Final answer:
Activity in balance sheet accounts reflects cash flows, which are essential for assessing financial health. Poor cash flows can occur despite growing sales due to issues like high inventory or uncollected receivables. Banks' balance sheets may show more assets than available cash due to lending, and the value of loans in the secondary market is influenced by factors like borrower reliability and interest rate changes.
Step-by-step explanation:
The balance sheet account activity from one year to the next can determine the cash flow for various accounts, which is vital for understanding a company's financial health. For example, if a company's inventory increases significantly, it suggests cash has been used to purchase more inventory, which could imply either stockpiling for anticipated sales or a problem with inventory management if not matched with sales growth. Likewise, an increase in accounts receivable might indicate sales growth, but it also means that cash has yet to be received for those sales, which could affect liquidity.
Poor cash flows despite increases in sales or profits can occur due to reasons such as high levels of inventory, uncollected receivables, or significant capital expenditures. Analysts would recommend corrective actions like improving inventory turnover, enhancing credit collection processes, or reconsidering investment strategies to ensure that cash flows align with sales and profit growth.
The money listed under assets on a bank balance sheet may not actually be in the bank because banks often lend out a portion of their deposits, which are still recorded as liabilities on the balance sheet. This banking model is known as fractional-reserve banking and is an essential part of the banking system, allowing banks to generate earnings from interest on loans.
When considering purchasing loans in the secondary market, various factors affect how much a buyer is willing to pay:
- If a borrower has been late on loan payments, the risk of default increases, and the loan would be purchased at a discount.
- If interest rates have risen, existing loans with lower rates become less attractive, thereby reducing their value.
- A borrower declaring high profits could suggest a lower risk of default, potentially making the loan more valuable.
- If interest rates have fallen, loans with higher fixed rates become more valuable due to their above-market returns.
Firms have various options to raise financial capital for investments, such as from early-stage investors, reinvesting profits, borrowing, or selling stock. The choice depends on the cost of capital, risk tolerance, control considerations, and the projected return on investment.