CHANGES IN BALANCE SHEET ACCOUNTS
The total assets of a firm and the claims on assets change over time because of investing and financing activities. For example, a firm may issue common stock for cash; acquire a building by mortgaging a portion of the purchase price, or issue common stock in exchange for convertible bonds. These investing and financing activities affect the amount and structure of a firm’s assets, liabilities, and shareholders’ equity. The total assets of a firm and the claims on assets also change every day because of operating activities. The firm engages in daily business operations to generate revenues and create assets, but to do so, the firm must consume resources and incur obligations. Ideally, the firm sells goods or services to customers for an amount larger than the firm’s cost to acquire or produce the goods and services. Creditors and owners provide capital to a firm with the expectation that the firm will use the capital to conduct profitable business operations and provide an adequate return to the suppliers of capital for the level of risk involved. The balance sheet is the summary of the firm’s financial position at the end of each period; therefore, it summarizes the results of the operating, investing, and financing activities. Analysts frequently examine the relation between items in the balance sheet when assessing a firm’s financial position and credit risk. For example, an excess of current assets over current liabilities suggests that a firm has sufficient liquid resources to pay short-term creditors. A relatively low percentage of long-term debt to shareholders’ equity suggests that a firm likely has sufficient long-term assets to repay the long-term debt at maturity, or at least an ability to take on new debt financing using the long-term assets as collateral to repay debt coming due. However, when using the balance sheet for these purposes, the analyst must recognize the following:
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