Mindjet: Liquidity Ratios Measure The Short-Term

The balance sheet provides information about the nature and amounts of investments in a companys resources, obligations to creditors,
and owners equity. The balance sheet contributes to financial reporting by providing a basis for (1) computing rates of return, (2) evaluating the capital structure of the enterprise, and (3) assessing the liquidity, solvency, and financial flexibility of the enterprise. Three limitations of a balance sheet are: (1) The balance sheet does not reflect fair value because accountants use a historical cost basis in valuing and reporting most assets and liabilities. (2) Companies must use judgments and estimates to determine certain amounts, such as the collectibility of receivables and the useful life of long-term tangible and intangible assets. (3) The balance sheet omits many items that are of financial value to the business but cannot be recorded objectively, such as human resources, customer base, and reputation. The information to prepare the statement of cash flows usually comes from comparative balance sheets, the current income statement, and selected transaction data. Companies follow four steps to prepare the statement of cash flows from these sources: (1) Determine the cash provided by operating activities. (2) Determine the 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 the beginning and ending cash balances. Creditors examine the cash flow statement carefully because they are concerned about being paid. The net cash flow provided by operating activities in relation to the companys liabilities is helpful in making this assessment. Two ratios used in this regard are the current cash debt ratio and the cash debt ratio. In addition, the amount of free cash flow provides creditors and stockholders with a picture of the companys financial flexibility. Ratios express the mathematical relationship between one quantity and another, expressed as a percentage, a rate, or a proportion. Liquidity ratios measure the short-term ability to pay maturing obligations. Activity ratios measure the effectiveness of asset usage. Profitability ratios measure the success or failure of an enterprise. Coverage ratios measure the degree of protection for long-term creditors and investors.
Explain the uses and limitations of a balance sheet.
Prepare a basic statement of cash flows
Understand the usefulness of the statement of cash flows.
Identify the major types of financial ratios and what they measure
Prepare a classified balance sheet using the report and account formats
The report form lists liabilities and stockholders equity directly below assets on the same page. The account form lists assets, by sections, on the left side, and liabilities and stockholders equity, by sections, on the right side. The primary purpose of a statement of cash flows is to provide relevant information about a companys cash receipts and cash payments during a period. Reporting the sources, uses, and net change in cash enables financial statement readers to know what is happening to a companys most liquid resource. In the statement of cash flows, companies classify the periods cash receipts and cash payments into three different activities: (1) Operating activities : Involve the cash effects of transactions that enter into the determination of net income. (2) Investing activities : Include making and collecting loans, and acquiring and disposing of investments (both debt and equity) and of property, plant, and equipment. (3) Financing activities: Involve liability and owners equity items. Financing activities include (a) obtaining capital from owners and providing them with a return on their investment, and (b) borrowing money from creditors and repaying the amounts borrowed.
Chapter 5 Balance Sheet and Statement of Cash Flows
Companies use four methods to disclose pertinent information in the balance sheet: (1) Parenthetical explanations: Parenthetical information provides additional information or description following the item. (2) Notes: A company uses notes if it cannot conveniently show additional explanations or descriptions as parenthetical explanations. (3) Cross-reference and contra items: Companies cross-reference a direct relationship between an asset and a liability on the balance sheet. (4) Supporting schedules: Often a company uses a separate schedule to present more detailed information than just the single summary item shown in the balance sheet. Four types of information normally are supplemental to account titles and amounts presented in the balance sheet: (1) Contingencies: Material events that have an uncertain outcome. (2) Accounting policies: Explanations of the valuation methods used or the basic assumptions made concerning inventory valuation, depreciation methods, investments in subsidiaries, etc. (3) Contractual situations: Explanations of certain restrictions or covenants attached to specific assets or, more likely, to liabilities. (4) Fair values: Disclosures related to fair values, particularly related to financial instruments.
Indicate the purpose of the statement of cash flows.
Describe the major disclosure techniques for the balance sheet
Identify the content of the statement of cash flows.
Determine which balance sheet information requires supplemental disclosure.
Identify the major classifications of the balance sheet.
The general elements of the balance sheet are assets, liabilities, and equity. The major classifications of assets are current assets; long-term investments; property, plant, and equipment; intangible assets; and other assets. The major classifications of liabilities are current and long-term liabilities. The balance sheet of a corporation generally classifies owners equity as capital stock, additional paid-in capital, and retained earnings
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Mindjet: Liquidity Ratios Measure The Short-Term

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The balance sheet provides information about the nature and amounts of investments in a companys resources, obligations to creditors,

Explain the uses and limitations of a balance sheet.

Prepare a basic statement of cash flows

Understand the usefulness of the statement of cash flows.

Chapter 5 Balance Sheet and Statement of Cash Flows

Indicate the purpose of the statement of cash flows.

Describe the major disclosure techniques for the balance sheet

Identify the content of the statement of cash flows.

Determine which balance sheet information requires supplemental disclosure.

Identify the major classifications of the balance sheet.

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