Discursive Questions

Question 1

Limitations of Cash Flow Statement

Answer 1

• Ignores non-cash and accrual-based items –> doesn’t give a full picture of liquidity and profitability. For example, a company may have positive cash flow but still be unprofitable - selling assets to raise cash, working-capital squeeze rather than sustainable profit. Therefore cannot replace BS and IS, cannot confirm long-term viability itself.
• Relies on Accuracy of Other Statements. Especially under the indirect method, any errors in B/S and I/S will affect the cash flow statement’s reliability.
• Backward-Looking Only. This limits its use for forecasting or planning.

Question 2

Use of Cash Flow Statement

Answer 2

• Reveals Liquidity Health. It shows whether the business is generating enough cash to sustain itself and can meet short-term obligations - crucial for survival!
• Broken down by activity type (Operating, Investing, and Financing) so stakeholders can clearly see where cash is coming from, where cash is going, and whether activities are sustainable.
  Investors and lenders use it to decide whether the business can pay interest/dividends and generating enough to cash sustain/grow; Managers use it to plan for loan repayments and dividend policies.

Question 3

Use of Ratio Analysis

Answer 3

• Used to assess financial health and performance of a business
• Helps compare businesses over time and with competitors
• Can identify trends, strengths, weaknesses –> useful for management, investment and credit decisions

Question 4

Limitation of Ratio Analysis

Answer 4

• Different accounting policies, financing methods, and year-ends limits comparability company-to-company
• Inflation limites comparability year-to-year - understate asset value and cost, overstate profit
• Relies on quality of financial statements
• Ignores non-financial factors (e.g. goodwill, customer satisfaction, market conditions) that may significantly imapct long-term success

Overall: ratios are useful but not in isolation, best used with multiple years’ data and industry benchmarks for comparison, and full financial statements for context

Question 5

Use of Balance Sheet

Answer 5

• Summarizes assets, liabilities, equity, helping users understand the company’s financial position - what it owns and owes
• Useful for assessing liquidity and solvecy; tells whether the firm has sufficient current assets to meet maturing obligations.
• Basis for calculating financial ratios –> assessing the value and performance of a business

Question 6

Limitation of Balance Sheet

Answer 6

• Static - Only shows finanical position at a specific point in time, should be used incombination with the other two dynamic statements to see profit and cash flow generated over a period
• Money measurement - only includes items that can be measured reliably in monetary terms, omits intangible assets like staff talent, product qualitive, and reputation
• Historic cost: undervalues long-term assets
• Subject to manipulation - should use in combination with cash flow statement, which is harder to manipulate

Question 7

Use of Income Statement

Answer 7

• Dynamic - measures profitability over a period
• Shows the business’s ability to generate profit, and how the profit was generated
• Breaks down types of expenses –> investors and managers can gauge operational efficiency and cost management

Question 8

Limitation of Income Statement

Answer 8

• Doesn’t reflect cash flow directly: A company can show strong profits but still suffer from cash shortages if revenues are not collected promptly.
• Money mesaurement 0 Some revenues/expenses may be excluded if not reliably measurable (e.g. uncertain lawsuits)
• Subject to manipulation: Companies might time revenue recognition or defer expenses to manipulate reported profits.