Chapter 5
Balance Sheet and
Statement of Cash Flow
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1. Introduction to Balance Sheet
How important is the balance sheet?
 Is the balance sheet useful?
 What are the limitations of the balance
sheet?
 What information is available on the
balance sheet?

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2. Important Concepts

Liquidity
◦ the speed with which the firm’s assets or liabilities
are converted into cash or paid

Financial flexibility
◦ the ability of an enterprise to take effective
actions to alter the amounts and timing of cash
flows

Solvency
◦ the ability of an enterprise to pay its debts as they
mature
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2. Important Concepts (con’t)

Operating capability
◦ the entity’s ability to maintain a given physical
level of operations

Capital maintenance
◦ a method of measuring income by comparing
beginning capital with ending capital

Capital Structure
◦ shows the sources of capital provided to the
entity
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3. Recognition in the Bal. Sheet
Recognition means recording the item in
the AIS or disclosing it in the notes to the
financial statements
 General Recognition Criteria

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meet the definition of an element
be measurable
be relevant
have faithful representation
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4. Balance Sheet Classifications

Assets
◦ Current
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cash and cash equivalents (3 months or less maturity)
investments
accountants receivable
inventories
prepaid assets

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investments
property, plant, and equipment
intangible assets
other assets
◦ Noncurrent
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4. Balance Sheet Classifications

Liabilities
◦ Current

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accounts payable
notes payable
unearned revenues
accrued liabilities
current portion of long-term debt
◦ Long-term liabilities
 notes payable
 bonds payable
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4. Balance Sheet Classifications

Stockholders’ Equity
◦ Contributed capital
 preferred stock
 common stock
 paid-in capital…
◦ Retained earnings
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5. Disclosures

Notes
◦
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summary of significant accounting policies
contingencies
contractual situations
related party transactions
subsequent events
MD&A
 Management’s responsibilities

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6. Other
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Comparative financial statements
Interim financial statements
SEC reports
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10-K
10-Q
8-K
proxy statement
EDGAR
XBRL
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7. Alternative Valuation Methods

To be recognized an item m/b measurable
◦ alternative bases of measurability could be used

Historical cost (input value)
◦ the exchange price of the asset when it was acquired

Replacement cost (current cost) (input value)
◦ the amount of cash necessary to currently obtain the same
asset

Current market value(current exit value)(output value)
◦ the amount of cash that could be obtained from selling the
asset in an orderly transaction between market
participants
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7. Alternative Valuation Methods

Net realizable value (output value)
◦ the amount of cash that may result when the
asset is sold in the future in the ordinary course
of business

Present value (discounted cash flows)
◦ considers the time value of money - values items
at the present value of all future cash flows


Price level adjusted (constant dollar)
reporting
What is current GAAP?
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8. Financial Statement Analysis

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Horizontal analysis
Vertical analysis
Liquidity ratios
◦ working capital
◦ current ratio
◦ quick ratio

Financing (coverage) ratios
◦ debt to equity
◦ debt to assets
◦ times interest earned
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8. Financial Statement Analysis

Activity ratios
◦ receivables turnover
◦ inventory turnover
◦ asset turnover

Profitability ratios
◦ profit margin
◦ return on assets
◦ return on equity
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9. Cash Flow Statement
Only basics now - More in 3040
 Required statement
 Classifications on statement

◦ operating activities
 direct method
 indirect method
◦ investing activities
◦ financing activities
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9. Cash Flow Statement
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