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Questions and Answers
Explain how the balance sheet can be used to assess a company's ability to meet its short-term obligations.
Explain how the balance sheet can be used to assess a company's ability to meet its short-term obligations.
By examining the current assets and current liabilities sections to determine if there are enough liquid assets to cover debts due within a year.
Why is the fundamental accounting equation (Assets = Liabilities + Owner’s Equity) so critical to the balance sheet?
Why is the fundamental accounting equation (Assets = Liabilities + Owner’s Equity) so critical to the balance sheet?
It ensures that the balance sheet balances, reflecting that all assets are financed by either borrowing (liabilities) or investments (equity).
How would a significant increase in accounts receivable, without a corresponding increase in sales, affect your assessment of a company's financial health based on the balance sheet?
How would a significant increase in accounts receivable, without a corresponding increase in sales, affect your assessment of a company's financial health based on the balance sheet?
It can signal potential issues with collecting payments, over optimistic revenue recognition, or deteriorating credit quality of customers.
Differentiate between current and non-current liabilities, providing an example of each, and explain why this distinction is important.
Differentiate between current and non-current liabilities, providing an example of each, and explain why this distinction is important.
How do retained earnings reflect a company's performance, and what does a significant decrease in retained earnings suggest?
How do retained earnings reflect a company's performance, and what does a significant decrease in retained earnings suggest?
Explain the difference between contributed capital and retained earnings within owner's equity.
Explain the difference between contributed capital and retained earnings within owner's equity.
Explain how an increase in valuation equity impacts the balance sheet and give an example.
Explain how an increase in valuation equity impacts the balance sheet and give an example.
If a company incorrectly classifies a long-term loan as a current liability, how would this error affect the analysis of its balance sheet?
If a company incorrectly classifies a long-term loan as a current liability, how would this error affect the analysis of its balance sheet?
How is personal net worth calculated, and why is it an important metric?
How is personal net worth calculated, and why is it an important metric?
Describe a scenario where a company might have a high amount of assets but still be at risk of financial distress.
Describe a scenario where a company might have a high amount of assets but still be at risk of financial distress.
Flashcards
Why investors use financial info?
Why investors use financial info?
Assess profitability and risk.
Why creditors use financial info?
Why creditors use financial info?
Evaluate ability to repay debts.
Why management uses financial info?
Why management uses financial info?
Make business decisions.
Why governments use financial info?
Why governments use financial info?
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What are flow statements?
What are flow statements?
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What are stock statements?
What are stock statements?
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What are assets?
What are assets?
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What are liabilities?
What are liabilities?
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What is owner's equity?
What is owner's equity?
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What are current liabilities?
What are current liabilities?
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Study Notes
- Key users of financial information include investors, creditors, management, and government agencies.
- Investors use financial information to assess profitability and risk.
- Creditors use financial information to evaluate a company's ability to repay debts.
Flow Statements
- Flow statements measure performance over a period.
- The Income Statement and Statement of Cash Flows are flow statements.
Stock Statements
- Stock statements measure financial position at a specific point in time.
- The Balance Sheet is a stock statement.
Fundamental Accounting Equation
- Assets = Liabilities + Owner’s Equity
- This equation ensures that a company's resources are financed by borrowing or owner investments.
Balance Sheet Basics
- The Balance Sheet shows assets, liabilities, and owner's equity at a specific time.
- An alternative name for the Balance Sheet is the Statement of Financial Position.
- The classic accounting identity is Assets = Liabilities + Owner’s Equity.
- Assets are resources a company owns like cash, inventory, and buildings.
- Liabilities are debts the company owes, such as loans and accounts payable.
- Owner’s Equity is the owner's claim on the company's assets.
Asset Classification
- Assets are classified according to liquidity.
- Current assets are expected to be converted to cash within one year, e.g., cash, accounts receivable, and inventory.
- Non-current assets provide long-term value (more than one year), e.g., property, equipment, and intangible assets.
Liability Classification
- Liabilities are classified according to maturity.
- Current liabilities are obligations due within one year, e.g., accounts payable and short-term loans.
- Non-current liabilities are obligations due after one year, e.g., long-term loans and bonds payable.
Equity Components
- Valuation Equity represents adjustments made to assets based on their market value.
- Contributed Capital is money invested in the company by owners or shareholders.
- Retained Earnings are profits reinvested in the business.
Equity Calculations
- Valuation Equity = Fair Market Value of Assets – Book Value of Assets
- Retained Earnings = Beginning Retained Earnings + Net Income – Dividends
- Personal Net Worth = Total Assets – Total Liabilities
Preparing a Balance Sheet
- List all assets (current and non-current).
- List all liabilities (current and non-current).
- Calculate owner’s equity using the fundamental equation.
- Ensure that Assets = Liabilities + Owner’s Equity.
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