Question

Situation. L05 (C122 P1-2A. Financial Statements While each of the financial statements is likely to aid in any business decision. it is often the case that a particular financial statement may be best suited to help in a particular deci- sion. Consider each decision below independently: You are trying to determine whether a particular firm is a good investment. You understand than share price increases are impacted heavily by a company's earnings potential. a. statereen meer C. ancome b. You are employed in the lending department of a large bank. You are trying to determine if you should lend to a potential customer. If you do make the loan you are especially concerned that the company will have sufficient collateral in the event that it is unable to repay the loan. You wish to invest in a firm that provides you with a steady source of income. You especially want a firm that pays out a large part of its net income as dividends. Stolemout of SE d. You are trying to determine if a particular firm will have sufficient cash flow in order to keep expanding without relying too heavily on external sources of financing. Required Determine which of the financial statements contains the most useful information to help in your deci- sion. Explain what information you used from each statement to help you make your decision.

Answer 1

(a) Income statement: An income statement is the best way to understand a company's earnings potential. You can use the income statement of the past few years to get a better understanding of the Profit margin which the company is able to achieve over the year, which will provide you a better understanding of the share prices of the said company.

(b) Balance sheet: The balance sheet will provide a better view of the assets held by the company on a given date. The amount of assets which can be held as collateral can be determined by the balance sheet. In such a way, by taking the value of collateral as the base, we can decide on the amount which can be lended as a loan to the said company.

(c) Statement of stockholders Equity: The two major components here are " net income" and "dividends paid", Hence, you can use this statement to determine which firm pays out a larger part of its net income as dividends.

(d) Cash flow statement: As all the other financial statement work on accrual basis, cash flow statement is the best measure to determine whether the firm has enough cash on hand, or it future cash generating abilities, for expansion, without relying too heavily on external financing.