Usefulness of the Statements of Financial Position and Cash
Flows from a Business Perspective
Analyzing a Statement of Financial Position
Provides information about a company's liquidity and solvency in order to assess the
risk of investing in a company.
Provides details about the company's financial structure, such as whether it is
financed primarily by debt or equity.
Assessing Earnings Quality
One concern of users of financial statements is that company insiders might manipulate
information to make earnings look better or worse than they are, for strategic reasons.
Assessing the Credit Worthiness of Companies
Creditors often rely on the statement of financial position to assess a company's liquidity
and its ability to service debt.
Statement of Financial Position
Statement of financial position (Balance sheet): reports a business enterprise's assets,
liabilities, and shareholders' equity at a specific date.
it helps in predicting the amounts, timing, and uncertainty of future cash flows.
Usefulness of the Statement of Financial Position
The SFP is useful for analyzing a company's liquidity, solvency, and financial flexibility.
Helps with analyzing the profitability, but not primary focus…)
Liquidity: Depends on the amount of time that is expected to pass until an asset is
realized. (converted into cash or other monetary asset).
Current cash debt coverage ratio
The liquidity of certain assets, like receivables and inventory, is assessed through turnover
Creditors are interested in short-term liquidity ratios.
In general, the greater the liquidity, the lower the risk of enterprise or business failure.
Solvency: Reflects an enterprise's ability to pay its debts and related interest.
Liquidity and solvency affect an entity's 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.
Limitations of the Statement of Financial Position 1. Many assets and liabilities are stated at their historical cost.
2. Judgements and estimates are used in determining many of the items reported in the SFP.
Includes many "soft" numbers.
3. The SFP necessarily leaves out many items that are of relevance to the business but
cannot be recorded objectively.
Classification in the Statement of Financial Position
SFP accounts are classified so that similar items are grouped together to arrive at
Helps analysts and other financial statement users by grouping items with similar
characteristics and separating items with different characteristics.
1. Assets that are of a different type or that have a different function in the
company's activities should be reported as separate items.
2. Liabilities with different implications for the enterprises's financial flexibility
should be reported as separate items.
3. Assets and liabilities with different general liquidity characteristics should be
reported as separate items.
4. Certain assets, liabilities, and equity instruments have attributes that allow
them to be measured or valued more easily.
Monetary versus Nonmonetary Assets and Liabilities
Monetary assets represent either money itself or claims to future cash flows that are fixed
and determinable in amounts and timing.
Likewise, liabilities that require future cash outflows that are fixed and determinable
in amounts and timing.
Nonmonetary assets - their value in terms of a monetary unit such as dollars is not fixed.
Financial Instruments are contracts between two or mote parties that create financial
assets for n party and financial liability or equity instrument for the other.
They are often marketable or tradable, and therefore easy to measure.
Many financial instruments are also monetary assets or liabilities.
Contractual rights to receive cash or another financial instrument
Equity investments in other companies.
Contractual rights to receive cash or other financial instruments are assets,
whereas contractual obligations to pay are liabilities.
Elements of the statement of financial position
1. Assets: Present economic benefits that are controlled by an entity as a result of past
transactions or events.
2. Liabilities: Present obligations that arise from past transactions or events.
3. Equity/Net assets: The residual interest in an entity's assets that remains after deducting
its liabilities. In a business enterprise, the equity is the ownership interest.
Preparation of the Classified Statement of Financial Position (Balance Sheet)
Current Assets: Current assets: include cash and other assets that will ordinarily be realized within
one year from the date of the statement of financial position or within the normal
operating cycle if the cycle is longer than a year.
Current assets are generally segregated and presented in the SFP in order
according to their liquidity.
1. Cash: at its stated value
Cash is often grouped with other cash-like liquid assets and reported
as Cash and cash equivalents.
Cash: defined as cash, demand deposits, and short-term, highly liquid
investments that are readily convertible into known amounts of cash
and have an insignificant risk of changing in value.
2. Investments: at cost/amortized cost or fair value
Companies that have excess cash often have significant amounts of
3. Accounts receivable: at the estimated amount that is collectible.
Should be segregated to show ordinary trade accounts, amounts
owing by related parties, and other unusual items of a substantial
Anticipated losses due to uncollectibles should be accrued.
The amount and nature of any non trade receivables and any
receivables that have been designated or pledged as collateral should
4. Inventories: generally at the lower of cost and net realizable value
Inventories are assets:
1. Held for sale in the ordinary course of business
2. In the process of production for such sale, or
3. In the form of materials or supplies to be consumed in the
production process or in the rendering of service.
Determined using a cost formula:
First in, first out (FIFO)
Weighted average cost
5. Prepaid items: at cost
Prepaid expenses included in current assets are expenditures already
made for benefits (usually services) that will be received within one
year or the operating cycle, whichever is longer.
See Illustration 5 - 7 page 232 for types of accounts...
Long term investments are usually presented on the SFP just below current assets in
a separate section called "Investments".
Property, Plant, and Equipment