Chapter 5: Balance Sheet


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  • Chapter 5: Balance Sheet

    1. 1. Chapter 5: Balance Sheet and Statement of Cash Flows Systems
    2. 2. Part 1: The Balance Sheet
    3. 3. <ul><li>Provides information for evaluating: </li></ul><ul><li>Capital structure </li></ul><ul><li>Rates of return </li></ul>Balance Sheet: Usefulness
    4. 4. <ul><li>Provides information for evaluating: </li></ul><ul><li>Analyzing an enterprise’s: </li></ul><ul><ul><li>Liquidity </li></ul></ul><ul><ul><ul><li>Time to elapse until converted to cash/liability has to be paid </li></ul></ul></ul><ul><ul><li>Solvency </li></ul></ul><ul><ul><ul><li>Ability to pay debts when due </li></ul></ul></ul><ul><ul><li>Financial flexibility </li></ul></ul><ul><ul><ul><li>Ability to alter amounts & timing of cash flows to respond to unexpected situations </li></ul></ul></ul><ul><ul><ul><li>Affected by liquidity & solvency </li></ul></ul></ul>Balance Sheet: Usefulness
    5. 5. <ul><li>Most assets & liabilities stated at historical cost </li></ul><ul><li>Judgments & estimates used </li></ul><ul><li>Does not report items that can not be objectively determined </li></ul><ul><li>Does not report information regarding off-balance sheet financing </li></ul><ul><ul><li>FIN 45 & FIN 46 </li></ul></ul>Balance Sheet: Limitations
    6. 6. <ul><li>Guidelines for reporting assets & liabilities separately: </li></ul><ul><li>Type/expected function in central operations </li></ul><ul><ul><li>Inventories vs. PP&E </li></ul></ul><ul><li>Implications for financial flexibility </li></ul><ul><ul><li>Assets used in operations vs. invested </li></ul></ul><ul><li>Liquidity characteristics </li></ul><ul><ul><li>Cash vs. inventories vs. AR </li></ul></ul>Balance Sheet: Classification
    7. 7. <ul><li>Current Assets </li></ul><ul><li>Long-term investments </li></ul><ul><li>Property, plant, & equipment </li></ul><ul><li>Intangible assets </li></ul><ul><li>Other assets </li></ul><ul><li>Current liabilities </li></ul><ul><li>Long-term debt </li></ul><ul><li>Owners’ equity </li></ul><ul><ul><li>Capital stock </li></ul></ul><ul><ul><li>Additional paid-in capital </li></ul></ul><ul><ul><li>Retained earnings </li></ul></ul>Balance Sheet: Classification Assets Liabilities and Equity
    8. 8. <ul><li>Expected to be consumed, sold, or converted into cash: </li></ul><ul><ul><li>Either in one year or in operating cycle, whichever is longer </li></ul></ul><ul><li>Presented in order of liquidity </li></ul><ul><ul><li>Illustration 5-9 page 177 </li></ul></ul><ul><li>Valuation principles </li></ul><ul><ul><li>Certain short-term investments = fair value </li></ul></ul><ul><ul><ul><li>Trading, available-for-sale, held-to-maturity </li></ul></ul></ul><ul><ul><li>Accounts receivable = net realizable value </li></ul></ul>Current Assets
    9. 9. <ul><li>Don’t meet definition for current </li></ul><ul><ul><li>LT investments </li></ul></ul><ul><ul><ul><li>Illustration page 178 </li></ul></ul></ul><ul><ul><li>PP&E </li></ul></ul><ul><ul><ul><li>Illustration page 178 </li></ul></ul></ul><ul><ul><li>Intangibles </li></ul></ul><ul><ul><ul><li>Illustration page 179 </li></ul></ul></ul><ul><ul><li>Other assets </li></ul></ul><ul><ul><ul><li>Vary widely in practice </li></ul></ul></ul>Non Current Assets
    10. 10. <ul><li>Long-term investments may be: </li></ul><ul><li>Securities </li></ul><ul><ul><li>Bonds, stocks </li></ul></ul><ul><li>Fixed assets </li></ul><ul><ul><li>Land not used in operations, held for investment </li></ul></ul><ul><li>Amounts set aside in special funds </li></ul><ul><ul><li>Sinking fund </li></ul></ul><ul><li>Unconsolidated subsidiaries or affiliated companies </li></ul>Long-Term Investments
    11. 11. <ul><li>Current liabilities are liquidated: </li></ul><ul><ul><li>Either through the use of current assets, or </li></ul></ul><ul><ul><li>By creation of other current liabilities </li></ul></ul><ul><ul><li>Exception = refinanced/retired from LT assets </li></ul></ul><ul><li>Examples </li></ul><ul><ul><li>Payables resulting from acquisitions of goods & services </li></ul></ul><ul><ul><li>Collections received in advance of services </li></ul></ul><ul><ul><li>Other liabilities which will be paid in the short term </li></ul></ul><ul><li>Illustration 5-13 page 180 </li></ul>Current Liabilities
    12. 12. <ul><li>Long-term obligations are those not expected to be paid within the operating cycle </li></ul><ul><li>Examples </li></ul><ul><ul><li>Obligations arising from specific financing situations (issuance of bonds) </li></ul></ul><ul><ul><li>Obligations arising from ordinary business operations (pension obligations) </li></ul></ul><ul><ul><li>Obligations that are contingent (product warranties) </li></ul></ul><ul><li>Illustration 5-14page 181 </li></ul>Long-Term Liabilities
    13. 13. <ul><li>Capital stock </li></ul><ul><li>Additional paid-in-capital </li></ul><ul><li>Retained earnings </li></ul><ul><li>Partnership/sole proprietors </li></ul><ul><ul><li>Capital (permanent) drawing (temporary) separate </li></ul></ul><ul><li>Illustration 5-15 page 182 </li></ul>Owners’ Equity
    14. 14. <ul><li>Account form </li></ul><ul><ul><li>Assets on left side </li></ul></ul><ul><ul><li>Liabilities & SE on right side </li></ul></ul><ul><li>Report form </li></ul><ul><ul><li>Pancake </li></ul></ul><ul><ul><li>Illustration 5-16 page 183 </li></ul></ul>Balance Sheet Format
    15. 15. <ul><li>Supplemental information </li></ul><ul><ul><li>Not presented elsewhere </li></ul></ul><ul><ul><li>Qualifies items in the balance sheet </li></ul></ul><ul><ul><li>Examples </li></ul></ul><ul><ul><ul><li>Accounting policies (FN 1 or 2) </li></ul></ul></ul><ul><ul><ul><li>Contractual situations </li></ul></ul></ul><ul><ul><ul><li>Covenant restrictions </li></ul></ul></ul><ul><ul><ul><li>Fair values </li></ul></ul></ul><ul><ul><ul><ul><li>Illustration page 187 </li></ul></ul></ul></ul><ul><ul><ul><li>Material events having an uncertain outcome </li></ul></ul></ul><ul><ul><ul><ul><li>Illustration page 185 </li></ul></ul></ul></ul>Balance Sheet: Additional Information Reported
    16. 16. <ul><li>Parenthetical explanations </li></ul><ul><li>Notes </li></ul><ul><ul><li>Illustrations page 188 </li></ul></ul><ul><li>Cross references and contra/adjunct items </li></ul><ul><ul><li>Illustrations page 189 </li></ul></ul><ul><li>Supporting schedules </li></ul><ul><ul><li>Illustration page 189 </li></ul></ul>Balance Sheet: Techniques of Disclosure
    17. 17. Part 2: The Statement of Cash Flows
    18. 18. <ul><li>Provides information about: </li></ul><ul><ul><li>Cash receipts (cash inflows) </li></ul></ul><ul><ul><li>Uses of cash (cash outflows) </li></ul></ul><ul><ul><li>During a period of time </li></ul></ul><ul><li>Helps users evaluate </li></ul><ul><ul><li>Liquidity </li></ul></ul><ul><ul><ul><li>Nearness of cash </li></ul></ul></ul><ul><ul><li>Solvency </li></ul></ul><ul><ul><ul><li>Ability to pay debts </li></ul></ul></ul><ul><ul><li>Financial flexibility </li></ul></ul><ul><ul><ul><li>Ability to respond & adapt to changes </li></ul></ul></ul>The Cash Flow Statement
    19. 19. <ul><li>Information comes from </li></ul><ul><ul><li>Comparative BS </li></ul></ul><ul><ul><li>Current IS </li></ul></ul><ul><ul><li>Selected transaction data </li></ul></ul><ul><li>Inflows and outflows are reported for: </li></ul><ul><ul><li>Operating </li></ul></ul><ul><ul><li>Investing </li></ul></ul><ul><ul><li>Financing activities </li></ul></ul>The Cash Flow Statement
    20. 20. <ul><li>Steps </li></ul><ul><ul><li>Determine cash provided/used by operations </li></ul></ul><ul><ul><li>Determine cash provided/used by </li></ul></ul><ul><ul><ul><li>Investing </li></ul></ul></ul><ul><ul><ul><li>Financing </li></ul></ul></ul><ul><ul><li>Determine change in cash for period </li></ul></ul><ul><ul><li>Reconcile change in cash </li></ul></ul><ul><li>Illustrations page 194 & 195 </li></ul>The Cash Flow Statement
    21. 21. Cash Inflows and Outflows
    22. 22. <ul><li>There are two methods of preparing: </li></ul><ul><ul><li>Indirect method </li></ul></ul><ul><ul><ul><li>Most common in practice </li></ul></ul></ul><ul><ul><ul><li>Derives cash flows from accrual based statements </li></ul></ul></ul><ul><ul><ul><li>Illustration page 194 </li></ul></ul></ul><ul><ul><li>Direct method </li></ul></ul><ul><ul><ul><li>Derives cash flows directly for each source or use of cash </li></ul></ul></ul>Preparing a Statement of Cash Flows
    23. 23. The Statement of Cash Flows: Indirect Method Accrual Based Statements Cash Flow Statement Income Statement items & Changes in Current Assets and Current Liabilities Operating activities : Adjust net income for accruals and non-cash charges to get cash flows Balance Sheet: Changes in Non-Current Assets Investing activities : Inflows from sale of assets and Outflows from purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities : Inflows and outflows from loan and equity transactions
    24. 24. <ul><li>Ratio analysis expresses the relationship between selected financial data. </li></ul><ul><li>These relationships can be expressed as: </li></ul><ul><li>Percentages </li></ul><ul><li>Rates </li></ul><ul><li>Proportions </li></ul>Ratio Analysis
    25. 25. 06/02/10 Type What is measured Examples Types of Ratios Coverage ratios Some protection for LT creditors & investors Debt to total assets Times interest earned Liquidity ratios Short-term ability to pay maturing obligations Current ratio Quick assets ratio Profitability ratios Degree of success or failure for a given period Return on assets Earnings per share Activity ratios Effectiveness in using assets employed Receivables turnover Inventory turnover
    26. 26. <ul><li>Liquidity ratio (high) </li></ul><ul><ul><li>Current assets / current liabilities </li></ul></ul><ul><li>Current cash debt coverage ratio (high) </li></ul><ul><ul><li>Ability to pay CL in given year from operations </li></ul></ul><ul><ul><ul><li>Net cash operating activities / average current liabilities </li></ul></ul></ul><ul><li>Cash debt coverage ratio (high) </li></ul><ul><ul><li>Ability to pay liabilities from net cash from operations w/o liquidating assets </li></ul></ul><ul><ul><ul><li>Net cash operating activities / average total liabilities </li></ul></ul></ul>Ratio Analysis
    27. 27. <ul><li>Free cash flow </li></ul><ul><ul><li>Measures financial flexibility </li></ul></ul><ul><ul><ul><li>Discretionary cash flow available for </li></ul></ul></ul><ul><ul><ul><ul><li>Additional investments </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Debt retirement </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Purchase treasury stock </li></ul></ul></ul></ul><ul><ul><li>Formula </li></ul></ul><ul><ul><ul><li>Net cash from operating activities </li></ul></ul></ul><ul><ul><ul><li>Less </li></ul></ul></ul><ul><ul><ul><li>Capital outlay </li></ul></ul></ul><ul><ul><ul><li>Dividends </li></ul></ul></ul><ul><ul><li>Illustration page 198 </li></ul></ul>Cash Flow Analysis
    28. 28. <ul><li>Class exercises </li></ul><ul><li>E5-3 E5-4 E5-6 </li></ul><ul><li>E5-8 E5-9 E5-13 </li></ul><ul><li>E5-14 </li></ul>Balance Sheet & Statement of Cash Flows