Financial Accounting Concepts - Essay Example

Creditors are interested in solvency— the ability of the business to pay its debts as they come due. Business concerns that are able to pay their debts promptly are said to be solvent. Investors as well as creditors are interested in the solvency of a business organization, but they are even more interested in its profitability. Profitable operations increase the value of the owners’ equity in the business (Meigs & Meigs p941). For a bank to decide on which company is most suitable for the loan approval, let’s do some analysis on the two companies. L.L.

Sams Company and Garcia Career Services. 1. Working Capital Analysis: As a banker my primary concern is in the current position of the firm— its ability to generate sufficient funds (working capital) to meet current operating needs and to pay current debts promptly. Thus the analysis of balance sheet by a banker, considering short-term loan, is likely to center on the working capital of the prospective debtors. Working capital is the excess of current assets over the current liabilities.

Let’s calculate the working capital of the two companies. L.L. Sams Company Garcia Career Services Current Assets $108,500 $19,000 Current Liabilities (30,000) (174,000) Considering the Current Assets and Liabilities of both the companies, we can calculate the working capital for each company as: Working Capital = Current Assets – Current Liabilities According to this formula, the working capital for both the companies can be stated as: L.L. Sams Company Garcia Career Services Working Capital: 78,500 (155,000) After analyzing and comparing the Working Capital of both the companies, the result clearly indicates that L.L. Sams Company’s current condition is much superior to that of Garcia Career Services.

Hence, the bank’s decision should be to give loan to L.L. Sams Company as this company seems to be the most appropriate for the loan and has the greatest assurance that its liabilities can be paid out of the current assets. Other data required when considering a loan application: 1. Total Sales: In an assessment of the overall liquidity of the current assets, the current trend of sales in an important factor. Since it takes sales to convert inventory into receivables or cash, an up trend of sales indicates that the conversion of inventories into more liquid assets will be easier to achieve than what sales remain constant.

Declining sales, on the other hand, will retard the conversion of inventories into cash (Bernstein p538). 2. Net Income: When we measure the net income earned by a business we are measuring its economic performance— its success or failure as a business enterprise. Decision making processes of loan allocation requires a great variety of data processing, a wide range of reliability, and relevance to the decision at hand. The information used includes data on general economic conditions and on industry trends, as well as data on intangibles such as the character and motivation of the management group (Bernstein p538).

References Meigs & Meigs (9th edition) ACCOUNTING: The Basis for Business Decisions. New York: McGraw-Hill Inc. Leopold A. Bernstein (5h edition) Financial Statement Analysis: Theory, Application and Interpretation. Boston: Richard D. Irwin Inc.