Accounting & Financial concepts

Working Capital & Matching concept:

a) We can breakdown balance sheet into investment side which consist of working capital and fixed assets and resources side which consist of first, debt financing which must be repaid according to a designated pattern, second, equity financing with uncertain return and no legal obligation to pay dividends.

The higher the debt to capital structure the higher the risk & the higher the equity to capital structure the lower the risk.

b) Matching concepts says the short term investment to be financed by short term resources and long term investment to be financed by long term resources whether debt or equity.

c) The higher the percentage of total investment (assets) to the debt financing the more secured creditors are said to be and the firm is more solvent as it can survive in the long term by settling its long term obligations.

d) Net working capital is the difference between current assets and current liabilities. The higher the netting the more liquid and flexible the firm in paying short term obligations.

Common stock dividends treatment:

All dividends are paid from the retained earnings and all dividends except stock dividends reduce the stockholders equity. There are many types of common stock dividends the most common is cash dividends which affect the ratio analysis as follows:

a) Cash Dividends:

when the cash dividends is approved and declared by the board of directors it becomes a liability on the organization.

The working capital and liquidity ratios are reduced by the declaration of cash dividends.

Dr. Retained Earnings (cash dividends declared)                       

Cr. Dividends payable.

The payment of cash dividends does not affect net working capital but liquidity ratios.

Dr. Dividends Payable

Cr. Cash                                      

Preferred stock dividends treatment:

a) Preferred stock is classified under the owner's equity in the balance sheet. While it is not considered as legal obligation on the   firm like debt, it enjoys certain privileges over common shares in respect to dividends and liquidation.

b) Preferred stock may enjoy many features; one of them is the cumulative feature by which cumulative preferred stock dividends that was not paid in any year must be made up in a latter year before any dividends can be distributed to common stockholders. These unpaid dividends are called dividends in arrears. Because no liability exists until the board of directors declares dividends, dividends in arrears are not recorded as a liability but it must be disclosed in a note to the financial statements and must also be taken into consideration while calculating the ratios such as ROE,  Net profit margin, EPS ---.

Basic  / Diluted Earning Per Share:

a) The corporation is said to have a complex capital structure if it have convertible debt , options, warrants or other rights that upon conversation or exercise could dilute earning per share.

Basic earning per share =   Net income available to common stock holders

           Weighted average common shares outstanding.