Reading 24- Understanding Balance Sheets

Question 1

Describe the elements of the balance sheet: assets, liabilities, and equity.

Answer 1

Assets= resources controlled by the actions of past transactions that were bought in the “hope” of acquiring more FUTURE ECONOMICS BENEFITS.

Liabilities= obligations that result in past transactions that cause “OUTFLOW OF ECONOMIC BENEFITS”

Equity= net assets- liabilities

Question 2

Describe uses and limitations of the balance sheet in financial analysis.

Answer 2

A balance sheet is used to look at the businesses’ health. An example of this includes liquidity and solvency.

*Health is determined by the ability to liquidate assets to pay for debt when notices are due.

Question 3

Describe alternative formats of balance sheet presentation.

Answer 3

a. ) Classified balance sheet- broken down into current and non-current assets as well as current and non-current liabilities.
b. ) Liquidity Based Format- all assets and liabilities are ordered from most liquid to least liquid.

Question 4

Distinguish between current and non-current assets and current and non-current liabilities.

Answer 4

Current= able to liquidate within 1 year/ needs to be paid within 1 year or 1 inventory cycle.

Question 5

Describe different types of assets and liabilities and the measurement bases of each.

Answer 5

ASSETS-

a. ) cash & cash-equivalents- high liquid assets that are close to maturity. (ex: cash, cash equivalents, marketable securities, T-BILLS, Market Funds)
b. ) marketable securities- securities that make up common-stock that can be sold on the daily and liquidated quickly.

Current Assets-
Accts Recievable, Inventories, Prepaid Expenses

Current Liabilities- (HIGH LIQUIDITY)

a. ) accounts payable
b. ) notes payable
c. ) accrued liabilities
d. ) unearned revenues

Question 6

Describe the components of shareholders’ equity.

Answer 6

Shareholders Equity/ Owners Equity-
+ A-L=SHE
+ SHE may include: contributed capital, preferred stock, treasury stock, RE, non-controlling interests, other comprehensive income

Question 7

Convert balance sheets to common-size balance sheets and interpret common-size balance sheets.

Answer 7

• All assets are made a percentage of TOTAL ASSETS

- All liabilities are made a percentage of TOTAL LIABILITIES.

Question 8

Calculate and interpret liquidity and solvency ratios.

Answer 8

LIQUIDITY RATIOS- the ability to pay short-term obligations w/ next 30 DAYS

• CURRENT RATIO, CASH RATIO, QUICK RATIO

SOLVENCY RATIOS- solvency is the ability of the firm to continue its operations for a “LONG-PERIOD-OF-TIME” by demonstrating the ability to pay off its long term obligations.

*LONG TERM DEBT RATIO, TOTAL DEBT-EQUITY RATIO, DEBT RATIO