We've looked at the income statement and the statement of cash flows. Now let's move to the balance sheet. Here, we can make some of the same observations we made when we looked at the statement of cash flows, which shouldn't be that surprising given how closely these two financial statements are linked. Recall that on the statement of cash flows, we saw a lot of investment activity. Well, that investing activity has led to a substantial increase in the company's total assets. We saw a lot of land purchased. And we see a few more receivables in inventory because of the growth in revenues. Let's look for a minute at a ratio called the current ratio. This ratio was calculated as current assets divided by current liabilities. It can help us assess a company's liquidity or how quickly it can turn things into cash, if needed. Remember, the current assets are those that the company expects to use on operations or convert to cash within a year. And the current liabilities are those liabilities that are due within a year. A ratio of current assets to current liabilities less than one often raises concern because the company has more liabilities that it must pay within a year than it has assets that it expects to be able to convert to cash within the year. The Garden Spot's current ratio for year one is 3.6. And I calculate that by taking current assets, which total to 108,010, and divide by current liabilities. A total of 30,000. The ratio in year two is 2.7. Calculate that by taking current assets that total 166,110 and divide that by the current liabilities for the year of 61,775. Now, neither of these suggests concerns because they're substantially greater than one, but certainly something that we need to look at to assess liquidity. Let's now look to see how much of our assets are financed by debt using the debt, To assets ratio. This ratio is calculated as total liabilities divided by total assets. This is a common ratio to look at when looking at the balance sheet to try to draw some inferences about a company's financing decisions, whether it has chosen to rely more heavily on debt or on equity for funds. In year one, That ratio, here, is 0.48. I calculated that by taking total liabilities of 60,000 and dividing by the total assets. The 0.48 suggests that 48% of the company's assets were financed by debt. So the remaining 52%, then, were financed by equity. The debt to asset ratio increased to 0.62 in the second year. There, I calculated that by taking total liabilities of 171,775 and dividing that by total assets. Now, this is consistent with what we saw when we looked at the statement of cash flows. There we saw more financing through debt in the second year than in the first year. The last thing that I will point out on the balance sheet is that the company does have a positive retained earnings balance, In both year one and year two, as the company has been generating and retaining earnings. Now, let me summarize what we've done. We've looked at the income statement to get a sense of the company's growth, profitability and the relationship between revenues and certain costs. We looked at the statement of cash flow to determine whether cash flow was positive or negative, whether the company was generating cash flow from day to day operations, what it was investing in and how it was financing those investments. And then, finally, we looked at the balance sheet to see what assets the company has, how it has chosen to finance the purchase of those assets and how much earning the company has retained since its inception. Now, this is a fairly simple, but important, start. It's important for managers to review the financial statements on an ongoing basis to be able to make key observations about the business. We have taken a first step toward that with the financial statements from the first two years of operation at the Garden Spot, where we saw an entrepreneur who was able to generate a positive cash flow from operations in her second year by growing the business quickly enough to cover its base of fixed operating costs.
