What is the purpose of a balance sheet?

Answer: The balance sheet provides a snapshot of a company's financial position at a

specific point in time. It shows what the company owns (assets), what it owes
(liabilities), and what is left over for shareholders (equity). This information is crucial for
understanding the company's financial health and stability.

2. Define the terms asset, liability, and equity.

Answer:

 Asset: Anything the company owns or has economic control over, such as
cash, equipment, inventory, or investments.
 Liability: What the company owes to others, such as loans, accounts payable, accrued
expenses, or taxes.
 Equity: The residual interest of shareholders in the company, representing their
ownership claim on assets after all liabilities are settled.

3. Explain the fundamental accounting equation: Assets = Liabilities + Equity.

Answer: This equation represents the core principle of double-entry bookkeeping. Every
transaction affects at least two accounts on the balance sheet, ensuring balance and
accuracy.

4. What are the main categories of assets, liabilities, and equity on a balance sheet?

Answer:

 Assets: Current assets (cash, receivables, inventory), non-current assets

(property, equipment, investments).
 Liabilities: Current liabilities (accounts payable, accrued expenses), non-current
liabilities (long-term loans, bonds).
 Equity: Share capital, retained earnings (accumulated profits), other equity components.

5. Describe the difference between current and non-current assets and liabilities.

Answer:
 Current: Expected to be realized or settled within one year of the balance sheet date
(e.g., cash, accounts payable).
 Non-current: Typically not expected to be realized or settled within one year
(e.g., property, long-term loans).

6. What is working capital, and how is it calculated?

Answer: Working capital is the difference between current assets and current liabilities.
It indicates the company's ability to meet its short-term financial obligations. Working
capital = Current Assets - Current Liabilities.

7. Explain the concept of depreciation and its impact on the balance sheet.

Answer: Depreciation is the process of allocating the cost of an asset over its useful life.
It gradually reduces the asset's book value on the balance sheet, while not affecting its
actual physical condition. This affects both asset value and net income (equity).

8. What is net assets, and how do you calculate it?

Answer: Net assets represent the total ownership interest of shareholders. It is

calculated by subtracting liabilities from total assets. Net assets = Total Assets - Total
Liabilities.

9. How does a company's profit or loss from the income statement affect the balance
sheet?

Answer: A net profit increases retained earnings (equity), while a net loss decreases it.
This directly affects the right side of the balance sheet equation.

Intermediate Level Questions and Answers:

10. Analyze the changes in key balance sheet items from one period to another.

Answer: Analyzing trends in key items like cash, inventory, receivables, payables, and
debt can reveal valuable insights into the company's liquidity, efficiency, and solvency.
Identifying significant increases or decreases may require further investigation into the
underlying causes.

11. Explain the difference between different inventory valuation methods and their
impact on the balance sheet.
 Answer: Different methods like FIFO, LIFO, and weighted average cost affect the cost
assigned to inventory, resulting in variations in reported asset value and net income.
Understanding these differences is essential for interpreting profitability and financial
health.

12. Discuss the accounting treatment of intangible assets and goodwill.

Answer: Intangible assets like patents or trademarks require special considerations

compared to physical assets. Goodwill arises from acquisition and represents the
excess purchase price paid for a company over the fair value of its identifiable assets.
Their valuation and presentation on the balance sheet can be complex and impact
financial ratios.

13. Describe the different types of liabilities and their implications for the company's
financial health.

Answer: Understanding the types of liabilities, such as secured vs. unsecured, current
vs. non-current, and contingent liabilities, is crucial for assessing the company's debt
burden and future payment obligations. High levels of debt or contingent liabilities can
raise concerns about the company's solvency.

14. Calculate and interpret various financial ratios based on the balance sheet data,
such as the debt-to-equity ratio, current ratio, and quick ratio.

Answer: Financial ratios provide valuable insights into various aspects of the company's
financial health. The debt-to-equity ratio indicates the company's reliance on debt, the
current ratio assesses its short-term

What is the difference between cash flow and net income?

Answer: Net income measures profitability on paper, while cash flow reflects the actual
movement of money in and out of the business. While they are connected, a profitable
company may not have positive cash flow if it struggles to collect payments or
experiences high upfront costs.

2. Explain the three main sections of a cash flow statement.

Answer:

 Operating activities: Cash inflows from sales and outflows for expenses related to
running the business.
 Investing activities: Cash inflows from selling assets and outflows for purchasing new
assets or investments.
 Financing activities: Cash inflows from borrowing money and issuing stock, and
outflows for repaying debt and repurchasing shares.

3. What are some reasons why a company might have negative cash flow?

Answer:

 Rapid growth: Expanding fast often requires significant upfront investments before
generating sufficient revenue to cover costs.
 Inefficient inventory management: Holding too much inventory can tie up cash, while
having too little may lead to lost sales.
 Poor credit collection: Delay in receiving payments from customers can significantly
impact cash flow.
 High upfront costs: Certain industries have large initial investments before generating
revenue, resulting in initial negative cash flow.

Intermediate Level:

4. Calculate free cash flow and explain its importance.

Answer: Free cash flow (FCF) is the amount of cash remaining after the company
covers operating expenses and capital expenditures. It represents the cash available for
dividends, debt repayment, or reinvestment. A higher FCF indicates stronger financial
health and growth potential.

5. How can a company analyze its cash flow to improve its financial performance?

Answer: By analyzing trends in different cash flow sections, a company can identify
areas for improvement, such as:

 Reducing operating expenses or optimizing inventory management to improve

operating cash flow.
 Negotiating better payment terms with suppliers or customers.
 Managing capital expenditures more effectively to maximize returns on investments.
 Exploring alternative financing options with lower interest rates or more flexible terms.

6. Discuss the challenges of forecasting cash flow and different methods used.

Answer: Forecasting cash flow can be challenging due to uncertainties in sales,

expenses, and external factors. Common methods include historical trends analysis,
budget projections, and scenario planning. However, it's crucial to recognize the
inherent uncertainties and incorporate contingencies into the forecasts.

Advanced Level:

7. How can a company use its cash flow statement to evaluate potential acquisitions or
investments?

Answer: Analyzing the target company's cash flow can reveal its operating efficiency,
debt burden, and ability to generate sustainable cash flow for future growth and
financing potential acquisitions. It also helps assess the potential impact of the
acquisition on the combined company's cash flow.

8. Discuss the limitations of the cash flow statement and how to address them.

Answer: Cash flow does not tell the whole story. Factors like accounting policies, non-
cash transactions, and off-balance sheet financing can mask underlying financial
weaknesses. It's essential to consider the cash flow statement in conjunction with other
financial statements and market trends for a comprehensive understanding of the
company's financial health