💥 RELATIONSHIP BETWEEN FINANCIAL STATEMENTS [PART : 2] 💥
ALL ABOUT ACCOUNTING : 47th BLOG
💎ACCOUNTING💎
★ Accounting exercise and practices : Lesson : 5 [Part : 2]
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Today's discuss remaining part of Relationship between Financial Statements.
So let's discuss ....
* RELATIONSHIP BETWEEN FINANCIAL STATEMENTS :
★ THE BALANCE SHEET :
A balance sheet lays out the ending balances in a company's asset, liability, and equity accounts as of the date stated on the report. The balance sheet is commonly used for a great deal of financial analysis of a business' performance. Some of the more common ratios that include balance sheet information are:
- ACCOUNTS RECEIVABLE COLLECTION PERIOD :
The accounts receivable collection period compares the outstanding receivables of a business to its total sales. This comparison is used to evaluate how long customers are taking to pay the seller. A low figure is considered best, since it means that a business is locking up less of its funds in accounts receivable, and so can use the funds for other purposes. Also, when receivables remain unpaid for a reduced period of time, there is less risk of payment default by customers.- CURRENT RATIO :
The current ratio measures the ability of an organization to pay its bills in the near-term. It is a common measure of the short-term liquidity of a business. The ratio is used by analysts to determine whether they should invest in or lend money to a business. To calculate the current ratio, divide the total of all current assets by the total of all current liabilities. The formula is:
Current assets ÷ Current liabilities = Current ratio
- DEBT TO EQUITY RATIO :
The debt to equity ratio measures the riskiness of a company's financial structure by comparing its total debt to its total equity. The ratio reveals the relative proportions of debt and equity financing that a business employs. It is closely monitored by lenders and creditors, since it can provide early warning that an organization is so overwhelmed by debt that it is unable to meet its payment obligations. This is also a funding issue. For example, the owners of a business may not want to contribute any more cash to the company, so they acquire more debt to address the cash shortfall. Or, a company may use debt to buy back shares, thereby increasing the return on investment to the remaining share holders.- INVENTORY TURNOVER :
Inventory turnover is the average number of times in a year that a business sells and replaces its inventory. Low turnover equates to a large investment in inventory, while high turnover equates to a low investment in inventory. Continual monitoring of inventory turnover is good management practice, in order to maintain a relatively low investment in this area.
- QUICK RATIO :
The quick ratio is used to evaluate whether a business has enough liquid assets that can be converted into cash to pay its bills. The key elements of current assets that are included in the ratio are cash, marketable securities, and accounts receivable. Inventory is not included in the ratio, since it can be quite difficult to sell off in the short term, and possibly at a loss. Because of the exclusion of inventory from the formula, the quick ratio is a better indicator than the current ratio of the ability of a company to pay its immediate obligations.
To calculate the quick ratio, summarize cash, marketable securities and trade receivables, and divide by current liabilities. Do not include in the numerator any excessively old receivables that are not likely to be paid, such as anything over 90 days old. The formula is:
(Cash + Marketable securities + Accounts receivable) ÷ Current liabilities = Quick ratio- RETURN ON NET ASSETS :
The return on net assets (RONA) measure compares net profits to net assets to see how well a company is able to utilizes its asset base to create profits. A high ratio of assets to profits is an indicator of excellent management performance. The RONA formula is to add together fixed assets and net working capital, and divide into net after-tax profits. Net working capital is defined as current assets minus current liabilities. It is best to eliminate unusual items from the calculation, if they are one-time events that can skew the results. The calculation is:
Net profit ÷ (Fixed assets + Net working capital) = NET ASSETS- WORKING CAPITAL TURNOVER RATIO :
The working capital turnover ratio measures how well a company is utilizing its working capital to support a given level of sales. Working capital is current assets minus current liabilities. A high turnover ratio indicates that management is being extremely efficient in using a firm's short-term assets and liabilities to support sales. Conversely, a low ratio indicates that a business is investing in too many accounts receivable and inventory assets to support its sales, which could eventually lead to an excessive amount of bad debts and obsolete inventory write-offs.
* Working Capital Turnover Formula
To calculate the ratio, divide net sales by working capital (which is current assets minus current liabilities). The calculation is usually made on an annual or trailing 12-month basis, and uses the average working capital during that period. The calculation is:
Net sales ÷ ((Beginning working capital + Ending working capital) / 2) = WORKING CAPITAL TURNOVER RATIO
Many of these ratios are used by creditors and lenders to determine whether they should extend credit to a business, or perhaps withdraw existing credit.
The information listed on the balance sheet must match the following formula:
Total assets = Total liabilities + Equity
The balance sheet is one of the key elements in the financial statements, of which the other documents are the income statement and the statement of cash flows. A statement of retained earnings may sometimes be attached.
The format of the balance sheet is not mandated by accounting standards, but rather by customary usage. The two most common formats are the vertical balance sheet (where all line items are presented down the left side of the page) and the horizontal balance sheet(where asset line items are listed down the first column and liabilities and equity line items are listed in a later column). The vertical format is easier to use when information is being presented for multiple periods.
The line items to be included in the balance sheet are up to the issuing entity, though common practice typically includes some or all of the following items:
1. CURRENT ASSETS :A current asset is an item on an entity's balance sheet that is either cash, a cash equivalent, or which can be converted into cash within one year. If an organization has an operating cycle lasting more than one year, an asset is still classified as current as long as it is converted into cash within the operating cycle. Examples of current assets are:
- Cash, including foreign currency
- Investments, except for investments that cannot be easily liquidated
- Prepaid expenses
- Accounts receivable
- Inventory
These items are typically presented in the balance sheet in their order of liquidity, which means that the most liquid items are shown first. The preceding example shows current assets in their order of liquidity. After current assets, the balance sheet lists long-term assets, which include fixed tangible and intangible assets.
Creditors are interested in the proportion of current assets to current liabilities, since it indicates the short-term liquidity of an entity. In essence, having substantially more current assets than liabilities indicates that a business should be able to meet its short-term obligations. This type of liquidity-related analysis can involve the use of several ratios, include the cash ratio, current ratio, and quick ratio.
The main problem with relying upon current assets as a measure of liquidity is that some of the accounts within this classification are not so liquid. In particular, it may be difficult to readily convert inventory into cash. Similarly, there may be some extremely overdue invoices within the accounts receivable number, though there should be an offsetting amount in the allowance for doubtful accounts to represent the amount that is not expected to be collected. Thus, the contents of current assets should be closely examined to ascertain the true liquidity of a business.
Similar Terms
Current assets are also known as current accounts.
2. NON CURRENT ASSETS : A non current asset is an asset that is not expected to be consumed within one year. If a company has a high proportion of non current to current assets, this can be an indicator of poor liquidity, since a large amount of cash may be needed to support ongoing investments in noncash assets.
Some non current assets, such as land, may theoretically have unlimited useful lives. A non current asset is recorded as an asset when incurred, rather than being charged to expense at once. Depreciation, depletion, or amortization may be used to gradually reduce the amount of a non current asset on the balance sheet.
In a capital-intensive industry, such as oil refining, a large part of the asset base of a business may be comprised of non current assets. Conversely, a services business that requires a minimal amount of fixed assets may have few or no non current assets.
Non current assets are aggregated into several line items on the balance sheet, and are listed after all current assets, but before liabilities and equity.
*Examples of non current assets are:
1. Cash surrender value of life insurance : Cash surrender value is the amount of cash that a person can receive upon the cancellation of an insurance policy or annuity. This amount is usually associated with whole life insurance policies, which have a built-in savings component. Term policies do not have a cash surrender value.
2. Long-term investments
3. Intangible fixed assets (such as patents)
4. Tangible fixed assets (such as equipment and real estate)
5. Goodwill : Goodwill is the excess of the purchase price paid for an acquired entity and the amount of the price not assigned to acquired assets and liabilities. It arises when an acquirer pays a high price to acquire another business. This asset only arises from an acquisition; it cannot be generated internally. Goodwill is an intangible asset, and so is listed within the long-term assets section of the acquirer's balance sheet.
There is more risk associated with non current assets than with current assets, since they may decline in value during their extended holding periods. An excessive amount of reduction in value may lead to an impairment charge.
3. CURRENT LIABILITIES :
A current liability is an obligation that is payable within one year. The cluster of liabilities comprising current liabilities is closely watched, for a business must have sufficient liquidity to ensure that they can be paid off when due. All other liabilities are reported as long-term liabilities, which are presented in a grouping lower down in the balance sheet, below current liabilities.
In those rare cases where the operating cycle of a business is longer than one year, a current liability is defined as being payable within the term of the operating cycle. The operating cycle is the time period required for a business to acquire inventory, sell it, and convert the sale into cash. In most cases, the one-year rule will apply.
Since current liabilities are typically paid by liquidating current assets, the presence of a large amount of current liabilities calls attention to the size and prospective liquidity of the offsetting amount of current assets listed on a company's balance sheet. Current liabilities may also be settled through their replacement with other liabilities, such as with short-term debt.
The aggregate amount of current liabilities is a key component of several measures of the short-term liquidity of a business, including:
* Current ratio. This is current assets divided by current liabilities.
* Quick ratio. This is current assets minus inventory, divided by current liabilities.
* Cash ratio. This is cash and cash equivalents, divided by current liabilities.
For all three ratios, a higher ratio denotes a larger amount of liquidity and therefore an enhanced ability for a business to meet its short-term obligations.
☆ Examples of Current Liabilities :
The following are common examples of current liabilities:
1. Accounts payable. These are the trade payables due to suppliers, usually as evidenced by supplier invoices.
2. Sales taxes payable. This is the obligation of a business to remit sales taxes to the government that it charged to customers on behalf of the government.
3. Payroll taxes payable. This is taxes withheld from employee pay, or matching taxes, or additional taxes related to employee compensation.
4. Income taxes payable. This is income taxes owed to the government but not yet paid.
5. Interest payable. This is interest owed to lenders but not yet paid.
6. Bank account overdrafts. These are short-term advances made by the bank to offset any account overdrafts caused by issuing checks in excess of available funding.
7. Accrued expenses. These are expenses not yet payable to a third party, but already incurred, such as wages payable.
8. Customer deposits. These are payments made by customers in advance of the completion of their orders for goods or services.
9. Dividends declared. These are dividends declared by the board of directors, but not yet paid to shareholders.
10. Short-term loans. This is loans that are due on demand or within the next 12 months.
11. Current maturities of long-term debt. This is that portion of long-term debt that is due within the next 12 months.
The types of current liability accounts used by a business will vary by industry, applicable regulations, and government requirements, so the preceding list is not all-inclusive. However, the list does include the current liabilities that will appear in most balance sheets.
4. NON CURRENT LIABILITIES :
Non current liabilities are those obligations not due for settlement within one year. These liabilities are separately classified in an entity's balance sheet, away from current liabilities. Examples of non current liabilities are:
1. Long-term portion of debt payable
2. Long-term portion of bonds payable
The aggregate amount of non current liabilities is routinely compared to the cash flows of a business, to see if it has the financial resources to fulfill its obligations over the long term. If not, creditors will be less likely to do business with the organization, and investors will not be inclined to invest in it. A factor to be considered in this evaluation is the stability of an organization's cash flows, since stable flows can support a higher debt load with a reduced risk of default.
5. EQUITY :
Equity is the net amount of funds invested in a business by its owners, plus any retained earnings. It is also calculated as the difference between the total of all recorded assets and liabilities on an entity's balance sheet. An analyst routinely compares the amount of equity to the debt stated on a balance sheet to see if a business is properly capitalised.
The equity concept also refers to the different types of securities available that can provide an ownership interest in a corporation. In this context, equity refers to common stock and preferred stock.
For an individual, equity refers to the ownership interest in an asset. For example, a person owns a home with a market value of ₹ 10,00,000 and owes ₹ 5,00,000 on the related mortgage, leaving ₹ 5,00,000 of equity in the home.
* Equity is divided in balance sheet mostly 3 parts :- Capital Stock
- Additional paid in capital
- Retained earnings
Let's discuss one by one:
1. Capital Stock : Capital stock is comprised of all types of shares issued by a corporation. This classification includes common stock, and may also include several types of preferred stock. The funds received from capital stock are recorded within the stockholders' equity section of the balance sheet.
A business that has a relatively small amount of capital stock is said to be thinly capitalised, and probably relies upon a significant amount of debt to fund its operations. Conversely, an entity with a large amount of capital stock requires less debt to fund its operations, and so is less subject to the negative effects of changes in interest rates.
An alternative definition of capital stock is that it is comprised of the total number of common and preferred shares that are authorised for issuance. This amount may be substantially larger than the number of shares actually issued. A change in the corporate charter is needed to increase the number of shares authorised for issuance.
2. Additional paid in capital : Additional paid-in capital is any payment received from investors for stock that exceeds the par value of the stock. The concept applies to payments received for either common stock or preferred stock. Par value is typically set extremely low, so most of the amount paid by investors for stock will be recorded as additional paid-in capital. Par value is commonly set at $0.01, and is printed on the stock certificate. Low par values are used because many state governments mandate that shares cannot be sold at prices below their par values.
There is no change in the additional paid-in capital account when a company's shares are traded on a secondary market between investors, since the amounts exchanged during these transactions do not involve the company that issued the shares.
For example, the board of directors of a business authorizes ₹ 10,00,000 shares of common stock at a par value of ₹ 1. The company then sells 2,00,000 of these shares for ₹ 2 each. To record the receipt of cash, the company records a debit of ₹4,00,000 to the cash account, Credit to ₹ 2,00,000 to the common stock account, and ₹ 2,00,000to the additional paid-in capital account.
The additional paid-in capital account and the retained earnings account typically contain the largest balances in the equity section of the balance sheet.
Similar Terms
Additional paid-in capital is also known as contributed capital in excess of par.
3. Retained Earnings : Retained earnings are the profits that a company has earned to date, less any dividends or other distributions paid to investors. This amount is adjusted whenever there is an entry to the accounting records that impacts a revenue or expense account. A large retained earnings balance implies a financially healthy organization. The formula for ending retained earnings is:
Beginning retained earnings + Profits/losses - Dividends = Ending retained earnings
A company that has experienced more losses than gains to date, or which has distributed more dividends than it had in the retained earnings balance, will have a negative balance in the retained earnings account. If so, this negative balance is called an accumulated deficit.
The retained earnings balance or accumulated deficit balance is reported in the stockholders' equity section of a company's balance sheet.
A growing company normally avoids dividend payments, so that it can use its retained earnings to fund additional growth of the business in such areas as working capital, capital expenditures, acquisitions, research and development, and marketing. It may also elect to use retained earnings to pay off debt, rather than to pay dividends. Another possibility is that retained earnings may be held in reserve in expectation of future losses, such as from the sale of a subsidiary or the expected outcome of a lawsuit.
As a company reaches maturity and its growth slows, it has less need for its retained earnings, and so is more inclined to distribute some portion of it to investors in the form of dividends. The same situation may arise if a company implements strong working capital policies to reduce its cash requirements.
When evaluating the amount of retained earnings that a company has on its balance sheet, consider the following points:
1. Age of the company. An older company will have had more time in which to compile more retained earnings.
2. Dividend policy. A company that routinely issues dividends will have fewer retained earnings.
3. Profitability. A high profit percentage eventually yields a large amount of retained earnings, subject to the two preceding points.
4. Cyclical industry. When a business is in an industry that is highly cyclical, management may need to build up large retained earnings reserves during the profitable part of the cycle in order to protect it during downturns.
for example of balance sheet and related topic clear in : https://accountingexpertiseincometaxgst.blogspot.com/2020/07/balance-sheet-part-2.html
Remaining part of Relationship between financial statements discuss in 49th blog...
So wait my 49th blog... ★★★★★★★★★ -----------------------------------------
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★ Accounting exercise and practices :
Lesson : 5 [Part : 2]
Hi friends 🙏
Today's discuss remaining part of Relationship between Financial Statements.
So let's discuss ....
* RELATIONSHIP BETWEEN FINANCIAL STATEMENTS :
- ACCOUNTS RECEIVABLE COLLECTION PERIOD :
- CURRENT RATIO :
The current ratio measures the ability of an organization to pay its bills in the near-term. It is a common measure of the short-term liquidity of a business. The ratio is used by analysts to determine whether they should invest in or lend money to a business. To calculate the current ratio, divide the total of all current assets by the total of all current liabilities. The formula is:
Current assets ÷ Current liabilities = Current ratio
- DEBT TO EQUITY RATIO :
- INVENTORY TURNOVER :
- QUICK RATIO :
The quick ratio is used to evaluate whether a business has enough liquid assets that can be converted into cash to pay its bills. The key elements of current assets that are included in the ratio are cash, marketable securities, and accounts receivable. Inventory is not included in the ratio, since it can be quite difficult to sell off in the short term, and possibly at a loss. Because of the exclusion of inventory from the formula, the quick ratio is a better indicator than the current ratio of the ability of a company to pay its immediate obligations.
To calculate the quick ratio, summarize cash, marketable securities and trade receivables, and divide by current liabilities. Do not include in the numerator any excessively old receivables that are not likely to be paid, such as anything over 90 days old. The formula is:
(Cash + Marketable securities + Accounts receivable) ÷ Current liabilities = Quick ratio
- RETURN ON NET ASSETS :
The return on net assets (RONA) measure compares net profits to net assets to see how well a company is able to utilizes its asset base to create profits. A high ratio of assets to profits is an indicator of excellent management performance. The RONA formula is to add together fixed assets and net working capital, and divide into net after-tax profits. Net working capital is defined as current assets minus current liabilities. It is best to eliminate unusual items from the calculation, if they are one-time events that can skew the results. The calculation is:
Net profit ÷ (Fixed assets + Net working capital) = NET ASSETS
- WORKING CAPITAL TURNOVER RATIO :
The working capital turnover ratio measures how well a company is utilizing its working capital to support a given level of sales. Working capital is current assets minus current liabilities. A high turnover ratio indicates that management is being extremely efficient in using a firm's short-term assets and liabilities to support sales. Conversely, a low ratio indicates that a business is investing in too many accounts receivable and inventory assets to support its sales, which could eventually lead to an excessive amount of bad debts and obsolete inventory write-offs.
* Working Capital Turnover Formula
To calculate the ratio, divide net sales by working capital (which is current assets minus current liabilities). The calculation is usually made on an annual or trailing 12-month basis, and uses the average working capital during that period. The calculation is:
Net sales ÷ ((Beginning working capital + Ending working capital) / 2) = WORKING CAPITAL TURNOVER RATIO
Many of these ratios are used by creditors and lenders to determine whether they should extend credit to a business, or perhaps withdraw existing credit.
The information listed on the balance sheet must match the following formula:
Total assets = Total liabilities + Equity
The balance sheet is one of the key elements in the financial statements, of which the other documents are the income statement and the statement of cash flows. A statement of retained earnings may sometimes be attached.
The format of the balance sheet is not mandated by accounting standards, but rather by customary usage. The two most common formats are the vertical balance sheet (where all line items are presented down the left side of the page) and the horizontal balance sheet(where asset line items are listed down the first column and liabilities and equity line items are listed in a later column). The vertical format is easier to use when information is being presented for multiple periods.
The line items to be included in the balance sheet are up to the issuing entity, though common practice typically includes some or all of the following items:
1. CURRENT ASSETS :
A current asset is an item on an entity's balance sheet that is either cash, a cash equivalent, or which can be converted into cash within one year. If an organization has an operating cycle lasting more than one year, an asset is still classified as current as long as it is converted into cash within the operating cycle. Examples of current assets are:
- Cash, including foreign currency
- Investments, except for investments that cannot be easily liquidated
- Prepaid expenses
- Accounts receivable
- Inventory
These items are typically presented in the balance sheet in their order of liquidity, which means that the most liquid items are shown first. The preceding example shows current assets in their order of liquidity. After current assets, the balance sheet lists long-term assets, which include fixed tangible and intangible assets.
Creditors are interested in the proportion of current assets to current liabilities, since it indicates the short-term liquidity of an entity. In essence, having substantially more current assets than liabilities indicates that a business should be able to meet its short-term obligations. This type of liquidity-related analysis can involve the use of several ratios, include the cash ratio, current ratio, and quick ratio.
The main problem with relying upon current assets as a measure of liquidity is that some of the accounts within this classification are not so liquid. In particular, it may be difficult to readily convert inventory into cash. Similarly, there may be some extremely overdue invoices within the accounts receivable number, though there should be an offsetting amount in the allowance for doubtful accounts to represent the amount that is not expected to be collected. Thus, the contents of current assets should be closely examined to ascertain the true liquidity of a business.
Similar Terms
Current assets are also known as current accounts.
2. NON CURRENT ASSETS :
A non current asset is an asset that is not expected to be consumed within one year. If a company has a high proportion of non current to current assets, this can be an indicator of poor liquidity, since a large amount of cash may be needed to support ongoing investments in noncash assets. Some non current assets, such as land, may theoretically have unlimited useful lives. A non current asset is recorded as an asset when incurred, rather than being charged to expense at once. Depreciation, depletion, or amortization may be used to gradually reduce the amount of a non current asset on the balance sheet. In a capital-intensive industry, such as oil refining, a large part of the asset base of a business may be comprised of non current assets. Conversely, a services business that requires a minimal amount of fixed assets may have few or no non current assets. Non current assets are aggregated into several line items on the balance sheet, and are listed after all current assets, but before liabilities and equity. *Examples of non current assets are: 1. Cash surrender value of life insurance : Cash surrender value is the amount of cash that a person can receive upon the cancellation of an insurance policy or annuity. This amount is usually associated with whole life insurance policies, which have a built-in savings component. Term policies do not have a cash surrender value.
2. Long-term investments
3. Intangible fixed assets (such as patents)
4. Tangible fixed assets (such as equipment and real estate)
5. Goodwill : Goodwill is the excess of the purchase price paid for an acquired entity and the amount of the price not assigned to acquired assets and liabilities. It arises when an acquirer pays a high price to acquire another business. This asset only arises from an acquisition; it cannot be generated internally. Goodwill is an intangible asset, and so is listed within the long-term assets section of the acquirer's balance sheet.
There is more risk associated with non current assets than with current assets, since they may decline in value during their extended holding periods. An excessive amount of reduction in value may lead to an impairment charge.
3. CURRENT LIABILITIES :
A current liability is an obligation that is payable within one year. The cluster of liabilities comprising current liabilities is closely watched, for a business must have sufficient liquidity to ensure that they can be paid off when due. All other liabilities are reported as long-term liabilities, which are presented in a grouping lower down in the balance sheet, below current liabilities.
In those rare cases where the operating cycle of a business is longer than one year, a current liability is defined as being payable within the term of the operating cycle. The operating cycle is the time period required for a business to acquire inventory, sell it, and convert the sale into cash. In most cases, the one-year rule will apply.
Since current liabilities are typically paid by liquidating current assets, the presence of a large amount of current liabilities calls attention to the size and prospective liquidity of the offsetting amount of current assets listed on a company's balance sheet. Current liabilities may also be settled through their replacement with other liabilities, such as with short-term debt.
The aggregate amount of current liabilities is a key component of several measures of the short-term liquidity of a business, including:
* Current ratio. This is current assets divided by current liabilities. * Quick ratio. This is current assets minus inventory, divided by current liabilities. * Cash ratio. This is cash and cash equivalents, divided by current liabilities.
For all three ratios, a higher ratio denotes a larger amount of liquidity and therefore an enhanced ability for a business to meet its short-term obligations.
☆ Examples of Current Liabilities :
The following are common examples of current liabilities:
1. Accounts payable. These are the trade payables due to suppliers, usually as evidenced by supplier invoices.
2. Sales taxes payable. This is the obligation of a business to remit sales taxes to the government that it charged to customers on behalf of the government.
3. Payroll taxes payable. This is taxes withheld from employee pay, or matching taxes, or additional taxes related to employee compensation.
4. Income taxes payable. This is income taxes owed to the government but not yet paid.
5. Interest payable. This is interest owed to lenders but not yet paid.
6. Bank account overdrafts. These are short-term advances made by the bank to offset any account overdrafts caused by issuing checks in excess of available funding.
7. Accrued expenses. These are expenses not yet payable to a third party, but already incurred, such as wages payable.
8. Customer deposits. These are payments made by customers in advance of the completion of their orders for goods or services.
9. Dividends declared. These are dividends declared by the board of directors, but not yet paid to shareholders.
10. Short-term loans. This is loans that are due on demand or within the next 12 months.
11. Current maturities of long-term debt. This is that portion of long-term debt that is due within the next 12 months.
The types of current liability accounts used by a business will vary by industry, applicable regulations, and government requirements, so the preceding list is not all-inclusive. However, the list does include the current liabilities that will appear in most balance sheets.
4. NON CURRENT LIABILITIES :
Non current liabilities are those obligations not due for settlement within one year. These liabilities are separately classified in an entity's balance sheet, away from current liabilities. Examples of non current liabilities are:
1. Long-term portion of debt payable
2. Long-term portion of bonds payable
The aggregate amount of non current liabilities is routinely compared to the cash flows of a business, to see if it has the financial resources to fulfill its obligations over the long term. If not, creditors will be less likely to do business with the organization, and investors will not be inclined to invest in it. A factor to be considered in this evaluation is the stability of an organization's cash flows, since stable flows can support a higher debt load with a reduced risk of default.
5. EQUITY :
Equity is the net amount of funds invested in a business by its owners, plus any retained earnings. It is also calculated as the difference between the total of all recorded assets and liabilities on an entity's balance sheet. An analyst routinely compares the amount of equity to the debt stated on a balance sheet to see if a business is properly capitalised.
The equity concept also refers to the different types of securities available that can provide an ownership interest in a corporation. In this context, equity refers to common stock and preferred stock.
For an individual, equity refers to the ownership interest in an asset. For example, a person owns a home with a market value of ₹ 10,00,000 and owes ₹ 5,00,000 on the related mortgage, leaving ₹ 5,00,000 of equity in the home.
* Equity is divided in balance sheet mostly 3 parts :
- Capital Stock
- Additional paid in capital
- Retained earnings
Let's discuss one by one:
1. Capital Stock : Capital stock is comprised of all types of shares issued by a corporation. This classification includes common stock, and may also include several types of preferred stock. The funds received from capital stock are recorded within the stockholders' equity section of the balance sheet.
A business that has a relatively small amount of capital stock is said to be thinly capitalised, and probably relies upon a significant amount of debt to fund its operations. Conversely, an entity with a large amount of capital stock requires less debt to fund its operations, and so is less subject to the negative effects of changes in interest rates.
An alternative definition of capital stock is that it is comprised of the total number of common and preferred shares that are authorised for issuance. This amount may be substantially larger than the number of shares actually issued. A change in the corporate charter is needed to increase the number of shares authorised for issuance.
2. Additional paid in capital : Additional paid-in capital is any payment received from investors for stock that exceeds the par value of the stock. The concept applies to payments received for either common stock or preferred stock. Par value is typically set extremely low, so most of the amount paid by investors for stock will be recorded as additional paid-in capital. Par value is commonly set at $0.01, and is printed on the stock certificate. Low par values are used because many state governments mandate that shares cannot be sold at prices below their par values.
There is no change in the additional paid-in capital account when a company's shares are traded on a secondary market between investors, since the amounts exchanged during these transactions do not involve the company that issued the shares.
For example, the board of directors of a business authorizes ₹ 10,00,000 shares of common stock at a par value of ₹ 1. The company then sells 2,00,000 of these shares for ₹ 2 each. To record the receipt of cash, the company records a debit of ₹4,00,000 to the cash account, Credit to ₹ 2,00,000 to the common stock account, and ₹ 2,00,000to the additional paid-in capital account.
The additional paid-in capital account and the retained earnings account typically contain the largest balances in the equity section of the balance sheet.
Similar Terms
Additional paid-in capital is also known as contributed capital in excess of par.
3. Retained Earnings : Retained earnings are the profits that a company has earned to date, less any dividends or other distributions paid to investors. This amount is adjusted whenever there is an entry to the accounting records that impacts a revenue or expense account. A large retained earnings balance implies a financially healthy organization. The formula for ending retained earnings is:
Beginning retained earnings + Profits/losses - Dividends = Ending retained earnings
A company that has experienced more losses than gains to date, or which has distributed more dividends than it had in the retained earnings balance, will have a negative balance in the retained earnings account. If so, this negative balance is called an accumulated deficit.
The retained earnings balance or accumulated deficit balance is reported in the stockholders' equity section of a company's balance sheet.
A growing company normally avoids dividend payments, so that it can use its retained earnings to fund additional growth of the business in such areas as working capital, capital expenditures, acquisitions, research and development, and marketing. It may also elect to use retained earnings to pay off debt, rather than to pay dividends. Another possibility is that retained earnings may be held in reserve in expectation of future losses, such as from the sale of a subsidiary or the expected outcome of a lawsuit.
As a company reaches maturity and its growth slows, it has less need for its retained earnings, and so is more inclined to distribute some portion of it to investors in the form of dividends. The same situation may arise if a company implements strong working capital policies to reduce its cash requirements.
When evaluating the amount of retained earnings that a company has on its balance sheet, consider the following points:
1. Age of the company. An older company will have had more time in which to compile more retained earnings.
2. Dividend policy. A company that routinely issues dividends will have fewer retained earnings.
3. Profitability. A high profit percentage eventually yields a large amount of retained earnings, subject to the two preceding points.
4. Cyclical industry. When a business is in an industry that is highly cyclical, management may need to build up large retained earnings reserves during the profitable part of the cycle in order to protect it during downturns.
for example of balance sheet and related topic clear in : https://accountingexpertiseincometaxgst.blogspot.com/2020/07/balance-sheet-part-2.html
Remaining part of Relationship between financial statements discuss in 49th blog...
So wait my 49th blog...
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