Financial Accounting a Ratio Analysis Thesis

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The industry average current ratio is 2.5 (MSN Moneycentral, 2009), so the Gap has less capacity to meet its current obligations than many of its peers. However, in the retail industry most firms have a large portion of their current assets tied up in inventory, which distorts the current ratio figures higher. The Gap's figure of 1.855 is strong and indicates that the company will have little difficulty in meeting its upcoming obligations.

Overall, the liquidity measures provide an indication of the company's short-term health. Low amounts of working capital or a poor current ratio can indicate that the firm is in short-term distress. The figures for the Gap in 2008 do not indicate a firm in financial distress. Rather, they indicate that the company will have little difficulty in meeting its upcoming financial obligations. The company has strong working capital figure and a high current ratio. The latter is especially important in light of the fact that the company has a strong cash holding and will not need to rely on liquidated inventory in order to meet its obligations.

The liquidity and profitability ratios tell us that the Gap Inc. is a company in good financial health. It has the current assets needed to meet its debt obligations. In addition, the company does a better-than-average job of converting its revenues into profit and equity. The Gap's solid financial ratios paint a picture of a company in good financial health at the beginning of 2009.

Notes to the Balance Sheet

For Gap Inc.'s 2008 Form 10-K, the notes to the financial statements are outlined in two different ways. The first is Note 1 (p.41), which is the summary of significant accounting policies, many of which directly impact the balance sheet. Note 2 is "Additional Financial Statement Information" (p.47), under which a couple of balance sheet items are explained in more detail.

The first note to the balance sheet (p.41) discusses the policies regarding the treatment of cash and cash equivalents. It states that amounts in transit from banks or credit card companies are recorded on the balance sheet under cash and cash equivalents.

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This is because the remittances typically take around two days to complete. Thus, while these monies are not presently in the company's account, they will be imminently. Other policies include that short-term investments less than 91 days in maturity are considered cash equivalents and any long-term investment with a maturity in the next 91 days are given the same treatment.

The second note to the balance sheet regards merchandise inventory (p.42). The company practices the weighted-average cost method of recording inventory. They make particular note of the fact that prior to 2006 they used the FIFO method. The Gap uses the lower of cost or market to record its inventories, creating a reserve fund for current merchandise inventory that is expected to be liquidated below cost.

The third note is with respect to depreciation policy. The company uses the straight line method for depreciation on the balance sheet. The note outlines the useful lives of different asset classes and illustrates the treatment of assets that are sold with respect to whatever undepreciated value may remain at the time of disposal.

In the second "Notes" section, the Gap's 2008 Form 10-K has a note that breaks down the contents of the cash and cash equivalents section of the balance sheet (p.47). Within this category are a number of different sub-categories, including cash, domestic commercial paper, bank certificates and time deposits, and cash equivalents defined as securities less than 91 days to maturity. Short-term investments are also outlined in this note, including U.S. treasury and agency securities and bank certificates and time deposits exceeding 91 days.

Another note outlines the manner in which derivates are valued (p.52). The Gap uses the fair value system in accordance with SFAS 157. The company primarily uses derivatives for currency hedging in U.S. dollars, pounds, Euros, Canadian dollars and yen. Pricing models are based on market rates to determine fair value. Another category of derivative is deferred compensation plan assets, which are recorded at market value. These are designate for the relevant plans. Some derivatives may be considered liabilities, if they are not.....

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