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Chapter 5_ Balance Sheet _ Cash Flows_1_

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					Chapter 5: Balance Sheet and Statement of Cash Flows Systems

Part 1: The Balance Sheet

Balance Sheet: Usefulness
Provides information for evaluating: Capital structure Rates of return

Balance Sheet: Usefulness
Provides information for evaluating:  Analyzing an enterprise’s:
 Liquidity
 Time to elapse until converted to cash/liability has to be paid

 Solvency
 Ability to pay debts when due

 Financial flexibility
 Ability to alter amounts & timing of cash flows to respond to unexpected situations  Affected by liquidity & solvency

Balance Sheet: Limitations
Most assets & liabilities stated at historical cost • Judgments & estimates used • Does not report items that can not be objectively determined • Does not report information regarding offbalance sheet financing
•
–

FIN 45 & FIN 46

Balance Sheet: Classification
Guidelines for reporting assets & liabilities separately: • Type/expected function in central operations
– Inventories vs. PP&E

• Implications for financial flexibility
– Assets used in operations vs. invested

• Liquidity characteristics
– Cash vs. inventories vs. AR

Balance Sheet: Classification
Assets Liabilities and Equity

• Current Assets • Long-term investments • Property, plant, & equipment • Intangible assets • Other assets

• Current liabilities • Long-term debt • Owners’ equity
– Capital stock – Additional paid-in capital – Retained earnings

Current Assets
• Expected to be consumed, sold, or converted into cash:
– Either in one year or in operating cycle, whichever is longer

• Presented in order of liquidity
– Illustration 5-9 page 177

• Valuation principles
– Certain short-term investments = fair value
• Trading, available-for-sale, held-to-maturity

– Accounts receivable = net realizable value

Non Current Assets
• Don’t meet definition for current
– LT investments
• Illustration page 178

– PP&E
• Illustration page 178

– Intangibles
• Illustration page 179

– Other assets
• Vary widely in practice

Long-Term Investments
Long-term investments may be:
• • •

Securities
– Bonds, stocks

Fixed assets
– Land not used in operations, held for

investment

Amounts set aside in special funds
– Sinking fund

•

Unconsolidated subsidiaries or affiliated companies

Current Liabilities
• Current liabilities are liquidated:
– Either through the use of current assets, or – By creation of other current liabilities – Exception = refinanced/retired from LT assets

• Examples
– Payables resulting from acquisitions of goods & services – Collections received in advance of services – Other liabilities which will be paid in the short term

•

Illustration 5-13 page 180

Long-Term Liabilities
• Long-term obligations are those not expected to be paid within the operating cycle • Examples
– Obligations arising from specific financing situations (issuance of bonds) – Obligations arising from ordinary business operations (pension obligations) – Obligations that are contingent (product warranties)

• Illustration 5-14page 181

Owners’ Equity
• • • • Capital stock Additional paid-in-capital Retained earnings Partnership/sole proprietors
– Capital (permanent) drawing (temporary) separate

• Illustration 5-15 page 182

Balance Sheet Format
• Account form
– Assets on left side – Liabilities & SE on right side

• Report form
– Pancake – Illustration 5-16 page 183

Balance Sheet: Additional Information Reported
• Supplemental information
– Not presented elsewhere – Qualifies items in the balance sheet – Examples
• • • • Accounting policies (FN 1 or 2) Contractual situations Covenant restrictions Fair values
– Illustration page 187

• Material events having an uncertain outcome
– Illustration page 185

Balance Sheet: Techniques of Disclosure
• Parenthetical explanations • Notes
– Illustrations page 188

• Cross references and contra/adjunct items
– Illustrations page 189

• Supporting schedules
– Illustration page 189

Part 2: The Statement of Cash Flows

The Cash Flow Statement
• Provides information about:
– Cash receipts (cash inflows) – Uses of cash (cash outflows) – During a period of time

• Helps users evaluate
– Liquidity
• Nearness of cash

– Solvency
• Ability to pay debts

– Financial flexibility
• Ability to respond & adapt to changes

The Cash Flow Statement
• Information comes from
– Comparative BS – Current IS – Selected transaction data

• Inflows and outflows are reported for:
– Operating – Investing – Financing activities

The Cash Flow Statement
• Steps
– Determine cash provided/used by operations – Determine cash provided/used by
• Investing • Financing

– Determine change in cash for period – Reconcile change in cash

• Illustrations page 194 & 195

Cash Inflows and Outflows

Preparing a Statement of Cash Flows
• There are two methods of preparing:
– Indirect method
• Most common in practice • Derives cash flows from accrual based statements • Illustration page 194

– Direct method
• Derives cash flows directly for each source or use of cash

The Statement of Cash Flows: Indirect Method
Accrual Based Statements
Income Statement items & Changes in Current Assets and Current Liabilities

Cash Flow Statement
Operating activities: Adjust net income for accruals and non-cash charges to get cash flows
Investing activities: Inflows from sale of assets and Outflows from purchases of assets Financing activities: Inflows and outflows from loan and equity transactions

Balance Sheet: Changes in Non-Current Assets
Balance Sheet: Changes in Non-Current Liabilities and Equity

Ratio Analysis
Ratio analysis expresses the relationship between selected financial data. These relationships can be expressed as: • Percentages • Rates • Proportions

Types of Ratios
Type Liquidity ratios What is measured
Short-term ability to pay maturing obligations Effectiveness in using assets employed Degree of success or failure for a given period Some protection for LT creditors & investors

Examples
Current ratio Quick assets ratio Receivables turnover Inventory turnover Return on assets Earnings per share

Activity ratios
Profitability ratios Coverage ratios

Debt to total assets Times interest earned

Ratio Analysis
• Liquidity ratio (high)
– Current assets / current liabilities

• Current cash debt coverage ratio (high)
– Ability to pay CL in given year from operations
• Net cash operating activities / average current liabilities

• Cash debt coverage ratio (high)
– Ability to pay liabilities from net cash from operations w/o liquidating assets
• Net cash operating activities / average total liabilities

Cash Flow Analysis
• Free cash flow
– Measures financial flexibility
• Discretionary cash flow available for
– Additional investments – Debt retirement – Purchase treasury stock

– Formula
Net cash from operating activities Less Capital outlay Dividends

– Illustration page 198

Balance Sheet & Statement of Cash Flows
Class exercises E5-3 E5-4 E5-8 E5-9 E5-14
E5-6 E5-13


				
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