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Chapter 5 BALANCE SHEET.docx

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Administrative Studies
ADMS 3585
Ping Peng

Chapter 5: Financial Position and Cash Flows Balance Sheet: Usefulness • Also known as Statement of Financial Position • The balance sheet provides information: • for evaluating the capital structure and • for computing rates of return on invested assets • It is also useful for assessing an enterprise’s: o Liquidity (time until asset is realized or liability has to be paid) o Solvency (ability to pay debts and related interest) o Financial flexibility (ability to respond to unexpected needs and opportunities) Liquidity CurrentAssets • Current Ratio: CurrentLiabilities • Quick Ratio Cash,MarketableS ecurities,NetReceivables AverageCurrentLiabilities • Working Capital = Current Assets – Current Liabilities • Combining with Statement of Cash Flow • Current Cash Debt Coverage Ratio = Net Cash Provided by Operating Activities Average Current Liabilities Solvency Coverage Ratios: TotalDebt • Debt to assets: TotalAssets • Debt to equity: TotalDebt Shareholders 'Equity Flexibility • Combining with Statement of Cash Flow o Cash Debt Coverage Ratio = Net Cash Provided by Operating Activities Average Total Liabilities 1. Free cash flow – Calculated as net cash from operations less capital expenditures and dividends Balance Sheet: Limitations 1. Many assets and liabilities are stated at historical cost o Information presented is reliable, however o Reporting at current fair value would result in more relevant information 2. Judgement and estimates are used in determining many of the items reported on the Balance Sheet o Many “soft” numbers (estimates) are included which may be uncertain o e.g. accounts receivable; inventory 3. The balance sheet does not report items that cannot be recorded objectively (e.g. internally generated goodwill) Balance Sheet: Classification • Similar items are grouped together, with sub-total • Items with different characteristics are separated • Individual balance sheet items should be: • Reported separately, and in • Sufficient detail in order to:  Allow users to assess amounts, timing, and uncertainty of future cash flows  Allow users to evaluate liquidity, financial flexibility, profitability, and risk  Helps to calculate important ratios (e.g. current ratio to assess liquidity) • More choice and flexibility is permitted under IFRS with respect to the format of the balance sheet (reverse order liquidity is more common). Profitability • Return on assets: NetIncome AverageTotalAssets • Return on equity: NetIncome AverageCommonShareholders 'Equity Elements Of The Balance Sheet • Assets: Present economic benefits that the entity has rights or access to (and others do not) • Liabilities: Present economic obligation/burden that is enforceable • Equity (or net assets): The residual interest in assets after liabilities are deducted Balance Sheet: Classification Assets: • Current assets • Long-term investments • Property, plant, and equipment • Intangible assets • Other assets Liabilities and Equity: • Current liabilities • Long-term debt • Shareholders’ equity o Capital shares o Contributed surplus o Retained earnings o Accumulated other comprehensive income / other surplus Financial Instruments vs. Monetary Items • Financial instruments o include three categories 1. Cash 2. Strategic investments in other companies 3. Contractual rights to receive or contractual obligations to deliver cash or another financial instrument (examples: all receivables, payables, loans, passive investments in stocks, bonds, derivatives, etc.) – Classified into financial assets and financial liabilities • Monetary items  include category (1) and (3) only  C
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