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Chapter 5

RSM220H1 Chapter Notes - Chapter 5: Debt Service Coverage Ratio, Cash Flow, Historical Cost

Rotman Commerce
Course Code
Amy Kwan

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Usefulness of statements of financial position and cash flows
Assess risk of investing in company
Information about liquidity and solvency
Debt or equity?
Heavily indebted company may not be able to make most of opportunities
More financial flexibility helps companies survive economic downturns, take advantage
of opportunities to invest and expand
Statement of financial position
Can compare net income to cash flow to see potential red flags
Management might manipulate information to make results look better or worse, for strategic
Earnings quality
Ability to service debt
Statement of financial position
Long-term debt, shareholder's equity
Solvency level
Need more cash to make principal and interest payments
Companies with higher debt are higher risk
Assessing creditworthiness
Information about nature, amounts of investment in resources, obligations to creditors, equity
Helps predict amounts, timing, uncertainty of future cash flows
Statement of financial position
Current ratio
Quick (acid test) ratio
Current cash debt coverage ratio
Activity and turnover ratios
Greater liquidity means lower risk of business failure
Analyze liquidity
Ability to pay debt and interest
More assets required to meet fixed obligations
Higher debt is riskier
Coverage ratios
Analyze solvency
Affected by liquidity, solvency
Financial flexibility: ability to take action to alter amounts and timing of cash flows to respond
to unexpected needs/opportunities
Assets, liabilities stated at historical cost
Determined using judgement and estimates
"soft numbers
Leaves out relevant items that cannot be recorded objectively
Individual items should be separately classified in enough detail for users to assess liquidity,
financial profitability, risk
Carrying value (is approximately net realizable cost) represents economic reality
Monetary asset: money or claims to future cash flows that are fixed/determinable in amount and
Non-monetary assets recorded at historical or amortized cost
Monetary vs non-monetary assets and liability
Often marketable or tradeable
Cash, contractual rights to receive cash/another financial instrument, equity instruments of
other companies
Financial instruments
Week 4: Chapter 5: Financial Position and Cash Flows
January 29, 2018
RSM220 Page 1
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