471 Accounting and Financial Statements by statement. With Mary Pruitt, the firm

Question

471 Accounting and Financial Statements by statement. With Mary Pruitt, the firm's trusted senior finan cial analyst, by your side, you delve into the accounting state ments as never before. You resolve to "get to the bottom" of th firm's financial problems and set a new course for the future- a course that will take the firm from insolvency and failure financial recovery and perpetual prosperity. Discussion Questions 1. Describe the three basic accounting statements. What types of information does each provide that can help you evaluate the situation? Which of the financial ratios are likely to prove to be of greatest value in identifying problem areas in the company? Why? Which of your company's financial rati might you expect to be especially poor? 2. 3. Discuss the limitations of ratio analysis determine what expenses will be necessary to generate level of sales revenue. The second financial statement you need to create is balance sheet. Your balance sheet is a snapshot of your f clal position in a moment in time. Refer to Table 14.6 to a you in listing your assets, liabilities, and owner's enut The last finan ial l

Explanation / Answer

1. Income statement, Balancesheet and statement of cash flows are basic accounting statement.

The income statement that illustrate the profitability of the company

The balance sheet in other words statement of affairs of the company shows the companies resources and funding of those resources. Assets must always equal to the sum of liabilities and equity

The statement of cash flow is a magnification of the cash account on the balancesheet and accounts for the entire period reconciling the begining of period to end of such cash balances.

2.The most important financial ratios are

a. Debt to equity ratio (Total liabilties / Shareholders fund

b. Current ratio ( Current Assets/ Current liabilities

c. Quick ratio (Current assets-Inventories/ Current liabilities

d. Return on Equity (Net income / shareholders fund

e . Net profit margin ( net profit / Sales)

The debt-to-equity ratio, is a quantification of a firm’s financial leverage estimated by dividing the total liabilities by stockholders’ equity. The current ratio is a liquidity ratio which estimates the ability of a company to pay back short-term obligations. The quick ratio, also referred as the “acid test ratio” or the “quick assets ratio”, this ratio is a gauge of the short term liquidity of a firm. The quick ratio is helpful in measuring a company’s short term debts with its most liquid assets.The return on equity is the amount of net income returned as a percentage of shareholders equity. Moreover, the return on equity estimates the profitability of a corporation by revealing the amount of profit generated by a company with the money invested by the shareholders. The net profit margin is a number which indicates the efficiency of a company at its cost control. A higher net profit margin shows more efficiency of the company at converting its revenue into actual profit. This ratio is a good way of making comparisons between companies in the same industry, for such companies are often subject to similar business conditions.

3.

a. Many large firms operate different divisions in different industries. For these companies it is difficult to find a meaningful set of industry-average ratios.

b. Inflation may have badly distorted a company's balance sheet. In this case, profits will also be affected. Thus a ratio analysis of one company over time or a comparative analysis of companies of different ages must be interpreted with judgment.

c. Seasonal factors can also distort ratio analysis. Understanding seasonal factors that affect a business can reduce the chance of misinterpretation. For example, a retailer's inventory may be high in the summer in preparation for the back-to-school season. As a result, the company's accounts payable will be high and its ROA low.

d. Different accounting practices can distort comparisons even within the same company (leasing versus buying equipment, LIFO versus FIFO, etc.).

e. It is difficult to generalize about whether a ratio is good or not. A high cash ratio in a historically classified growth company may be interpreted as a good sign, but could also be seen as a sign that the company is no longer a growth company and should command lower valuations.

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