Unformatted text preview: useful for assessing a company’s solvency can be found in both the balance sheet and
statement of cash flows. The balance sheet lists the company’s obligations and the assets currently
available to the company to use to pay off the liabilities. In addition, the balance sheet indicates which
liabilities are expected to mature in the near future and which assets are more liquid. The statement of
cash flows provides information about where the company is getting its cash and how it is using it. Of
particular interest is the net cash generated or used by operating activities.
The income statement is the primary source to assess a company’s earning power. Net income
represents the net assets the company generated during the year from operations. By comparing net
income to certain balance sheet amounts, such as average stockholders’ equity or average total assets,
one can assess how effectively a company is using its assets to generate returns. c. Bankruptcies usually imply that a company was unable to pay its debts. Because cash is the most
common medium of exchange in the United States, creditors expect to receive interest and principal
payments in cash. Thus, a wave of bankruptcies implies that companies were having cash flow problems,
which, in turn, increases interest in assessing nonbankrupt companies’ cash flows to avoid other problem
a. SuperValu paid out cash when it acquired fixed and intangible assets. Depreciation and amortization of
these assets simply represent the allocation of the assets' cost to particular accounting periods. There is
no cash outflow or inflow associated with depreciation and amortization.
SuperValu is adding depreciation and amortization back to net income to arrive at net cash flow from
operating activities because it uses the indirect method to report cash flows from operating activities. With
the indirect method, a company begins with net income and then reconciles (i.e., explains) why net
income is different from cash flows from operating activities. Since depreciation...
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