A Further Look At Financial Statement

classified balance sheet

☑︎ a balance sheet that groups together similar assets and similar liabilities, using a number of standard classifications and sections

☑︎ it improves users' understanding of a company's financial position

standard balance sheet classifications

☑︎ assets

- current assets

- long-term investments

- property, plant, and equipment (PPE)

- intangible assets

☑︎ liabilities & stockholders' equity

- current liabilities

- long-term liabilities

- stockholders' equity

importance of groupings in classified financial balance sheets

they help those reading the financial statements to determine whether the company has enough assets to pay its debts as they come due, and the claims of short-and long-term creditors on the company's total assets

current assets

☑︎ assets that a company expects to convert to cash or use up within one year or its operating cycle (whichever is longer)

common types of current assets:

☑︎ cash

☑︎ investments

☑︎ receivables (accounts receivable, notes receivable, interest receivable)

☑︎ inventories

☑︎ prepaid expenses

*companies list current assets in the order in which they expect to convert them into cash*

operating cycle

☑︎ the average time required to go from cash to cash in producing revenue (to purchase inventory, sell it on account, and then collect cash from customers)

☑︎ companies with an operating cycle longer than a year include aeroplane manufacturers and vineyards

long-term investments

☑︎ investments in stocks and bonds of other corporations that companies hold for more than one year

☑︎ long-term assets, such as land and buildings, that are not currently being used in the company's operations

☑︎ long-term notes receivable

property, plant, and equipment

assets with relatively long useful lives that are currently used in operating the business

☑︎ land

☑︎ buildings

☑︎ equipment

☑︎ delivery vehicles

☑︎ furniture

depreciation

the allocation of the cost of an asset to a number of years

accumulated depreciation

the total amount of depreciation expense that has been recorded since the purchase of an asset

intangible assets

assets that do not have physical substance, yet are often very valuable

☑︎ goodwill

☑︎ patents

☑︎ copyrights

☑︎ trademarks

current liabilities

obligations that a company expects to pay within the next year or operating cycle, whichever is longer

☑︎ accounts payable

☑︎ salaries and wages payable

☑︎ notes payable

☑︎ interest payable

☑︎ income taxes payable

long-term liabilities

obligations that a company expects to pay after one year

☑︎ bonds payable

☑︎ mortgages payable

☑︎ long-term notes payable

☑︎ lease liabilities

☑︎ pension liabilities

common stock

the investments of assets into the business by the stockholders

retained earnings

the income retained for use in the business

ratio analysis

expresses the mathematical relationship among selected items of financial statement data

intracompany comparisons

covering two years for the same company

industry-average comparisons

based on average ratios for particular industries

intercompany comparisons

based on comparisons with a competitor in the same industry

profitability ratios

measure the income or operating success of a company for a given period of time

☑︎ earnings per share (EPS)

liquidity ratios

measure short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash

☑︎ current ratio

solvency ratios

☑︎ measure the ability of the company to survive over a long period of time

☑︎ longterm creditors and stockholders are interested in a company's solvency—its ability to pay interest as it comes due and to repay the balance of debt due at its maturity

☑︎ debt to assets ratio

earnings per share (EPS)

☑︎ measures the net income earned on each share of common stock

☑︎ as stockholders usually think in terms of the

number of shares they own or plan to buy or sell, stating net income earned as a per-share amount provides a useful perspective for determining the investment return

☑︎ it also helps users compare a company's performance with that of previous years

☑︎ note that comparisons of EPS across companies are not meaningful because of the wide variations in the numbers of shares of outstanding stock among companies

working capital

☑︎ a measure of liquidity

☑︎ the difference between the amounts of current assets and current liabilities

☑︎ a positive working capital means there is a greater likelihood that the company will pay its liabilities

current ratio

☑︎ helps users determine if a company can meet its near-term obligations

☑︎ the current ratio is a more dependable indicator of liquidity than working capital

*e.g.* a current ratio of 1.41:1 means that for every dollar of current liabilities, that company has $1.41 of current assets

☑︎ potential weakness: it does not take into account the composition of the current assets

☑︎ the composition of the current assets matters because a dollar of cash is more readily available to pay the bills than is a dollar of inventory

Can a company be too liquid?

☑︎ there actually is a point where a company can be too liquid—that is, it can have too much working capital

☑︎ while it is important to be liquid enough to be able to pay short-term bills as they come due, a company does not want to tie up its cash in extra inventory or receivables that are not earning the company money

debt to assets ratio

☑︎ helps users determine if a company can meet its long-term obligations

☑︎ it measures the percentage of total financing provided by creditors rather than stockholders

☑︎ the higher the percentage of total liabilities (debt) to total assets, the greater the risk that the company may be unable to pay its debts as they come due

*e.g.* a ratio of 72% means that every dollar of assets was financed by 72 cents of debt

free cash flow

☑︎ describes the net cash provided by operating activities after adjusting for capital expenditures (invest in new property, plant, and equipment to maintain the current level of operations) and dividends paid

☑︎ provides additional insight regarding a company's cash-generating ability

☑︎ helps users determine the amount of cash a company generated to expand operations, pay off debts, or increase dividends

Securities and Exchange Commission (SEC)

the agency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies

Financial Accounting Standards Board (FASB)

the primary accounting standard-setting body in the US

International Accounting Standards Board (IASB)

☑︎ an international accounting standard-setting body responsible for the convergence of accounting standards worldwide

☑︎ issues standards called International Financial Reporting Standards (IFRS)

☑︎ today, the FASB and IASB are working closely together to minimise the differences in their standards

Public Company Accounting Oversight Board (PCAOB)

the group charged with determining auditing standards and reviewing the performance of auditing firms

According to the FASB, useful information should possess two fundamental qualities...

☑︎ relevance

- information that would make a difference in a business decision

- relevant information has predictive and confirmatory value, meaning it helps provide accurate expectations

about the future, and confirms or corrects prior expectations

☑︎ faithful representation

- information accurately depicts what really happened

- complete (nothing important has been omitted)

- neutral (not biased toward one position or another)

- free from error