Holding and Subsdiary Accounts - Click above to read more.
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Showing posts with label Accounts. Show all posts
Showing posts with label Accounts. Show all posts
Sunday, January 15, 2012
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Friday, September 16, 2011
Drawing Conclusions from Your Final Balance Sheet
You can analyze balance sheet numbers through a series of ratio tests to draw conclusions, check your cash status, and track your debt. Because these are the types of tests financial institutions and potential investors use to determine whether or not to loan money to or invest in your company, it’s a good idea to run these tests yourself before seeking loans or investors.
Testing your cash
When you approach a bank or other financial institution for a loan, you can expect the lender to use one of two ratios to test your cash flow: the current ratio and the acid test ratio (also known as the quick ratio).
Current ratio
This ratio compares your current assets to your current liabilities. It provides a quick glimpse of your company’s ability to pay its bills.
The formula for calculating the current ratio is:
Current assets ÷ Current liabilities = Current ratio
The following is an example of a current ratio calculation:
$5,200 ÷ $2,200 = 2.36 (current ratio)
Lenders usually look for current ratios of 1.2 to 2, so any financial institution would consider a current ratio of 2.36 a good sign. A current ratio under 1 is considered a danger sign because it indicates the company doesn’t have enough cash to pay its current bills.
A current ratio over 2.0 may indicate that your company isn’t investing its assets well and may be able to make better use of its current assets. For example, if your company is holding a lot of cash, you may want to invest that money in some long-term assets, such as additional equipment, that you need to help grow the business.
Acid test (quick) ratio
The acid test ratio only uses the financial figures in your company’s Cash account, Accounts Receivable, and Marketable Securities. Although it’s similar to the current ratio in that it examines current assets and liabilities, the acid test ratio is a stricter test of a company’s ability to pay bills.
The assets part of this calculation doesn’t take inventory into account because it can’t always be converted to cash as quickly as other current assets and because, in a slow market, selling your inventory may take a while.
Many lenders prefer the acid test ratio when determining whether or not to give you a loan because of its strictness.
Calculating the acid test ratio is a two-step process:
1. Determine your quick assets.
Cash + Accounts Receivable + Marketable Securities = Quick assets
2. Calculate your quick ratio.
Quick assets ÷ Current liabilities = Quick ratio
The following is an example of an acid test ratio calculation:
$2,000 + $1,000 + $1,000 = $4,000 (quick assets)
$4,000 ÷ $2,200 = 1.8 (acid test ratio)
Lenders consider a company with an acid test ratio around 1 to be in good condition. An acid test ratio less than 1 indicates that the company may have to sell some of its marketable securities or take on additional debt until it’s able to sell more of its inventory.
Assessing your debt
Before you even consider whether or not to take on additional debt, you should always check out your debt condition. One common ratio that you can use to assess your company’s debt position is the debt to equity ratio. This ratio compares what your business owes to what your business owns.
Calculating your debt to equity ratio is a two-step process:
1. Calculate your total debt.
Current liabilities + Long-term liabilities = Total debt
2. Calculate your debt to equity ratio.
Total debt ÷ Equity = Debt to equity ratio
The following is an example of a debt to equity ratio calculation:
$2,200 + $29,150 = $31,350 (total debt)
$31,350 ÷ $9,500 = 3.3 (debt to equity ratio)
Lenders like to see a debt to equity ratio close to 1 because it indicates that the amount of debt is equal to the amount of equity. With a debt to equity ratio of 3.3, most banks probably would not loan the company in this example any more money until either its debt levels were lowered or the owners put more money into the company
Testing your cash
When you approach a bank or other financial institution for a loan, you can expect the lender to use one of two ratios to test your cash flow: the current ratio and the acid test ratio (also known as the quick ratio).
Current ratio
This ratio compares your current assets to your current liabilities. It provides a quick glimpse of your company’s ability to pay its bills.
The formula for calculating the current ratio is:
Current assets ÷ Current liabilities = Current ratio
The following is an example of a current ratio calculation:
$5,200 ÷ $2,200 = 2.36 (current ratio)
Lenders usually look for current ratios of 1.2 to 2, so any financial institution would consider a current ratio of 2.36 a good sign. A current ratio under 1 is considered a danger sign because it indicates the company doesn’t have enough cash to pay its current bills.
A current ratio over 2.0 may indicate that your company isn’t investing its assets well and may be able to make better use of its current assets. For example, if your company is holding a lot of cash, you may want to invest that money in some long-term assets, such as additional equipment, that you need to help grow the business.
Acid test (quick) ratio
The acid test ratio only uses the financial figures in your company’s Cash account, Accounts Receivable, and Marketable Securities. Although it’s similar to the current ratio in that it examines current assets and liabilities, the acid test ratio is a stricter test of a company’s ability to pay bills.
The assets part of this calculation doesn’t take inventory into account because it can’t always be converted to cash as quickly as other current assets and because, in a slow market, selling your inventory may take a while.
Many lenders prefer the acid test ratio when determining whether or not to give you a loan because of its strictness.
Calculating the acid test ratio is a two-step process:
1. Determine your quick assets.
Cash + Accounts Receivable + Marketable Securities = Quick assets
2. Calculate your quick ratio.
Quick assets ÷ Current liabilities = Quick ratio
The following is an example of an acid test ratio calculation:
$2,000 + $1,000 + $1,000 = $4,000 (quick assets)
$4,000 ÷ $2,200 = 1.8 (acid test ratio)
Lenders consider a company with an acid test ratio around 1 to be in good condition. An acid test ratio less than 1 indicates that the company may have to sell some of its marketable securities or take on additional debt until it’s able to sell more of its inventory.
Assessing your debt
Before you even consider whether or not to take on additional debt, you should always check out your debt condition. One common ratio that you can use to assess your company’s debt position is the debt to equity ratio. This ratio compares what your business owes to what your business owns.
Calculating your debt to equity ratio is a two-step process:
1. Calculate your total debt.
Current liabilities + Long-term liabilities = Total debt
2. Calculate your debt to equity ratio.
Total debt ÷ Equity = Debt to equity ratio
The following is an example of a debt to equity ratio calculation:
$2,200 + $29,150 = $31,350 (total debt)
$31,350 ÷ $9,500 = 3.3 (debt to equity ratio)
Lenders like to see a debt to equity ratio close to 1 because it indicates that the amount of debt is equal to the amount of equity. With a debt to equity ratio of 3.3, most banks probably would not loan the company in this example any more money until either its debt levels were lowered or the owners put more money into the company
Consolidated Financial Statements – Some Facts
The financial statement reflects the financial results including the details of all the assets and liabilities. After a stock purchase by the parent company, the subsidiary continues to maintain separate accounting records. But in reality, the parent company controls the subsidiary, so it no longer functions autonomously.
Because the parent concern now fully reins the subsidiary, by accounting rules, the parent company must present its subsidiary's and its own financial operations in a consolidated manner (even though the two companies may be separate legal entities).
The parent company does so by producing a consolidated financial statement, which combines the assets, liabilities, revenue, and expenses of the parent company as well as those of its associates (i.e. its subsidiaries, associates, and joint ventures).
If someone holds a minority interest in the subsidiary of a parent company, the consolidated financial statement won't give the required information that one needs to make decisions about one’s holdings. A subsidiary with minority shareholders must report its financial results separately from the parent company along with the report included in the consolidated financial statements.
When a company owns all the common stock of its subsidiaries, the company doesn't really need to publish reports about its subsidiaries' individual results for the general public to scrutinize. Shareholders need not know the results of these subsidiaries.
In preparing consolidated financial statements, the parent company must remove numerous transactions among the parent and its associates before presenting the consolidated financial statements to the public. For example, the parent company must eliminate transactions among the parent and the subsidiaries for accounts receivable and accounts payable to avoid counting revenue twice and giving the financial report reader a false impression that the consolidated entity has more profits or owes more money than it actually does. Other key transactions that a parent company must eliminate when preparing consolidated financial statements are:-
Investments in the subsidiary: The books of parent company show its investments in a subsidiary as an asset account. The subsidiary's books show the stock that the parent company holds as shareholders' equity. Rather than double-counting this type of transaction, the parent company eliminates it on the consolidated statements by writing off one transaction.
Interest revenue and expenses: Sometimes parent company loans money to a subsidiary or subsidiary loans money to a parent company; in these business transactions, one company may charge the other one interest on the loan. On the consolidated statements, any interest revenue or expenses that these loans generate must be eliminated.
Advances to subsidiary: If a parent company advances money to a subsidiary or a subsidiary advances money to its parent company, both entities carry the opposite side of this transaction on their books (that is, one entity gains money while the other one loses it, or vice versa). Again, companies avoid the double transaction on the consolidated statements by getting rid of one transaction.
Dividend revenue or expenses: If a subsidiary declares a dividend, the parent company receives some of these dividends as revenue from the subsidiary. Any time parent company records revenue from its subsidiaries on its books, the parent company must eliminate any dividend expenses that the subsidiary recorded on its books.
Management fees: Sometimes a subsidiary pays its parent company a management fee for the administrative services it provides. These fees are recorded as revenue on the parent company's books and as expenses on the subsidiary's books.
Sales and purchases: Parent companies frequently buy products or materials from their subsidiaries or their subsidiaries buy products or materials from them. In fact, most companies that buy other companies do so within the same industry as a means of getting control of a product line, a customer base, or some other aspect of that company's operations.
However, the consolidated income statements shouldn't show these sales as revenue and shouldn't show the purchases as expenses. Otherwise, the company would be double-counting the transaction. Accounting rules require that parent companies eliminate these types of transactions.
As you can see, these major transactions are all critical for determining whether a company made a profit or loss from its activities. Eliminating assets, liabilities, revenue, and expenses from public view makes determining a subsidiary's financial results nearly impossible for shareholders or creditors. But if these transactions were included, the value of the parent company's stock would be distorted, because these transactions would be counted twice. The shareholders of the parent company would not know the true value of the company's assets and liabilities; the income statement would not reflect the company's true revenues and expenses.
Because the parent concern now fully reins the subsidiary, by accounting rules, the parent company must present its subsidiary's and its own financial operations in a consolidated manner (even though the two companies may be separate legal entities).
The parent company does so by producing a consolidated financial statement, which combines the assets, liabilities, revenue, and expenses of the parent company as well as those of its associates (i.e. its subsidiaries, associates, and joint ventures).
If someone holds a minority interest in the subsidiary of a parent company, the consolidated financial statement won't give the required information that one needs to make decisions about one’s holdings. A subsidiary with minority shareholders must report its financial results separately from the parent company along with the report included in the consolidated financial statements.
When a company owns all the common stock of its subsidiaries, the company doesn't really need to publish reports about its subsidiaries' individual results for the general public to scrutinize. Shareholders need not know the results of these subsidiaries.
In preparing consolidated financial statements, the parent company must remove numerous transactions among the parent and its associates before presenting the consolidated financial statements to the public. For example, the parent company must eliminate transactions among the parent and the subsidiaries for accounts receivable and accounts payable to avoid counting revenue twice and giving the financial report reader a false impression that the consolidated entity has more profits or owes more money than it actually does. Other key transactions that a parent company must eliminate when preparing consolidated financial statements are:-
Investments in the subsidiary: The books of parent company show its investments in a subsidiary as an asset account. The subsidiary's books show the stock that the parent company holds as shareholders' equity. Rather than double-counting this type of transaction, the parent company eliminates it on the consolidated statements by writing off one transaction.
Interest revenue and expenses: Sometimes parent company loans money to a subsidiary or subsidiary loans money to a parent company; in these business transactions, one company may charge the other one interest on the loan. On the consolidated statements, any interest revenue or expenses that these loans generate must be eliminated.
Advances to subsidiary: If a parent company advances money to a subsidiary or a subsidiary advances money to its parent company, both entities carry the opposite side of this transaction on their books (that is, one entity gains money while the other one loses it, or vice versa). Again, companies avoid the double transaction on the consolidated statements by getting rid of one transaction.
Dividend revenue or expenses: If a subsidiary declares a dividend, the parent company receives some of these dividends as revenue from the subsidiary. Any time parent company records revenue from its subsidiaries on its books, the parent company must eliminate any dividend expenses that the subsidiary recorded on its books.
Management fees: Sometimes a subsidiary pays its parent company a management fee for the administrative services it provides. These fees are recorded as revenue on the parent company's books and as expenses on the subsidiary's books.
Sales and purchases: Parent companies frequently buy products or materials from their subsidiaries or their subsidiaries buy products or materials from them. In fact, most companies that buy other companies do so within the same industry as a means of getting control of a product line, a customer base, or some other aspect of that company's operations.
However, the consolidated income statements shouldn't show these sales as revenue and shouldn't show the purchases as expenses. Otherwise, the company would be double-counting the transaction. Accounting rules require that parent companies eliminate these types of transactions.
As you can see, these major transactions are all critical for determining whether a company made a profit or loss from its activities. Eliminating assets, liabilities, revenue, and expenses from public view makes determining a subsidiary's financial results nearly impossible for shareholders or creditors. But if these transactions were included, the value of the parent company's stock would be distorted, because these transactions would be counted twice. The shareholders of the parent company would not know the true value of the company's assets and liabilities; the income statement would not reflect the company's true revenues and expenses.
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