Question

How does accrual accounting complicate the use of corporate financial statements in estimating corporate value (by investors) or managing and maximizing corporate value (by management)? 1. 2. Explain how management and investors can effectively determine a company's financial condition using financial statement ratio analysis? 3. Explain the underlying ideas behind time value of money. Explain when one would use Present Value to make a financial decision and when one would use Future Value.

Answer 1

3. Time value of money is the concept that the value of a dollar to be received in future is less than the value of a dollar on hand today. One reason is that money received can be invested thus generating more money, mostly in the form of interest overtime. It means that a dollar amount on hand today has the potential earning power. Also money is subject to inflation, So the value of a currency will depreciate overtime due to the increased price level products and services.

1. Accrual accounting requires much more judgement, guesswork, and estimation than the cash basis of accounting. These judgments and estimations makes it difficult for an investor to take a decision on his investments, because the financial statements of a company may seems like good in figures. But the exact figure may differ due to the uncertain nature of economy.For example, huge amount in accounts receivable balance is a good thing for any company. But at the same time it has the risk that a portion of the accounts receivable would be bad debts.

2. Ratio Analysis is a comparison across time or benchmarks, of relationships between financial statement accounts, and non-financial data. Ratios provide incremental information about the financial health of the company beyond the raw amounts presented in the financial statements. It compares line item data from a company's financial statements to reveal insights regarding profitability, liquidity, operational efficiency, and solvency. Ratio Analysis can be used to look at trends over time for on e company or to compare companies with in an industry.