Introduction

Having looked (albeit briefly!) at the format and content of the main financial statements we’ll now start looking at the usefulness of the statements, in particular to investors.

This week we will look at:

a) how accounting data is made up of two components – an economic event and a measurement
b) how an individual figure is not very meaningful by itself – we need to make comparisons
c) liquidity. Liquidity is important because it is of paramount importance during an economic crisis, and because it is the main reason for businesses failing.

Lecture notes

The lecture notes (in pdf format) for this week are available:

• Introduction to interpretation

• Liquidity

Tesco plc

We’ll relate the ideas covered in the lecture to the most recent financial statements of Tesco.

Course video: An introduction to the Statement of Cash Flows

Study hint

It might be a good idea to print out the lecture notes. We will be adding calculations and additional notes based on Tesco’s financial statements.

Additional resources [ADD]

FRC Reporting Lab: Disclosures on the sources and uses of cash

COVID-19: nine principles for finance professionals – adapting cash flow processes, analysis and forecasting

A case study for you to try [CORE]

Mondrayne plc [a question from a previous exam]. A suggested solution is here.

Directed Private Study [CORE]

Read the study notes for the lecture; research any issues you find difficult.

Browse the supportive reading as appropriate. Browse the internet for current material in which liquidity is an issue.

Continuously review your understanding of liquidity ratios. Pay particular attention to the ideas that:

• changes in liquidity ratios over time may be more important than absolute values. Resolve never to use benchmark values for liquidity ratios e.g. never write/say ‘the ideal working capital ratio is ….’.
• The cash flow statement is more important that liquidity ratios
• It might be possible to ‘optimise’ liquidity ratios. How?
• Financial statements are historical and liquidity problems can arise quite quickly.
• Liquidity problems are not just being ‘short of cash’; it also means that the entity cannot easily solve things by borrowing more/selling unessential assets. Increasing borrowing increases gearing (and hence financial risk) and may be expensive (higher interest charges).

Supportive reading [ADD]

Lance Moir: Managing Corporate Liquidity, Google ebook.