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Chapter 5

Chapter 5 – financial position and cash flows.docx

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ACC 414
Else Grech

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Chapter 5 – financial position and cash flows BALANCE SHEET  Usefulness of the balance sheet o Useful for analyzing company’s liquidity, solvency, and financial flexibility; as well as analyzing profitability o Liquidity : the amount of time that is expected to pass until an asset is realized (converted to cash or monetary asset)  Current ratio, quick ratio or acid test ratio (calculate liquidity)  Turnover ratios  The greater the liquidity, the lower the risk of enterprise or business failure o Solvency: an enterprises ability to pay its debts and related interest. o Financial flexibility: measures the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities  Affected by liquidity and solvency  Limitations of the balance sheet o Most assets and liabilities are stated at the historical cost which isn’t as relevant as would be the fair value o Estimates and judgements are used in determining many of the items reported in the balance sheet o Although relevant to the business the balance sheet leaves out many items because it cannot be recorded objectively  Classification in the balance sheet o Classified so that similar items are grouped together to arrive at significant subtotals. o Information should be separately reported so that users can assess the amounts, timing and uncertainty of future cash flows, company’s liquidity and flexibility o Monetary versus non monetary assets and liabilities  Monetary assets : represent either money itself or claims to future cahs flows that are fixed and determinable in amounts and timing  Non-monetary assets: their value interms of a monetary unit such as dollars is not fixed  Additional measurement uncertainty (recorded at their historical cost) o Financial instruments: contracts between two or more parties that are marketable or tradable (easy to measure)  Financial assets  cash, contractual rights to receive, or obligations to deliver (financial liability), cash or another financial instrument, investments in other companies o Balance sheet classification Assets Liabilities and Shareholers equity Current assets Current liabilities Long term investments Long term debt Prperty plant and equipement Intagible assets Shareholders’ equity Other assets Capital shares Contributed surplus Retained earnings Accumulated other comprehensive income/other surplus  These standard classfications make it easier to calculate important ratios such as the current ratio for assessing liquidity and debt-to-equity ratios for assessing solvency o Current assets: cash and other assets that will ordinarily be realized within one year from the date of the balance sheet or within the normal operating cycle if the cycle is longer than a year  Segregated and presented in order of liquidity o ASSETS  Current ass
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