Limitation of ratios; five-question approach; limitation of financial statements
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1. A company's financial statements consist of the balance sheet, income statement, and statement of cash flows. Describe what each statement tells us and their limitations.
2. What is the purpose and importance of financial analysis? What are financial ratios? Describe the "five-question approach" to using financial ratios. What are the limitations of financial ratio analysis? If we divide users of ratios into short-term lenders, long-term lenders, and stockholders, in which ratios would each group be most interested, and for what reasons?
250-300 words
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Solution Summary
Your discussion is 455 words and explains the purchase and importance of financial ratios, indicates the "five-question approach" to ratios, and lists a number of limitations of financial ratios.
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1. A company's financial statements consist of the balance sheet, income statement, and statement of cash flows. Describe what each statement tells us and their limitations.
The balance sheet reports the assets, liabilities and equity at the last day of the period being reported. Its limitation is that it only shows the resources and obligations on that one day. The income statement reports the sales and expenses and resulting profits for the period. Its limitation is that it contains estimates of what will be used up, collected and paid (accrual basis) but this may differ from actual cash flows later and may not be the actual amounts used. For example, depreciation expense is only an estimate of how much of the long term asset is used up during the period. The cash flow statement shows the inflows and outflows of cash classified by operating, financing ...
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