Analyzing Financing Activities

Liabilities

  • Financing obligations that require future payment of money, services, or other assets.
  • Financing liabilities, credit financing
  • Operating liabilities, trade creditors
  • Current liabilities, obligations within a year
  • Noncurrent liabilities, mature more than one year

Leases

  1. Capital lease, recognized on the balance sheet
  2. Operating lease, no asset or liability is recognized on the balance sheet

Impact of Operating Leases

  1. Understates liabilities which positively impacts solvency ratios
  2. Understates assets which inflates return on investment and asset turnover ratios
  3. Delay recognition of expenses which overstates income (early term of the lease)
  4. Understates current liabilities which inflates liquidity ratios
  5. Understates operating income and interest expenses which inflates interest coverage ratios and times interest earned

Off-balance sheet activities

Contingencies

  • Potential gains and losses whose resolution depends on one o r more future events
  • Contingent liabilities, potential claim on a company’s resources
  • Contingent liabilities must be probable and estimable

Commitments

  • Potential claims against a company’s resources due to future performance under contract

Shareholders’ Equity

Equity refers to owner (shareholder) financing of a company. Claims of owners on the net assets of the company.

Capital Stock

Shares issued to equity holders in return for assets and services

Sources of increases in capital stock outstanding

  1. Issuances of stock
  2. Conversion of debentures and preferred stock
  3. Issuances pursuant to stock dividends and gifts
  4. Issuances of stock in acquisitions and mergers
  5. Issuances pursuant to stock options and warrants exercised

Sources of decreases in capital stock outstanding

  1. Purchases and retirements of stocks
  2. Stock buybacks
  3. Reverse stock splits

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