Chapter 10

*Liquidity

A business--or a person, for that matter--that has enough money to pay off any debt owed is described as being liquid. The _____ of a business depends on the availability of cash to meet maturing debt obligations. The current ratio is traditionally used to measure a company's ____. This ratio compares a firm's current assets to its current liabilities, as follows: Current Ratio = Current Assets/Current Liabilities

*Return on Equity

The last financial ratio considered here is the rate of return that the owners are receiving on their equity investment. It is computed as follows: Return on Equity = Net profits/Total Owner's Equity

*Cash Flows from Day-to-Day Business Operations

To convert the company's income statement from an accrual basis to a cash basis, we take two steps: (1) Add back depreciation to net profits, since depreciation is not a cash expense, and (2) subtract any uncollected sales (increase in accounts receivable) and payments for inventory (increases in inventory less increases in accounts payable).

*Balance Sheet

While an income statement reports the results of business operations over a period of time, a ____ provides a snapshot of a business's financial position at a specific point in time. It shows the assets a firm owns, the liabilities (or debt) outstanding or owed, and the amount the owners have invested in the business (owners' equity) on that date. In its simplest form, a balance sheet follows this formula: Total assets = Debt + Owner's equity

*Dividend

Now the owners have to decide what to do with these profits. They can let the company pay them a ____ out of the profits, which represents a withdrawal of capital from the business (assuming cash is available to do so). Or, they can retain the profits in the business to help finance the firm's growth.

*Short-term notes

Represents cash amounts borrowed from a bank or other lending source for 12 months or less.

*Fixed Assets

Also called property, plant, and equipment (PPE), include land, buildings, machinery, trucks, computers, and every other physical asset a company owns that will be used in the business for more than a year.

*Current debt

Also called short-term liabilities, is borrowed money that must be repaid within 12 months.

*Income Statement

Also called the profit and loss statement, indicates the amount of profits or losses generated by a firm over a given time period, usually monthly, quarterly, or yearly. In its most basic form, the income statement may be represented by the following equation: Sales (revenue) - Expenses = Profits (income)

*Accrual-basis Accounting

An income statement is not a measure of cash flows because it is calculated on an accrual basis rather than a cash basis

*Return on Equity (Continued)

As the amount of a firm's debt increases, its return on equity will increase, provided that the return on assets is higher than the interest rate paid on any debt.