Chap 14: Financial Statement Analysis – measures of liquidity
Three measures of a company’s ability to pay current obligations:
a. Current ratio: current assets/current liabilities
b. Quick ratio: Quick assets/current liabilities
 Quick assets include cash, marketable securities, current accounts, and notes
receivable.
c. Working capital: current assets-current liabilities.
Chap 10: Liabilities
Liabilities are debts owed from past transactions.
Two categories: Current and Non-current.
Current liabilities are due to be paid within one year or the normal operating cycle of
the business, whichever is longer. For most businesses, one year is longer than the
operating cycle.
Noncurrent liabilities are due to be paid sometime after one year.
Notes payable: The portion of a note payable that is due within one year would be
classified as a current liability. The remainder of the note that is due outside of one year
is classified as noncurrent.
Payroll liabilities
Unearned revenue
Installment notes payable: Long-term notes that call for a series of installment
payments.
When allocating a payment between interest and principal, follow these four steps.
First, identify the unpaid principal balance.
Second, calculate the interest expense.
Third, determine the reduction in the principal balance.
Fourth, compute the new unpaid principal balance.
Example: On January 1, 2007, Rocket Corp. borrowed $7,581.57 from First Bank of
River City. The loan was a five-year loan and had an interest rate of 10%. The annual
payment is $2,000.
Date
Jan. 1, 2007
Dec. 31, 2007
Dec. 31, 2008
Dec. 31, 2009
Dec. 31, 2010
Dec. 31, 2011
Payment
Interest
Expense
$ 2,000.00
2,000.00
2,000.00
2,000.00
2,000.00
$ 758.16
633.97
497.37
347.11
181.82
Reduction in
Unpaid
Balance
$
1,241.84
1,366.03
1,502.63
1,652.89
1,818.18
Unpaid
Balance
$ 7,581.57
6,339.73
4,973.70
3,471.07
1,818.18
(0.00)
Bonds payable: when companies need large amounts of cash, they often issue bonds.
The principal on bonds is typically paid at the end of the bond period. Bonds are often
denominated with a face value, or par value, of $1,000.
Bond prices are usually quoted as a percentage of the face amount. E.g. a $1,000 bond
priced at 102 would sell for $1,020.
There are several types of bonds. For Mortgage bonds, the issuer pledges specific assets
as collateral. Debenture bonds are backed by the issuer’s general credit standing.
Convertible bonds can be exchanged for a fixed number of common shares of the
issuing corporation. Junk bonds have very high risk associated with them.
Selling price of the bond: When bonds are issued between interest payment dates, the
investor pays for the bond PLUS the accrued interest since the last interest payment date.
The Present Value Concept and Bond Prices: The selling price of a bond is determined by
comparing the market interest rate with the stated interest rate on the bond.
Interest
Rates
Bond
Price
Stated = Market Bond =
Rate
Rate
Price
Accounting for
the Difference
Par Value
of the Bond
There is no difference
to account for.
Stated < Market Bond <
Rate
Rate
Price
Par Value
of the Bond
The difference is
accounted
for as a bond discount.
Stated > Market Bond >
Rate
Rate
Price
Par Value
of the Bond
The difference is
accounted
for as a bond premium.
Operating vs. Capital Lease
To qualify as a capital lease, a lease contract must have one of the following criteria:
1. The lease transfers ownership to the lessee at the end of the lease.
2. The lease contains a bargain purchase option to buy the asset for a small amount.
3. The lease term is equal to or greater than seventy-five percent of the life of the
asset under lease.
4. The present value of the minimum lease payments is equal to or greater than
ninety percent of the fair market value of the asset under lease.
If any one of these criteria is met, the lease must be recorded as a capital lease.