Concept explainers
(a) Jose Ramirez believes that the analysis of financial statements is directed at two characteristics of a company: liquidity and profitability. Is Jose correct? Explain.
(b) Are short-term creditors, long-term creditors, and stockholders interested primarily in the same characteristics of a company? Explain.
(a)
Financial Analysis: Analysis of financial statements of the firm helps to frame policies and plans. The financial analysis determines the financial situation of the firm. It can be used for comparison.
To explain: Whether Mr. J correctly analyzes the financial statements based on liquidity and profitability.
Explanation of Solution
No, Mr. J is not correctly analyzed the financial statements based on liquidity and profitability because the financial statements must be analyzed based on liquidity, profitability, and solvency.
Liquidity refers to the ability to pay short-term liabilities. Profitability refers to the earning capacity of the firm. Solvency determines the ability to pay long-term liabilities of the firm.
So, Mr. J was incorrect in the analysis of the financial statements based on liquidity and profitability only.
(b)
Financial Analysis: Analysis of financial statements of the firm helps to frame policies and plans. The financial analysis determines the financial situation of the firm. It can be used for comparison.
To explain: The interest of short-term creditors, long-term creditors, and stockholders in the company.
Explanation of Solution
Short-term creditors: Short-term creditors are interested in liquidity ratio as they want to know whether their funds are safe or not.
Short-term creditors are the current liability of the company and must be paid within a short period of time. So, they are interested in the company’s short-run performance of the company.
Long-term creditors: Long-term creditors are interested in solvency ratio as they want to know whether their funds are safe or not in long run.
Long-term creditors are the non-current liability of the company and paid after a long period of time. So, they are interested in the company’s long-run performance of the company.
Stockholders: Stockholders are interested in all the three characteristics that are liquidity, profitability, and solvency to know the overall performance of the company.
Stockholders have significant influence over the company’s activities and operations; therefore, they are interested in the overall performance of the company.
No, the short-term creditors, the long-term creditors, and the stockholders do not have same primary interest in characteristics of the company.
Want to see more full solutions like this?
Chapter 14 Solutions
Managerial Accounting: Tools for Business Decision Making
- Financial analysis considers the profitability, liabilities and other financial capacities of a company. A True B) Falsearrow_forwardThe return on total assets is the focus of analysts, creditors, and other users of financial statements. 1. How is the return on total assets computed? 2. What does this important ratio reflect? 3. Return on total assets can be separated into two important components. Write the formula to separate the return on total assets into its two basic components. 4. Explain how these components of the return on total assets are helpful to financial statement users for business decisions.arrow_forwardThe quality of earnings concept indicates thata. stockholders want the corporation to earn enough income to be able to pay its debts.b. net income is the best measure of the results of operations.c. continuing operations and one-time transactions are of equal importance.d. income from continuing operations is a more relevant predictor of future performancethan income from one-time transactionsarrow_forward
- 1. What is an investor’s objective in financial statement analysis? a. To determine if the firm is risky b. To determine the stability of earnings. c. To determine changes necessary to improve future performance d. To determine whether or not an investment is warranted by estimating a company’s future earnings stream 2. The current ratio isa. calculated by dividing current liabilities by current assets. b. used to evaluate a company's liquidity and short-term debt paying ability c. used to evaluate a company's solvency and long-term debt paying ability. d. calculated by subtracting current liabilities from current assets.arrow_forwardAdvantages and disadvantages of using financial statements as a tool to analyse the financial performance of a company.arrow_forwardIn analyzing a company's financial statements, which financial statenent would a potential investor primarily use to assess the company's liquidity and financial fiexibility?arrow_forward
- How does the balance sheet help users? O a. It depicts the true value of an entity. O b. It shows the financial performance of an entity over a specific accounting period. O c. It assesses an entity's liquidity, solvency, financial flexibility, and operating capability. O d. It measures the nonfinancial performance of an entity. РОСОРНONЕ SHOT ON POCOPHONE F1arrow_forwardWhich of the following is NOT a financial statement?Choose one answer.a. Income statement b. Balance sheet c. Company performance sheet d. Cash flow statementarrow_forwardIs accrual accounting more closely related to a company’s goal of profitability or liquidity?arrow_forward
- Please discuss the questions followings: 1. What is the difference between liquidity and solvency? 2. What is the difference between working capital and the current ratio? 3. Why is the accrual basis of accounting requied by geneally accepted acccounting principles (GAAP)? 4. What is the most important output of the accounting cycle? Do all companies have an accounting cycle?arrow_forwardThe ability of a business to pay its debts as they come due and to earn a reasonable net income is a. solvency and equity b. solvency and profitability c. solvency and leverage d. solvency and liquidityarrow_forwardn analyzing a company’s financial statements, which financial statement would a potential investor primarily use to assess the company’s liquidity and financial flexibility? a. Income statement b. Statement of retained earnings c. Statement of cash flows d. Statement of financial positionarrow_forward
- AccountingAccountingISBN:9781337272094Author:WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.Publisher:Cengage Learning,Accounting Information SystemsAccountingISBN:9781337619202Author:Hall, James A.Publisher:Cengage Learning,
- Horngren's Cost Accounting: A Managerial Emphasis...AccountingISBN:9780134475585Author:Srikant M. Datar, Madhav V. RajanPublisher:PEARSONIntermediate AccountingAccountingISBN:9781259722660Author:J. David Spiceland, Mark W. Nelson, Wayne M ThomasPublisher:McGraw-Hill EducationFinancial and Managerial AccountingAccountingISBN:9781259726705Author:John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting PrinciplesPublisher:McGraw-Hill Education