Decision guidelines

Question 1

1. Can the company sell its services or products?

Answer 1

NET REVENUE on the income statement. Are revenues growing or falling?

Question 2

2. What are the main income measures to watch for trends?

Answer 2

GROSS PROFIT (sales - cost of goods sold)
OPERATING INCOME (gross profit - operating expenses)
NET INCOME  (bottom line of the income statement)
All three measures should be increased over time.

Question 3

3. What percentage of revenue ends up as profit?

Answer 3

Divide NET INCOME by SALES REVENUE. Examine the trend of NET INCOME percentage from year to year

Question 4

4. Can the company collect its receivables ?

Answer 4

From the balance sheet, compare the percentage increase in ACCOUNTS RECEIVABLE to the percentage increase in SALES. If receivables are growing much faster than sales, collections may be too slow and a cash shortage may result.

Question 5

. Can the company pay its:
Current liabilities?
Current and Long-Term liabilities

Answer 5

From the Balance Sheet, compare:
CURRENT ASSETS to CURRENT LIABILITIES. Current assets should be somewhat greater than current liabilities.
Total assets to total liabilities. Total assets must be somewhat greater than total liabilities.

Question 6

Where is the company’s cash coming from? How is cash being used?

Answer 6

On the cash flow statement, operating activities should provide the bulk of the company’s cash during most of the year. Otherwise, the business will fail.

Examine investing cash flows to see if the company is purchasing long-term assets – property, plant, and equipment and intangibles (the signals growth)

Question 7

Where to record a transaction

Answer 7

In the journal , the chronological record of transactions

Question 8

Where to store all the information for each account?

Answer 8

In the ledger

Question 9

Where to list all the accounts and their balances

Answer 9

In the trial balance

Question 10

Where to report results of operations

Answer 10

In the income statement (revenues - expenses = net income or net loss)

Question 11

Financial position

Answer 11

In the balance sheet (assets = liabilities + stockholder’s equity)

Question 12

How can you measure a company’s ability to pay current liabilities with current assets?

Answer 12

Net working capital = total current assets - total current assets

Current ratio = total current assets/total current liabilities

Question 13

What is a good value of net working capital and the current ratio

Answer 13

Companies with strong cash flow: 1.1-1.2

Companies with slow cash flow: 1.3 - 1.5