Auditing and Attestation- Certified Public Accountant (CPA) Practice Exam -

In assessing a company's liquidity and financial flexibility, which financial statement is most relevant for an investor?

1. Statement of Retained Earnings

2. Statement of Cash Flows

3. Balance Sheet

4. Income Statement

The correct answer is: Balance Sheet

For assessing a company's liquidity and financial flexibility, the most relevant financial statement is the Balance Sheet. The Balance Sheet provides a snapshot of the company's financial position at a specific point in time, detailing its assets, liabilities, and equity. Liquidity refers to the company’s ability to meet its short-term obligations, and the Balance Sheet presents current assets and current liabilities, which are essential for analyzing this aspect. Current assets include cash, receivables, and inventory, while current liabilities cover obligations such as payables and short-term debt. By comparing these figures, investors can evaluate how readily a company can convert its assets into cash to cover its liabilities. Additionally, the Balance Sheet reflects a company's financial flexibility, which is the ability to adapt to changing financial circumstances and opportunities. The presence of a solid equity base compared to liabilities can indicate the ability to borrow or invest when necessary. While the Statement of Cash Flows also provides valuable insights into liquidity over time by tracking cash inflows and outflows, the Balance Sheet offers a more immediate view of a company's financial health. Thus, the Balance Sheet is most relevant for comprehensive assessments of a company's liquidity and financial flexibility.