Chapter 5: Balance Sheet and Statement of Cash Flows Flashcards
Current Ratio
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)
Liquidity Ratios
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
Liquidity
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.”
Long-Term Liabilities
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
Current Liabilties
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
Long term assets
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
Current Assets
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
Operating Cycle
Average time from purchase of inventory to collection of cash from customers
Lower-of-cost-or-Market Rule
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
Cash Ratio
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
Cash Equivalent
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
Current assets NRV on balance sheet
Net Realizable Value of current assets on balance sheet
Current Assets:
Accounts Receivable
Less: Allowance for bad debts
Receivables on the Balance Sheet
- 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
Valuing Accounts Receivable
- 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
Types of Receivables
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
Intangible assets on financial statements
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)
Intangible Assets
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
Current Liabilities on Balance Sheet
Notes Payable
Accounts Payable
Then in order of magnitude (largest to smallest)
When long term debt matures
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
Stock on balance sheet (common only)
Stockholders' Equity
Paid-In Capital
Common Stock
Paid-In-Capital in excess of par value
Total Paid-in-capital
Retained Earnings
Total Stockholder's EquityTreasury Stock on Balance Sheet
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
APIC
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
Stock on balance sheets
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
Par Value stock
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
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
Retained Earnings
Net income a corporation retains for future use
Earned but not property of/ distributable to the owners
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
Dividends on Financial Statements
Dividends not deducted as expense on income statement
Stock dividends distributable is shown as an addition to capital stock
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
Leases on Balance Sheet
portion to paid in next year = current liability
remainder outstanding = long term liability
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
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
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
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)
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
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
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)
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
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
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
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
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
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)
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)
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)
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
