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Chapter 5

Management and Organizational Studies 3360A/B Chapter Notes - Chapter 5: Debt Service Coverage Ratio, Financial Instrument, Current Liability


Department
Management and Organizational Studies
Course Code
MOS 3360A/B
Professor
Stacey Hann
Chapter
5

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Chapter 5 Financial Position and Cash Flows
STATEMENT OF FINANICAL POSITION
Usefulness and Limitations of the Statement of Financial Position
Statement of financial position reports a business enterprise’s assets, liabilities, and
shareholder’s equity at a specific date
Usefulness
o Useful for analyzing a company’s liquidity, solvency, and financial flexibility
o Liquidity a company’s ability to convert assets into cash to pay off its current
liabilities in the ordinary course of business
Ratios: current ratio, quick/acid ratio, and current cash debt coverage ratio
Creditors are interested in short term liquidity ratios because these ratios
indicate whether the enterprise will have the resources to pay its current
and maturing obligations
o Solvency a company’s ability to pay its debts and related interest
Companies with higher debt are riskier because more of their assets will
be required to meet these fixed obligations
Ratios: coverage ratio
o Financial flexibility the ability of an enterprise to take effective action to alter
the amounts and timing of cash flows so it can respond to unexpected needs and
opportunities
Liquidity and solvency affect a company’s financial flexibility
Limitations
1. Many assets and liabilities are recorded at their historical cost
2. Judgements and estimates are used in determining many of the items reported
in the statement of financial position
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
Similar items are grouped together and items with different characteristics are seperated
Monetary versus Non-Monetary Assets and Liabilities
o Monetary assets represents either money itself or claims to future cash flows
that are fixed or determinable in amount and timing
Examples include notes payable and long-term debt
o Non-monetary assets items whose values in terms of the monetary unit may
change over time
Financial instruments
o Financial instruments contracts between two or more parties that create a
financial asset for one party and a financial liability or equity instrument for the
other
o Financial assets include cash, contractual rights to receive cash or another
financial instrument, and equity instruments of other companies
o Current accounting standards require fair value accounting for certain types of
financial instruments
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