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Questions and Answers
What is the primary purpose of a balance sheet?
What is the difference between a short-term asset and a long-term asset?
What is the purpose of depreciating an asset?
What is the formula for calculating earnings per share (EPS)?
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What is the purpose of a cash flow statement?
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What is the return on equity (ROE) ratio used to measure?
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What is the purpose of liquidity and leverage measures?
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What is the acid test ratio used to measure?
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Study Notes
Balance Sheets
- A snapshot of a company's financial position at a specific point in time
- Assets are listed on the left side, and claims on assets are listed on the right side
- Equityholders have a claim on assets once debtholders have been satisfied
- Book value refers to an asset's value at the time of purchase
Assets
- Short-term assets are also known as current assets
- Long-term assets are also known as fixed assets, and include land, equipment, and property
- Some long-term assets, such as equipment and property, are affected by depreciation, or the loss of value over time
- Other assets include patents and goodwill
Liabilities
- Current liabilities include debts that must be paid within a year, such as accounts payable and notes payable
- Long-term liabilities include debts that do not need to be paid within a year
- Other liabilities also exist
Equity
- Preferred shares and common equity are both types of equity
Income Statements
- The accrual method is used to prepare income statements
- Revenue minus costs and expenses equals profit, which is calculated over a period of time
- Earnings per share (EPS) is calculated by dividing net income by the number of common shares outstanding
Cash Flow Statements
- Cash flow statements show the inflow and outflow of cash in a straightforward manner
- Cash flow is divided into three categories: operating activities, investing activities, and financing activities
- Depreciation is added back into the cash flow from operating activities
Performance Measures
- Financial ratios, also known as ratio analyses, are used to evaluate a company's performance
- Return on equity (ROE) measures a company's overall profitability relative to shareholders' investment
Profitability Measures
- Profitability measures focus on the income statement
- Gross margin percentage measures profitability
- Expense ratio measures the impact of expenses on profitability
Resource Management Measures
- Resource management measures use data from both the income statement and the balance sheet
- Age of inventory (days) measures the average time between purchase and sale
- Inventory turnover measures the number of times inventory is sold and replaced within a year
- Age of accounts receivable (days) measures the average time it takes to collect accounts receivable
- Age of accounts payable (days) measures the average time it takes to pay accounts payable
Liquidity and Leverage Measures
- Liquidity measures a company's ability to meet short-term and long-term obligations
- Leverage measures evaluate a company's optimal use of debt
- Short-term liquidity measures include the current ratio and acid test ratio
- Long-term leverage measures include the debt-to-equity ratio and long-term debt-to-capital ratio
- Interest coverage measures a company's ability to pay interest expenses
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Description
This quiz covers the concept of balance sheets, which provide a snapshot of a company's financial position at a particular point in time. It includes assets, liabilities, and equity, and how they are classified and valued.
