Accounting Chapter 6

Return on Total Assets

(Net Income+Interest Expense)/Average Total Assets

Inventory Turnover

Cost of Goods Sold/Average Inventory

Property and Equipment

Includes all the physical, long-term assets used in the operations of a company (fixed or operating assets)

Debt Ratio

Total Liabilities/Total Assets

Why is a company's balance sheet important?

A company's balance sheet is important because this statement provides internal and external users with information to help evaluate the company's ability to achieve its primary goals of earning a satisfactory profit and remaining solvent. A balance sheet provides information about a company's economic resources and the claims on those resources (its financial position) on a specific date.

Working Capital

A company's current assets minus its current liabilities - used because this excess of current assets is the dollar amount of liquid resources a company has to work with after it pays all of its short-term debt

Assets

A company's economic resources that it expects will provide future benefits to the company.

What is a company's financial flexibility, and how do users evaluate it?

A company's financial flexibility is its ability to adapt to change. Measures of a company's financial flexibility are used to assess whether the company can increase or reduce its operating activities as needed. Users study a company's current ratio and quick ratio to evaluate its short-term financial flexibility. They study a company's debt ratio (total liabilities divided by total assets) to evaluate its long-term financial flexibility.

What is a company's liquidity, and how does it evaluate it?

A company's liquidity is a measure of how quickly it can convert its current assets into cash to pay its current liabilities as they become due. Users evaluate a company's liquidity by studying working capital (current assets minus current liabilities), current ratio (current assets divided by current liabilities), and quick (acid-test) ratio (quick assets divided by current liabilities).

What is a company's operating capability, and how do users evaluate it?

A company's operating capability is its ability to sustain a given level of operations. Measures of a company's operating capability are used to assess how well the company is maintaining its operating level and to predict future changes in its operating activity. Users study a company's activity ratios to determine the length of the parts of the company's operating cycle. These ratios include the inventory turnover (net credit sales divided by average accounts receivable).

Liquidity

A measure of how quickly a company can convert its assets into cash to pay its bills

Current Assets

Cash and other assets that the company expects to convert into cash, sell, or use up within one year. Current assets include: cash, marketable securities, receivables, inventory, and prepaid items.

Current Ratio

Current Ratio= Current Assets/Current Liabilities

Long-Term Investments

Include items such as notes receivable, government bonds, bonds and capital stock of corporations, and other securities. A company must intend to hold the investment for more than one year to classify as a long-term investment.

Book Value

Its original cost minus the related accumulated depreciation

Accounts Receivable Turnover

Net Credit Sales/Average Accounts Receivable

Return on Owner's Equity

Net Income/Average Owner's Equity

Number of Days in the Collection Period

Number of days in business year/accounts receivable turnover

Number of Days in the Selling Period

Number of days in business year/inventory turnover

Noncurrent Liabilities

Obligations that a company does not expect to pay within the next year

Current Liabilities

Obligations that the company expects to pay within one year by using current assets. Include accounts payable, salaries payable, unearned revenues, and short term notes (and interest) payable

Quick Ratio

Quick Assets/Current Liabilitie

Operating Capability

Refers to a company's ability to sustain a given level of operations

Classified Balance Sheet

The balance sheet shows subtotals for assets, liabilities, and owner's equity in related groupings.

Liabilities

The economic obligations (debts) of a company

Owner's Equity

The owner's current investment in the assets of the company. Assets less liabilities

Accumulated Depreciation

The total amount of depreciation expense recorded over the life of an asset to date; thus, it is the portion of the asset's cost that has been "used up" to earn revenues to date.

Why and how do users evaluate a company's profitability?

Users evaluate a company's profitability to determine how well it has met its profit objectives in relation to the resources invested. They study a company's return on total assets [(net income plus interest expense) divided by average total assets] and return on owner's equity (net income divided by average owner's equity) ratios to evaluate the company's profitability.

What do users need to know about a company's classified balance sheet?

Users need to know that a company's classified balance sheet shows important subtotals, in related groupings, for the assets, liabilities, and owner's equity of the company. The groupings include current assets and noncurrent assets, as well as current liabilities and noncurrent liabilities. Current assets are cash and other assets that a company expects to convert into cash, sell, or use up within one year. Current assets include cash, marketable securities, receivables, inventory, and prepaid items. Noncurrent assets are assets other than current assets: these include items such as long-term investments, as well as property and equipment. Current liabilities are obligations that a company expects to pay within one year by using current assets. Current liabilities include accounts payable, unearned revenues, and short-term notes (and interest) payable. Noncurrent liabilities are obligations that a company does not expect to pay within the next year: these include items such as long-term notes payable, mortgages payable, and bonds payable.

Balance Sheet

a financial statement that reports the types and the monetary amounts of a company's assets, liabilities, and owner's equity on a specific date

accounting equation

assets = liabilities+owner's equity

Financial Flexibility

the ability of a company to adapt to change