Question

In: Economics

Find a journal article online about managing or analyzing long-term debt-paying ability (solvency). Provide a summary...

Find a journal article online about managing or analyzing long-term debt-paying ability (solvency). Provide a summary (approximately 250 words) and a reaction (approximately 150 words) to the article. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article and how you can apply that knowledge.

Solutions

Expert Solution

ans.......................

Name of the article: The power of cash flow ratios.

Link to the article: http://www.journalofaccountancy.com/issues/1998/oct/mills.html

Summary:......................

===> The article talks about the importance of cash flow ratios when analyzing and managing an organization's long term debt paying ability and when determining the viability of an organization as an ongoing concern.

===>The article states that cash flow is the most powerful tool when determining and managing solvency compared to other financial statements like balance sheet and income statement. Cash flow statement covers information for a period (usually a financial year). In contrast, balance sheet is static and measures the financial position at a point in time (i.e. as on December 31, 2015). Income statement is also considered a weaker tool than cash flow statements as it is marred by non cash allocations like depreciation and amortization.

===>Cash flow statements help in determining the amount of cash that is available for operations and investment purposes. For managing solvency, metrics like operating cash flows, cash debt coverage, and cash interest coverage should be used.

===>These metrics are better than the traditional measures of solvency and liquidity (like debt ratio or long term debt to capitalization ratio) as they directly address operating cash flows. Questions like - how many times do the operating cash flow of the organization cover its interest expenses? - can be easily answered.

Reaction:.........................

(*) I am in full agreement with the points suggested in the article. It is important to determine the long term viability of an organization to determine its viability as an ongoing concern.

(*) The long term viability of an organization can be best determined using its cash flow statements and metrics from its cash flow statements. Credit rating agencies like S&P's, FITCH, Moody's etc. have been using the cash flow statement's metrics to determine the long term viability of an organization.

(*) Long term debt paying ability can be better managed using metrics from cash flow statements as the insights that are provided by the cash flow statements are more accurate and relevant.

This knowledge can be applied when conducting audit of various organizations and determining their viability as on ongoing concern. During the financial audit of an organization due importance should be given to the analysis of cash flow statements.


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