Why Companies Invest

Most companies generate cash from their operations. This cash can be used for the following purposes: Investing in current operations Investing in temporary investments to earn additional revenue Investing in long-term investments in stock of other companies for strategic reasons 1. Investing Cash in Current Operations Cash is often used to support the current

Accounting for Debt Investments

Debt securities include notes and bonds, issued by corporations and governmental organizations. Most companies invest excess cash in bonds as investments to earn interest revenue. The accounting for bond investments1 includes recording the following: Purchase of bonds Interest revenue Sale of bonds 1. Purchase of Bonds The purchase of bonds is recorded by debiting

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Accounting for Equity Investments

A company may invest in the preferred or common stock of another company. The company investing in another company’s stock is the investor. The company whose stock is purchased is the investee. The percent of the investee’s outstanding stock purchased by the investor deter­mines the degree of control that the investor has over the

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Valuing and Reporting Investments

Debt and equity securities are financial assets that are often traded on public ex­changes such as the New York Stock Exchange. As a result, their market value can be observed and, thus, objectively determined. For this reason, generally accepted accounting principles (GAAP) allows some debt securities, and requires equity securities where there is less

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Fair Value Accounting

Fair value is the price that would be received to sell an asset or pay off a liability. Fair value assumes that this transaction occurs under normal business conditions. As illustrated earlier, generally accepted accounting principles require trading and available-for-sale investments to be recorded at fair value. In contrast, many assets and liabilities are

Financial Analysis and Interpretation: Dividend Yield

The dividend yield measures the rate of return to stockholders, based on cash divi­dends. Dividend yield is most often computed for common stock because preferred stock has a stated dividend rate. In contrast, the cash dividends paid on common stock normally vary with the profitability of the corporation. The dividend yield is computed as

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Financial Statements for Mornin’ Joe

The financial statements of Mornin’ Joe are provided in the following pages. Mornin’ Joe is a fictitious coffeehouse chain featuring drip and espresso coffee in a cafe setting. The financial statements of Mornin’ Joe are provided to illustrate the com­plete financial statements of a corporation, using the terms, formats, and reporting illustrated throughout this

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Mornin’ Joe International

Mornin’ Joe is planning to expand operations to various places around the world. Fi­nancing for this expansion will come from foreign banks. While financial statements prepared under U.S. GAAP may be appropriate for U.S. operations, financial state­ments prepared for foreign bankers should be prepared using international accounting standards. The European Union (EU) has developed

Reporting Cash Flows

The statement of cash flows reports a company’s cash inflows and outflows for a period.1 The statement of cash flows provides useful information about a company’s ability to do the following: Generate cash from operations Maintain and expand its operating capacity Meet its financial obligations Pay dividends The statement of cash flows is used

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Statement of Cash Flows – The Indirect Method

The indirect method of reporting cash flows from operating activities uses the logic that a change in any balance sheet account (including cash) can be analyzed in terms of changes in the other balance sheet accounts. Thus, by analyzing changes in noncash balance sheet accounts, any change in the cash account can be indi­rectly

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Statement of Cash Flows – The Direct Method

The direct method reports cash flows from operating activities as follows: Cash flows from operating activities: The Cash Flows from Investing and Financing Activities sections of the statement of cash flows are exactly the same under both the direct and indirect methods. The amount of net cash flow from operating activities is also the

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Financial Analysis and Interpretation: Free Cash Flow

A valuable tool for evaluating the cash flows of a business is free cash flow. Free cash flow measures the operating cash flow available to a company to use after purchasing the property, plant, and equipment (PP&E) necessary to maintain current productive capacity.[1] It is computed as follows: Analysts often use free cash flow,

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Spreadsheet (Work Sheet) for Statement of Cash Flows – The Indirect Method

A spreadsheet (work sheet) may be used in preparing the statement of cash flows. However, whether or not a spreadsheet (work sheet) is used, the concepts presented in this chapter are not affected. The data for Rundell Inc., presented in Exhibit 3 on pages 646-647, are used as a basis for illustrating the spreadsheet

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Basic Analytical Methods

Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are as follows: Horizontal analysis Vertical analysis Common-sized statements 1. Horizontal Analysis The percentage analysis of increases and decreases in related items in comparative finan­cial statements is called horizontal analysis. Each item on the most recent statement is compared

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Liquidity and Solvency Analysis

All users of financial statements are interested in the ability of a company to do the following: Maintain liquidity and solvency Earn income, called profitability The ability of a company to convert assets into cash is called liquidity, while the ability of a company to pay its debts is called solvency. Liquidity, solvency, and profitability

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Profitability Analysis

Profitability analysis focuses on the ability of a company to earn profits. This ability is reflected in the company’s operating results, as reported in its income statement. The ability to earn profits also depends on the assets the company has available for use in its operations, as reported in its balance sheet. Thus, income

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Corporate Annual Reports

Public corporations issue annual reports summarizing their operating activities for the past year and plans for the future. Such annual reports include the financial statements and the accompanying notes. In addition, annual reports normally include the following sections: Management discussion and analysis Report on internal control Report on fairness of the financial statements 1.

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Unusual Items on the Income Statement

Generally accepted accounting principles require that unusual items be reported sepa­rately on the income statement. This is because such items do not occur frequently and are typically unrelated to current operations. Without separate reporting of these items, users of the financial statements might be misled about current and future operations. Unusual items on the

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Quoted shares on the stock exchange

Once a company gets its shares quoted on the stock exchange there is a continuously updated and generally known market price, which is usually far higher than the level at which the original investors put their money into the fledgling business. In addition, there is a ‘liquid’ market, meaning there are large numbers of

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Returns

Shareholders benefit twice over when a business is doing well: they get dividends as their part of the company’s profits, and the value of the shares goes up so that when they sell they get capital appreciation as well. The return on shares over the long term has been substantially better than inflation or

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