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Balance Sheet: Net Worth Definition

Essay by   •  July 1, 2011  •  Case Study  •  9,597 Words (39 Pages)  •  1,520 Views

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Analysis: Fundamental Analysis:

Balance Sheet: Net Worth Definition

* The formula for Net Worth is:

* A corporation's Net Worth is the theoretical net liquidation value of the firm

* Net Worth is the owners' (both common and preferred shareholders) value in the enterprise

Analysis: Fundamental Analysis:

Balance Sheet: Net Working Capital Definition

* The formula for Net Working Capital is:

* Current Assets are all assets that will become cash within 1 year, and include cash, marketable securities, accounts receivable and inventories

* Current Liabilities are all bills that must be paid within 1 year, and include accounts payable, interest payable and dividends payable

* A corporation's Net Working Capital consists of the net liquid assets that the firm has available for uses other than to pay current bills, such as funds available for investment in plant and equipment, or research and development

Analysis: Fundamental Analysis:

Balance Sheet: Liquidity - Current Ratio

* The formula for the Current Ratio is:

* This is a measure of the corporation's liquidity

* Current Assets are all assets that will become cash within 1 year, and include cash, marketable securities, accounts receivable and inventories

* Current Liabilities are all bills that must be paid within 1 year, and include accounts payable, interest payable and dividends payable

* The Current Ratio should be comfortably above 1, showing that there are sufficient current assets to pay current liabilities

Analysis: Fundamental Analysis:

Balance Sheet: Liquidity - Acid Test Ratio

* The formula for the Acid Test Ratio, also called the Quick Ratio, is:

* This is a measure of the corporation's liquidity; and is a more stringent test than the Current Ratio

* Current Assets are all assets that will become cash within 1 year; to find the current assets that are "quickly convertible" into cash, inventories and prepaid expenses must be excluded since these can be hard to turn into cash, leaving only cash, marketable securities and accounts receivable

* Current Liabilities are all bills that must be paid within 1 year

* The Acid Test Ratio should be about 1, showing that there are sufficient "quick" current assets to pay current liabilities

Analysis: Fundamental Analysis:

Balance Sheet: Liquidity - Accounts Receivable Turnover Ratio

* The formula for the Accounts Receivable Turnover Ratio is:

* This ratio shows how quickly a corporation is collecting its receivables. For example, if the ratio is 4x, this means that receivables are "turning over" 4 times per year, or that on average, receivables equals 360 days in a year / 4 x turnover = 90 days worth of sales.

* The faster the turnover ratio, the more efficient the company is at collecting its receivables

Analysis: Fundamental Analysis:

Balance Sheet: Liquidity - Inventory Turnover Ratio

* The formula for the Inventory Turnover Ratio is:

* This ratio shows how quickly a corporation is selling its inventory. For example, if the ratio is 4x, this means that inventory is "turning over" 4 times per year, or that on average, inventory equals 360 days in a year / 4 x turnover = 90 days worth of sales.

* The faster the turnover ratio, the more efficient the company is managing its inventory levels

Analysis: Fundamental Analysis:

Balance Sheet: Liquidity - Summary

* The ratios that measure a company's liquidity are:

* The most stringent test of liquidity is the Cash Assets Ratio, showing whether there is enough immediate "cash" to pay bills as they come due

* The least stringent test of liquidity is the Current Ratio, since it includes cash, marketable securities, accounts receivable, inventory and prepaid expenses as the liquid assets available to pay bills as they come due

Analysis: Fundamental Analysis:

Balance Sheet: Inventory Valuation Methods

* Inventory can either be accounted for on the FIFO method or the LIFO method

o FIFO accounting is "first in, first out"

o LIFO accounting is "last in, first out"

* Under FIFO accounting, the first items into inventory are the first sold. Thus, in a period of rising prices, the "older" cheaper inventory is selling first, leaving the more expensive newer items in inventory. This inflates reported corporate profits since the "cheaper inventory" is included in cost of sales; and inflates reported inventory levels, since the "more expensive inventory" remains in reported inventory balances

* Under LIFO accounting, the last items into inventory are the first sold. Thus, in a period of rising prices, the "newer" more expensive inventory is selling first, leaving the more cheaper older items in inventory. This reduces reported corporate profits since the "more expensive inventory" is included in cost of sales; and results in lower inventory values, since the "less expensive inventory" remains in reported inventory balances

Analysis: Fundamental Analysis:

Balance Sheet: Inventory Valuation Methods - Effect on Reported

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