Analysis of Financial Statements and Statement of Cash Flows BUS512M. November 21, 2014 Session 2 8:00-11:30 Susan Crosson

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1 Analysis of Financial Statements and Statement of Cash Flows BUS512M November 21, 2014 Session 2 8:00-11:30 Susan Crosson

4 Homework See Handout

5 Today s Learning Outcomes Analyzing Financial Statementscommon size FS, ratios Transaction Impact on Ratios Cash Flow ratios-free cash flow; Cash conversion cycle Deriving Cash Flow from transactions- Direct method Deriving Cash Flow from Accrual Financial Statements-Indirect method

6 12.31.End?? Balance Sheet Begin Balance Sheet End Financial statement relationships: Vertical Analysis Cash Cash/TA Statement of Cash Flows End Cash Cash/TA Other CA Other CA/TA Cash-Operating IS, changes in CA&CL Other CA Other CA/TA LT Assets LTInvt, PP&E, Intan./TA Cash-Investing Changes in LTA LT Assets LTInvt, PP&E, Intan./TA T Assets 100% Cash-Financing Changes in LTL, CC T Assets!00% Change in Cash? C Liab. CL/TL+SHE Cash Begin? C Liab. CL/TL+SHE LT Liab. LTL/TL+SHE Cash End? LT Liab. LTL/TL+SHE CC CC/TL+SHE CC CC/TL+SHE RE RE/TL+SHE Income Statement (year ending ) RE RE/TL+SHE T L+SHE 100% Revenue 100% T L+SHE 100% Begin NI Dividends Stock Issue Expenses Net Income Statement of Shareholders Equity (year ended ) Contributed Capital XXXXXXXXXXXXXXX XXXXXXXXXXXXXXX COGS,Oper.,Other/ Sales Retained Earnings NI/Sales XXXXXXXXXXXXXXXXX

7 Balance Sheet- Beginning Emory Inc. Solution: Common Sized FS Balance Sheet -Ending Cash? Computations Cash % Other CA? Other CA % LT Assets? LT Assets % T Assets? T Assets 100% C Liab.? C Liab. % LT Liab.? LT Liab. % CC? CC % RE? Income Statement RE % T L+SHE? Revenue 100% T L+SHE 100% Expenses % Net Income % Statement of Shareholders Equity Beginning NI Dividends Stock Issue Ending Contributed Capital XXXXXXXXXXXXXX XXXXXXXXXXXXXX Retained Earnings XXXXXXXXXXXXXXXXX

8 ID5-1 Common Sized Financial Statements Bed, Bath & Beyond; Kelly Services; Bank of America; or Hewlett-Packard Balance Sheet Cash 34% 16% 9% 8% Accounts Receivable Inventories Long-term Assets Other Assets Current Liabilities Long-term Liabilities Shareholders Equity Sales of Goods 0% 100% 77% 0% Sales of Services 100% Cost of Goods Sold Operating Expenses Net Income (1)

9 Annual Report Treasure Hunt-Find the 6 Key Numbers Revenue Income (Loss) Cash Flow from (used by) Operating Activities Assets Liabilities Stockholders Equity Prove the Accounting Equation Can you tell the type of business? Service, Retail, Manufacturing

11 Six key numbers Revenue Total Assets Net Income (Loss) Income Statement Total Liabilities Balance Sheet Cash Flow from (used by) Operating Activities Statement of Cash flows Total Equity

12 Four Key Ratios: Profit Margin PROFITABILITY: Ability to earn a satisfactory net income Revenue Net Income (Loss) Cash Flow from (used by) Operating Activities Total Assets Total Liabilities Total Equity Net Income Revenue How well does management control expenses?

13 Four Key Ratios: Asset Turnover TOTAL ASSET MANAGEMENT: Ability to utilize all the assets of a company in a way that maximizes revenue and minimizes investment. Revenue Net Income (Loss) Cash Flow from (used by) Operating Activities Total Assets Total Liabilities Total Equity Revenue Average Total Assets* * Beginning + Ending Total Assets/2 How efficiently do assets generate revenue?

14 Return on Assets Net Income Average Total Assets Profit Margin x Asset Turnover = Return on Assets Net Income Revenue Revenue X = Average Total Assets Income Average Total Assets Return on Equity Net Income Average Total SHE Net Income Revenue Revenue X = Average Total SHE Income Average Total SHE

15 Four Key Ratios: Debt to Equity FINANCIAL RISK: Ability to use debt effectively without jeopardizing the future of the company. Revenue Net Income (Loss) Cash Flow from (used by) Operating Activities Total Assets Total Liabilities Total Equity Total Liabilities Total Equity Who controls the company? What is the company s level of financial risk?

16 BE 5-1 Ratio Analysis Coca-Cola & PepsiCo Compute profit margin, asset turnover, return on assets, return on equity, and debt to equity ratios for Comment on your findings. Company Coca-Cola Income Statement: Sales $48,017 $46,542 Net Income 9,019 8,584 Coca-Cola Balance Sheet: Assets $86,174 $79,974 Shareholders equity 33,168 31,921 PepsiCo Income Statement Sales $65,492 $66,504 Net Income 6,178 6,443 PepsiCo Balance Sheet: Assets $74,638 $72,882 Shareholders equity 22,399 20,899

17 Transactions Impact on Ratios

19 Inventory: Operating Cycle Ratios Inventory Turnover = COGS/Average inventory Average inventory = (Beginning + Ending)/2 Days Inventory on Hand = 365 days/inventory turnover Accounts Receivable: A/R Turnover=Net Credit Sales/Average A/R Average A/R= (Beginning + Ending)/2 Days Sales= 365/A/R Turnover Operating Cycle= Days Inventory on Hand + Days Sales

20 Accounts Payable: Is there a Financing Gap? Accounts Payable Turnover = COGS/Average A/P Average A/P = (Beginning + Ending)/2 Days Payables = 365 days/accounts Payable Turnover Financing Gap? Operating Cycle - Days Payables= Financing Gap BORROW SHORT TERM OR Days Payables Operating Cycle= No Gap Free Financing from Suppliers

21 Cash Conversion Cycle OPERATING ASSET MANAGEMENT: Ability to utilize current assets and liabilities in a way that supports growth in revenues with minimum investment. Measures the time it takes from cash invested in inventory to cash received from customers versus the time it takes to pay suppliers. (The time required to make or buy products, finance the products, and to sell & collect for them.) Days Inventory + Days Receivables - Days Payables Cash Conversion Cycle Operating Cycle If Operating Cycle is > Days Payables then Financing Gap If Operating Cycle is < Days Payables then able to Self-finance

22 Example In 2009 Coca-Cola had the following ratios: Days Inventory = 75 days Days Receivables = 40 days Days Payables = 45 days Was there a financing gap?

Cash Flow Basics Ways a business gets and gives cash Two Statement Formats-Direct and Indirect Operating- from daily operations: Income Statement, current asset & current liability activities

23 Cash Flow Basics Ways a business gets and gives cash Two Statement Formats-Direct and Indirect Operating- from daily operations: Income Statement, current asset & current liability activities Investing- noncurrent asset activities Financing- long-term liabilities and stockholders equity activities Key Numbers: Net Cash provided by operating activities Net Cash used in investing activities Net Cash used in financing activities Net change in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year In your opinion, what are the primary ways the company gets cash and spends cash?

24 Find the following key numbers for the most current year Net Cash provided by operating activities Net Cash used in investing activities Net Cash used in financing activities Net change in cash and cash equivalents Cash and cash equivalents at January 1 Cash and cash equivalents at December 31 In your opinion, what are the primary ways the company gets cash and spends cash?

25 E14-4 Cash Management Policies Kraft Foods, Kellogg s, General Mills For each company compute the missing dollar amounts, and briefly describe the cash management policy. Company Cash from Operations Cash from Investments Cash from Financing Net Change in Cash Kraft Foods $3,035? ($1,358) $1,255 Kellogg s 1,758 (3,245) 1,317? General Mills? (1,871) (661) (148)

26 E2-2 Identifying financing, investing, and operating transactions Listed below are 8 transactions. In each case, identify whether the transaction is an example of financing, investing, or operating activities and which of the financial statements it would affect. 1. Company borrowed $50,000 in cash, signed a 10-year note payable units of inventory are purchased from suppliers on account for $12, The utility bill is paid at the end of the month, $5, Services are performed, and customers are billed for $13, parcels of real estate are purchased for a total of $55,000 in cash. 6. A long-term investment in a equity security is sold for $4,500 cash. 7. Principal payments are made on outstanding debts. 8. Cash is received from customers for services completed in the previous period.

27 E4-9 Preparing journal entries and T-account for cash Prepare journal entries for each cash transaction during January, prepare the cash T-account (assume beginning balance is $5,000). 1. Issued 600 shares of stock for $25 each. 2. Sold services for $4, Paid wages of $1, Purchased land as a long-term investment for $9, Paid a $2,000 dividend. 6. Sold land with a book value of $3,000 for $3, Paid $1,500 to the bank: $900 to reduce the principal on the outstanding loan and $600 as an interest payment. 8. Paid miscellaneous expenses of $1,800.

28 T-account for cash to Statement of Cash Flows

29 E14-9 Cash Flows from Transactions-Direct method Prepare a statement of Cash flows (direct method) from Driftwood Shipbuilders following transactions during 2015: 1. Sold $6,000 of no-par common stock. 2. Purchased $6,000 of inventory on account. 3. Purchased new equipment for $5,000 cash. 4. Collections on accounts receivable totaled $10, Made payments of $5,000 to suppliers. 6. Declared and paid dividends of $2, Paid rent of $6,000 for the last six months of 2011 and $6,000 for the first six months of Made sales totaling $100,000; $35,000 on account and the remainder in cash. 9. Paid $40,000 in cash for miscellaneous expenses. 10. Sold investments with a cost of $20,000 for $25,000.

31 E14-11Cash effects Given the following information and that a machine with a cost of $8,000 was sold during 2015, answer the following questions; 1. How much machinery was purchased during 2015? 2. How much cash was collected on the sale of the machine? Machinery $45,000 $20,000 Accumulated depreciation ($15,000) ($10,000) Depreciation expense 7,000 6,000 Gain on sale of machine 2,

32 Four Key Ratios: Cash Flow Yield LIQUIDITY: Ability to generate sufficient cash to pay bills when due and to meet unexpected needs for cash. Revenue Net Income (Loss) Cash Flow from (used by) Operating Activities Total Assets Total Liabilities Total Equity Cash Flow Operating Activities Net Income Are operating activities generating sufficient cash flows?

33 Free Cash Flow The ability of a company to finance its growth from current operating cash flows and meet fixed commitments. Cash Flow from Operating Activities -Dividends -Net Capital Expenditures =Free Cash Flow

34 Deficiencies of Free Cash Flow No widely accepted definition of free cash flow. Absolute amounts, not ratios Not clear if large free cash flow is good and small free cash flow is bad. The only truly free cash flow is from operations because management is free to use them in a variety of ways.

35 Link between income statement and cash flow from operating activities: Indirect Approach to Cash Flow Statement Revenue Net Income (Loss) Cash Flow from (used by) Operating Activities Total Assets Total Liabilities Total Equity Revenue -Expenses = Net Income (Loss) +Non-cash Expenses +Operating Working Capital (CA-CL) Cash Flow Operating Activities

36 Cash Financial statement Statement relationships: of Cash Flows End Vertical Cash Analysis Other CA Cash-Operating IS, changes in CA&CL Other CA LT Assets LTInvt, PP&E, Intan. Cash-Investing Changes in LTA LT Assets LTInvt, PP&E, Intan. T Assets Cash-Financing Changes in LTL, CC T Assets Change in Cash? C Liab. Cash Begin? C Liab. LT Liab. Cash End? LT Liab. CC CC RE Income Statement (year ending ) RE T L+SHE Revenue T L+SHE Expenses COGS,Oper.,Other Net Income Statement of Cash Flows-Indirect Method 1. Compute change in cash from Beginning and Ending Cash on BS-THE ANSWER 2. Net Income, non-cash expenses, gains, & losses on the IS go to CF-Operating 3. Change in Current Assets and Current Liabilities accounts go to CF-Operating 4. Analyze Noncurrent Asset accounts for what goes in CF-Investing 5. Analyze Long-term Liabilities accounts for what goes in CF-Financing 6. Analyze Contributed Capital and Retained Earnings accounts for what goes in CF-Financing.

38 P14-13 Statement of Cash Flows-Indirect method page 633 in text

40 E14-22 Cash from Operating Activities-Indirect method page 627 in text

44 Today we: Analyzed Financial Statements-common size FS, ratios Learned how Transactions Impact Ratios Cash Flow ratios-free cash flow; Cash conversion cycle Derived Cash Flow from transactions- Direct method Derived Cash Flow from Accrual Financial Statements-Indirect method

Analysis of Financial Statements and Statement of Cash Flows BUS512M. December 16, 2016 Session 2 8:00-noon Susan Crosson

Analysis of Financial Statements and Statement of Cash Flows BUS512M December 16, 2016 Session 2 8:00-noon Susan Crosson P4-20 Reverse T-account analysis You are a credit analyst for a bank. Badger Business