline, will the company be
able to maintain it’s needed capital investment?
3 what is the amount of discretionary cash flow that
can be used for additional investment, retirement
Of debt, purchase of treasury stock or addition to liquidity?
4 types of information that are usually supplemental to account titles and amounts presented on the balance sheet?
- Contingencies
2 accounting policies
3 contractual situations
4 fair values
Contingencies
Material events that have uncertain outcomes
Accounting policies
Explanations of valuation methods used or basic
Assumptions made concerning inventory valuations,
Depreciation methods, investments in subsidiaries
Contractual situations
Explanations of certain restrictions or covenants attached
To specific assets or liabilities (more likely)
Fair values
Disclosures of fair values, particularly for financial
Instruments
Contra account, Adjunct account?
Contra - Reduces either an asset, liability or owners’ equity account
Adjunct - increases either asset, liability or owner’s equity
Account
Reserve
Means appropriation of retained earnings
