Chapter 5: Balance Sheet and Statement of Cash Flows Flashcards

1
Q

Current Ratio

A

Company’s ability to pay current liabilities from current assets

= Total current assets / total current liabilities

1.5 is strong, 1 is low/ risky

(Current = short term)

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2
Q

Liquidity Ratios

A

Measure the ability of the company to pay current liabilities with current assets

Current ratio: CA/ CL (2+ preferred)
Shows amount of current assets available for every $1.00 of current liabilities

Working Capital = CA- CL
shows assets left after paying all current liabilities

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3
Q

Liquidity

A

Ability to pay obligations expected due in the next year

“the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability is paid.”

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4
Q

Long-Term Liabilities

A

Obligations the company expects to pay after a year (or operating cycle)
- does not include currently maturing portions of long-term liabilities, those are current.

  • obligations from financing
  • obligations from extraordinary operations
  • obligations contingent of future events

Requires much supplementary disclosures - inclusion of terms of agreements in notes

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5
Q

Current Liabilties

A

Obligations whose liquidation is reasonably expected to require use of existing resources properly classified as current assets or the creation of other current liabilities

(generally in one year/ one operating cycle)

includes portion of long term liabilities currently coming due

  • notes payable
  • accounts payable
  • other current liabilities in order of magnitude
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6
Q

Long term assets

A

Holding over one year/ operating cycle

Order on balance sheet

2) Long-term investments
3) Property, plant and equipment
4) Intangible assets
5) Other assets

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7
Q

Current Assets

A

Assets the company expects to convert to cash or use up within one year or one operating cycle (whichever is longer)

Generally listed in order expected to change to cash

Cash (at fair value)
Short term investments (at fair value)
Accounts Receivable (at estimated amount collectable)
Inventory (lower of cost or market) 
Prepaid expenses (cost
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8
Q

Operating Cycle

A

Average time from purchase of inventory to collection of cash from customers

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9
Q

Lower-of-cost-or-Market Rule

A

If value of ending inventory is lower than its cost:
- companies must “write down” (recognize loss on income statement) the inventory to market value (replacement cost, not selling price) in the period where a decline below cost occurs

Conservatism in action

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10
Q

Cash Ratio

A

Measures company’s ability to pay current liabilities from cash and cash equivalent

= (cash + cash equivalents)/ total current liabilities

Cash equivalent = can be converted to cash in three months or less

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11
Q

Cash Equivalent

A

Cash equivalents: short term highly liquid investments that mature within THREE MONTHS (90 days) or less

company must disclose any restrictions or commitments in availability

  • current assets if current assets
  • other assets if NOT current obligations
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12
Q

Current assets NRV on balance sheet

A

Net Realizable Value of current assets on balance sheet

Current Assets:
Accounts Receivable
Less: Allowance for bad debts

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13
Q

Receivables on the Balance Sheet

A
  • identify each major type of receivable in the balance sheet or in the notes
  • report short term receivables as current assets
  • report both gross amount of A/R and allowance for doubtful accounts
  • identify any receivables used as collatoeral
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14
Q

Valuing Accounts Receivable

A
  • Always a current asset
  • reported at the amount the company thinks they will be able to collect (Net realizable cash value = NRV)
  • difficulty is that an unknown amount of receivables will become uncollectable
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15
Q

Types of Receivables

A

Amounts due to economic entity that are expected to be received in cash

Accounts Receivable: owed by customers for goods/ services sold

Notes Receivable: Claims for formal instruments of credit issued as proof of debt

Other receivables: “nontrade”, interest, loans to officers, advances in pay, income tax refundable

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16
Q

Intangible assets on financial statements

A

Usually shown as a separate category from PP&E

(Natural resources listed under PP&E)

Shown only at net book value (accumulated amortization not shown on balance sheet)

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17
Q

Intangible Assets

A

Characteristics

1) Lack physical existence
2) Not financial instruments

Categorized as having a limited life or an indefinite life

  • rights, privileges, competitive advantages that do not possess physical substance

Trademarks, patents, goodwill, copyrights, franchises/ licenses

categorized as internally created vs purchased

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18
Q

Current Liabilities on Balance Sheet

A

Notes Payable
Accounts Payable
Then in order of magnitude (largest to smallest)

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19
Q

When long term debt matures

A

On the balance sheet shows under current liabilities as “long term debt due within one year”

Some notes may have portions report as current and portions reported as long term

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20
Q

Stock on balance sheet (common only)

A
Stockholders' Equity 
Paid-In Capital
      Common Stock
      Paid-In-Capital in excess of par value
           Total Paid-in-capital
Retained Earnings
      Total Stockholder's Equity
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21
Q

Treasury Stock on Balance Sheet

A
Stockholder's Equity
   Paid-in- Capital
      Common Stock
      APIC
   Retained Earnings
      Total P-I-Capital & Retained Earnings
Less Treasury stock (qty at cost)
    Total Stockholder's Equity

Treasury Stock= reduction in total stockholder’s equity

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22
Q

APIC

A

Paid in capital in excess of stated or par value of stock

aka: additional paid-in-capital, premium on stock

usually on balance sheet as one amount though there may be subtotals

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23
Q

Stock on balance sheets

A

Stockholder’s Equity
Paid in Capital
% preferred Stock, $ par value
X shares authorized, x issued and outstanding
Common Stock, $ value (par or stated)
X shares authorized, x issued and outstanding
Total capital stock

Additional paid in capital also separated into preferred and common stock

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24
Q

Par Value stock

A

Value per share assigned by charter

while it used to be the legal capital per share a company was required to retain to protect creditors this is no longer required in most states

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25
Treasury Stock
Debit Natural Balance Corporations own stock that it was required from shareholders but not retired - a contra-stockholder's equity account - not an asset - reduces the value of stockholder's equity - holds no voting or dividend rights Buy back of outstanding stock = creation of treasury stock
26
Retained Earnings
Net income a corporation retains for future use Earned but not property of/ distributable to the owners
27
Effect of stock dividend on balance sheet
Total shareholders equity is unchanged (moves from retained earnings to common/ preferred stock or APIC) Number of shares outstanding and book value do change Cash dividends decrease stockholder's equity
28
Dividends on Financial Statements
Dividends not deducted as expense on income statement Stock dividends distributable is shown as an addition to capital stock
29
Discount on Bonds Payable on Balance sheet
Long term liabilities Bonds payable Less: Discount on bonds payable Total = carrying value/ book value Bond discount = increase on cost of borrowing
30
Leases on Balance Sheet
portion to paid in next year = current liability | remainder outstanding = long term liability
31
Premium on Bonds Payable on Balance sheet
Long Term Liabilities Bonds Payable (face value) Add Premium on Bonds Payable Total = carrying balue Bond premium = reduction of the cost of borrowing, lowers interest amount paid
32
Realized/ Unrealized Gain or loss on balance sheet
Other revenues and gains - Interest revenue - Dividend revenue - Gain on sale of investments - unrealized gain - income Other expenses and issues - loss on sale of investments - unrealized loss - income
33
Unrealized gain or loss on available for sale securities
Goes on balance sheet - separate component of stockholder's equity: other comprehensive income or loss Stockholder's Equity Common Stock Retained Earnings Total Paid in capital and retained earnings Less unrealized loss on AFS securities (or plus unrealized gain) = total stockholder's equity
34
Available For Sale Securities
As of 2016 okay for debit, but not for equity investments - securities held with the intent of selling sometime in the future - classified as current assets or long term assets depending on intent - reported at fair value (FMV) and report changes from cost as part of equity section)
35
Trading Securities
Trading debt investments - securities held with the intention of selling them in a short period (trading = frequent buying + selling_ Trading securities reported at fair market value and report changes in value from cost as part of net income Always short term/ current assets
36
Free Cash Flow
Measure of financial flexibility = net cash provided by operating activities Less: capital expenditures (planned) Less: cash dividends Describes cash remaining from operations after adjustment for capital expenditures (on PP&E) and dividends. aka discretionary cash
37
Financing Activities
A section of the statement of cash flows Activities that increase or decrease long term term liabilities or equity - issuing stock and paying dividends - buying and selling treasury stock - borrowing and paying off long term liabilities/ bonds, notes, mortgages - obtaining resources and providing a return (long term liabilities and equity)
38
Operating Activities
A section of the statement of cash flows Activities that create revenue or expense in the entity's business (net income) ``` Day to day operation PLUS interest revenue dividend income interest expense income tax expense ``` current assets and laibilties
39
Investing activities
A section of the statement of cash flows Activities that increase or decrease long term assets - PP&E - notes receivable - investments (acquiring and disposal) - sale and purchase of long term assets - lending and collection of long term notes receivables - making and collecting loans long term assets
40
Steps in preparing a statement of cash flows
1) Determine change in cash 2) Determine net cash flows from operating activities 3) Determine net cash flows from investing and financing activities 4) Ensure net change in cash from statement of cash flows matches the change from one balance sheet to the next
41
Classifications of cash flows
Operating activities - transactions from income statement Investment Activities - changes in investments and long term assets Financing Activities - changes in long term liabilties and stockholder's equity
42
Indirect method of statement of cash flows
- shows more detail than direct method - GAAP requires indirect method to be shown if direct method is used - easier, less costly to prepare - focus on difference between net income and net cash flow from operating activities - starts from net income and adjusts it to cash provided
43
Indirect method of Statement of cash flows: items subtracted from net income
Anything that increased net income without changing available cash - gains on disposal of long-term assets - increase on non-cash and current assets - decrease in current liabilities (long term assets gains & loss --> investing section)
44
Common Statement of Cash Flows adjustments to net income (loss)
Liabilities: Deduct decrease, add increase Assets: Add decrease, Deduct increase Anything that changes net income without affecting cash - add back non-cash expense (depreciation, amortization, depletion) - deduct gains, add losses - adjust for changes in non-cash current assets and current liabilities - accounts receivable (add any decrease between years) - inventory (deduct any increase between years) - prepaid accounts (deduct any increase) - payables (add increase, deduct decrease)
45
Determining Net Cash Flow from investing and financing activities
- analysis of comparative balance sheet data and selected additional info to determine affect on cash (remember to disclose non-cash transactions)
46
Significant noncash activities on cash flow statement
Full disclosure principle - direct issuance of common stock to purchase assets - conversion of bonds to common stock - issuance of debt to purchase assets - Exchange of plant assets (long lived assets) Reported in a separate schedule at the bottom of statement of cash flows or in a note to the financial statements
47
Sources of information for statement of cash flows
- comparative balance sheets (including analysis of statement of retained earnings - current income statements - selected transaction data - write downs - amortization charge - book entries such as depreciation that have no affect on cash
48
Form indirect method statement of cash flows
Cash Flows from Operating Activities Net Income Adjustments to reconcile net income to cash provided by operating activities - list of items that caused changes to income but not cash Net Cash provided by operations Cash Flows from investment activities Net cash used / provided by investment activities Cash flows from financing activities Net cash used/ provided by financing activities Net increase (decrease) in cash
49
Uses of statement of cash flows
Provides information to asses - entity's ability to generate future cash flows - entity's ability to pay dividends and obligations - reasons for differences between net income and net cash provided (used) by operating activities - cash investing and financing transactions during the period
50
Statement of cash flows format
Cash flows from operating activities Net cash provided/ used by operating activities Cash Flows from investing activities Net cash provided/ used by investing activities Cash Flows from Financing activities Net cash provided/ used by financing activities Net increase/ decrease in cash Cash at the beginning of the period cash at the end of the period non-cash investing and financing activities
51
Cash flows: investing activities
Changes in investments and long term assets Inflow - sale of PP&E - sale of investments (debit or equity of other corporations) - collection on principle of loans made Outflow - purchase of PP&E - Purchase of investments - loans made to other entities
52
Cash Flows from financing activities
Changes to long term liabilities and stockholders equity Inflows - sales of common stock - Issuance of debt (bonds/ notes) Outflows - dividends to stockholders - redemption of long-term debt - re-acquisition of capital stock (treasury stock)
53
Determining net cash flow from operating activities
Cash provided/ used by operating activities to find have to net income from accrual bases - current year's income statement - comparative year balance statement
54
Cash flows from operating activities
Inflows: - sales of goods or services - interest and dividends received ``` Outflows: Operating expenses: - to suppliers - to employees (payroll) - to governments (taxes) - to lenders (interest) ```
55
Net increase/ decrease in cash
= net cash provided by operating activities - net cash used for investing activities + net cash provided by investing activities
56
Times Interest Earned
A solvency ratio AKA interest coverage Indicates the company's ability to meet interest payments as they come due = (net income + interest expense + income tax expense) / interest expense net income before interest expense and income tax expense
57
Payout Ratio
A profitability ratio measures the percentage of earnings distributed in the form of cash deductions = cash dividends declared on common stock / net income
58
Price Earnings Ratio
A profitability ratio (AKA P-E ratio) reflects investors assessment of a company's future earnings = market price per share of common stock / earnings per share
59
Earnings per share
A profitability ratio (aka EPS) Measures net income earned on each share of stock = (Net income less preferred dividends) / weighted-average shares of common stock outstanding (weighted average = beg + end / 2) Per FASB must be shown on income statement
60
Return on COMMON stockholder's Equity
A profitability ratio (aka Return on Equity) Shows how many dollars of net income the company earned for each dollar invested by the owners = Net income less any preferred dividends / average common stockholder's equity (average = beg + end / 2) profitability of owner's investment
61
Return on Assets
A profitability ratio an overall measure of profitability of assets = net income + interest expense / average total assets net income + interest expense determines real return on income regardless of financing choices average = beg + end / 2 AKA return on total assets
62
Profit Margin
A profitability ratio Measures the percentage of each dollar of sales that results in net income = net income / net sales profit margin on sales
63
Profitability Ratios
Measure the income or operating success of a company for a given period of time. Income level affects companies ability to obtain debt and equity financing shows company's ability to grow Ratios: Profit margin, asset turnover, return on assets, return on common stockholder's equity, earnings-per-share, price-earnings, payout
64
Asset Turnover
A profitability Ratio Measures how efficiently a company uses its assets to generate sales = net sales / average total assets
65
Inventory Turnover
A liquidity ratio measures the average number of times the inventory is sold during a period = cost of goods sold / average inventory average = beg + end / 2 liquidity of inventory
66
Accounts Receivable Turnover
A liquidity Ratio Measures the average number of times a company collects receivables during a period = net credit sales / average net accounts receivable (net accounts receivable = net w/ allowance for doubtful accounts) liquidity of receivables
67
Acid Test Ratio
A liquidity ration (aka Quick Ratio) Measures immediate liquidity = (cash + short term investments + net accounts receivable) / current liabilities ignores inventory and prepaid accounts as not liquid enough
68
Current Ratio
A liquidity ratio measures amount of current assets for every dollar of current liabilities = current assets / current liabilities measures short term debt paying abilities
69
Liquidity Ratios
Measure the short term ability of a company to pay its maturing obligations and to meet unexpected needs for cash Of interest to short term creditors: bankers and suppliers current ratio, acid-test ratio, receivables turnover, inventory turnover
70
Working Capital
A measure of a businesses ability to meet its short-term obligations with its current assets = current assets - current liabilities
71
Ratio Analysis
Requires comparison for meaning: intra-company, inter-company or inventory average Expresses the relationship among selected items of financial data Liquidity: measures short term ability of a company to pay maturing obligations and meet unexpected needs for cash Profitability: measures income or operating success of a company for a period of time Solvency: Measures ability of a company to survive over a long period of time
72
Liquidity
The measure of the ability of a firm to meet its immediate current financial obligations
73
Solvency
The firm's ability to have sufficient assets to meet its debts in the long term
74
Solvency Ratios
Measure the ability of a company to survive over a long period of time Debt to total assets ratio Times interest Earned ratio both show debt-paying ability
75
Indirect method of statement of cash flow items added to net income
Anything that decreased net income without changing cash available: - depreciation, depletion and amortization expense - loss on disposal of long term assets - decreases in non-cash current assets - increases in current liabilities any long-term asset loss/gain goes to the inventory section
76
Purpose of statement of cash flows
- Predict future cash flows - evaluate management decisions - predict ability to pay debts and dividends
77
Usefulness of Balance Sheet
- computing rates of return - evaluating capital structure - company risk - future cash flows - liquidity - solvency - financial flexibility
78
Financial Instruments
Cash, an ownership interest or a contractual right to receive or obligation to deliver cash or another financial instrument Asset or liability includes: investments, payables and receivables
79
Financial Flexibility
Ability of an enterprise to take actions and alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities
80
Types of Stockholders' equity
- Capital Stock (par or stated value) - APIC: capital received over par/stated value) - Retained earnings - Accumulated other comprehensive income - Treasury Stock - Noncontrolling interest
81
Property Plant and Equipment
Tangible assets used in regular operation of the business all depreciate (except land) or deplete
82
Short term investments
Recorded at fair value with changes reported in net income unless equity method was used or measurement is not practical
83
Use of free cash flow measurement
- can a company pay dividends without external financing - if operations decline will company be able to maintain needed capital investment - what discretionary cash is available for additional investment, retirement of debt, purchase of treasury stock, added liquidity
84
Purpose of statement of cash flows
Summary of cash inflows and outflows (sources and uses) of cash in a period - financial flexibility - assess timing and uncertainty of future cash flows Assesses: - liquidity (availability of cash) - Solvency (ability to pay debts) - Financial flexibility (ability to respond and adapt)
85
Limitations of balance sheet
- Assets/ liabilities often reported at historical cost, not fair value - Judgements and estimates are made on many items - Omits items of financial value that cannot be measured objectively
86
Held-to-maturity securities
Debt investments Investments intended to be held / have the ability to be held until they mature current or long term assets depending on a maturity date reported at amortized cost
87
When is a liability payable in the next year NOT a current liability
- Debt will be refinanced via another long term issue - debt will be retired with non-current assets (So not resulting from use of current assets/ creation of new liabilities)
88
Long Term investments
A non-current asset - securities (bonds, stock, long term notes) - assets (like land) that are not used in operations - Funds (pension plans) - investments in nonconsolidated subsidiaries or affiliated companies
89
A/R, A/P, and the statement of cash flows
Increase in A/R = income increased but cash is not received. SUBTRACT the difference from net income Increase in A/P = income decreased but cash not paid out. ADD the difference to net income
90
Reporting stock on the balance sheet
Preferred always listed before common Report: par value, shares authorized, shares issued and shares outstanding for each class of stock additional paid-in capital is in its own section
91
Potential structure of statement of financial position
AKA balance sheet Framework: ``` Business: Operating assets and liabilities NET (total short term assets/ liabilities) Investing Assets and Liabilities NET (long term assets/ liabilities) Financing: Financing Assets Financing Liabilities NET Income Taxes Discontinued Operations Equity ``` Net Assets = Equity
92
"Netting" on financial statements
Currently in flux IFRS more restrictive than GAAP GAAP does not permit reporting of summary accounts alone "offsetting" = netting
93
Wording on balance sheet
- Understandable account titles - "reserve" recommended only used in regarding appropriation of retained earnings ("appropriated" also works) - discontinue use of "surplus"
94
Techniques of note disclosures
Focus on understandability - parenthetical explanations: in the body of the financial statement. Short. - Cross-reference and contra items: - relationship between asset and liability - contra account decreases account - adjunct account increases account - Supporting schedule: detailed information
95
Notes to the financial statements
To meet Full Disclosure principle - explanatory, supplemental - accounting polities used that involve selection or are industry specific - nature of operations - contractual situations (balance sheet note) - contingencies (balance sheet) - fair values (especially for financial instruments: balance sheet)
96
Fair value measurement disclosures in notes to financial statements
- fair value hierarchy level - fair value measurement - additional disclosure for any level 3 measurements must identify assumptions made and related income effects
97
Summary of significant accounting policies
- generally 1st note in financial statements - GAAP recommends disclosing all significant accounting principles and methods that: - involve selection from alternatives - are particular to industry - disclosure of use of estimates & basis of estimates - risk and uncertainties
98
Contractual obligations to disclose in notes to financial statements
Must disclose if material - commitments / obligations to maintain a level of working capital - limits on payments of dividends - restrictions on assets - requirements to maintain certain financial ratios - in tabular summary in management discussion of annual report "When in doubt, disclose"
99
Basic statement of cash flow components
- Cash effects of operating, investing and financing = net increase or decrease of cash during a period
100
Balance sheet account form
Lists assets (by sections) on the left side and liabilities and stockholders equity on the right side generally requires two facing pages
101
Balance sheet report form
Assets, liabilities and assets listed in sections down the same page. Assets - current - long term - PPE, intangible, other Liabilities and Stockholders' Equity - current - long term - stockholder's equity
102
Non-controlling interests
shown as a separate item as part of quity
103
Retained Earnings on balance sheet
May be divided between: unappropriated (available for dividend distribution) and restricted
104
Non-current assets on balance sheet
Long term investments: just below current assets - usually listed as "investments" - equity investments at fair value or equity method - may be adjusted for Available for Sale securities - PP&E shown with accumulated depreciation - discloses basis of value along with any liens in notes - intangible assets - other assets (vary) - prepaid expenses/ costs - special funds, restricted assets
105
Inventory on balance sheet
- must disclose basis of valuation (lower of cost or net realizable vs lower of cost or market) - must disclose cash flow assumption - manufacturers must also include state of completion (raw materials, work-in-progress, finished goods, inventories, and in-transit - may separate into product lines
106
Receivables from unusual transactions on balance sheet
Receivables arising from unusual transactions classified separately as long-term unless collection is expected with the year
107
Usefulness of statement of cash flows
- how successful is the company in generating net cash from operating activities - trends in cash flow from operations over time - major reasons for positive or negative cash flow from operating activities
108
Major classification categories
Assets: - current assets - long-term investments - PP&E - intangible assets - other assets Liabilities: - current liabilities - long-term debt - Owner's (stockholders') equity
109
Classified balance sheet
Items grouped together to arrive at significant subtotals and show important relationships FASB discourages use of summary accounts - items that differ in type/ expected function - different implications to financial flexibility - different general liquidity characteristics
110
Coverage Ratios
Measures the degree of protection for long term creditors and investors - debt to assets ratio - times interest earned - book value per share - free cash flow
111
Book Value per share
The amount each share would receive if the company were liquidated at the amounts shown on the balance sheet = common stockholders' equity / outstanding shares
112
Cash Debt coverage
Measure of financial flexibility = net cash provided by operating activities / average total liabilities ability to pay liabilities from net cash from operating activities higher = less difficulty meeting obligations
113
Activities Ratios
Measures of how effectively a company uses its assets - accounts receivable turnover - inventory turnover - asset turnover
114
Current cash debt coverage
Liquidity assessment = net cash provided by operating activities / average current liabilities higher = less likely to have liquidity problems
115
Z scores
Bankruptcy prediction module (used in loan evaluation) = (working capital/ total assets) x 1.2 + (retained earnings / total assets) x 1.4 + (EBIT / total assets) x 3.3 + (sales / total assets) x .99 + (MV equity x total liabilities) x 0.6
116
Working Capital
Net working capital Sometimes on the balance sheet Current assets less current liabilities