chapter 5 notes.docx

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University of Waterloo
Accounting & Financial Management
AFM 291
Robert Ducharme

Chapter 5 Financial Position and Cash Flows Balance Sheet Usefulness of the Balance Sheet  For analyzing company's liquidity, solvency and financial flexibility  Current ratio, quick or acid test ration and current cash debt coverage ratio help to measure liquidity  Liquidity of assets such as inventory is assessed with the turnover ratio  Solvency refers to the enterprise's ability to pay its debt and related interest  Liquidity and solvency affect the entity's financial flexibility -> ability of enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities  Air Canada eased its cash flow problems through: (1) arranging for interim financing (2) restructuring union contracts (3) renegotiating aircraft leases for 106 planes Limitations of the Balance Sheet  (1) stated at historical cost ->criticized as being less relevant than current fair value would be -> moving toward greater use of fair value  (2) judgement and estimates -> soft numbers  (3) leaves out items that are relevant but cannot be recorded objectively  Ie. Recognized liabilities -> worsen liability and solvency ratios -> biased to capitalize instead of expense
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