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Solvency, Depreciation, Capitalization/Expensing

1. How is the ratio of liabilities to stockholder's equity related to solvency?
2. What is the purpose of depreciation and why are there so many methods?
3. What is the principle defining whether you capitalize or expense an acquisition?
4. Given this distinction, how do capitalized items become appropriately expensed?
5. Why does a current, more than adequate cash flow assure that you are not insolvent?
6. How would the growth in the dollar value of accounts receivable impact the cash flow for any given level of income?
7. How does a firm's equity investment in other firms impact the cash flow of the firm?
8. Why is it critical to separate operating and non-operating income?
9. How would the relationship of revenues and accounts receivables and cash flow differ as a result of credit and collections policy?

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1. How is the ratio of liabilities to stockholder's equity related to solvency?
Solvency means the company is able to meet its financial commitments when they arise. In short the company must be able to pay its dues. On the other hand the ratio of liabilities to stockholder's equity indicates the extent to which the company is leveraged. That is the ratio of liabilities to stockholder's equity indicates the extent to which the company has borrowed and has used its borrowing capacity. Normally, a debt/equity ratio of 2:1 is acceptable. So, if the ratio of liabilities to stockholder's equity is low, then the company can borrow money to meet its financial commitments and remain solvent. On the other hand if the ratio of liabilities to stockholder's equity ratio is very high the company cannot borrow further funds, cannot meet its financial commitments and so becomes insolvent.
2. What is the purpose of depreciation and why are there so many methods?
Depreciation is the process of spreading the cost of an asset over the span of numerous years corresponding to the life of the asset. From another point of view depreciation means to reduce the value over a period of time. It is an expense recorded to reduce the value of long term assets. There are so many methods of depreciation so that they fulfill the special needs of different types of assets, businesses and tax requirements. The manner in which the company wants to write down its assets determines the selection of methods. The method selected affects the income calculated during the year, the tax paid and the manner in which the residual asset will be written down in future. There are so many methods because the nature of assets and the nature of businesses differ.
3. What is the principle defining whether you capitalize or expense an acquisition?
An acquisition is usually the acquiring of capital. It may be treated as the acquisition of the shares of a company or it may be treated as the acquisition of ...

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