Analysis of Financial Statements and
Statement of Cash Flows
BUS512MNovember 22, 2013
Session 28:00-11:30
Susan Crosson
Homework See Handout
Today’s Learning Outcomes
• Analyzing Financial Statements-common 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
First Homework-Emory Inc. Solution: Financial statement relationshipsBalance Sheet- Beginning Balance Sheet -Ending
Cash ? Computations Cash 110
Other CA ? Other CA: (210-20) +340+80+15+40+10=675 Other CA 675
LT Assets ? LT Assets: (400-140) + (200+350+20)= 830 LT Assets 830
T Assets ? C Liab.: 70+120+12+130+150+90=572 T Assets 1,615
Exp: 25+13+800+50+110+97+27+215+15=1352
C Liab. ? C Liab. 572
LT Liab. ? LT Liab. 481+ (?=25) 506
CC ? CC 135
RE ? Income Statement RE 402
T L+SHE ? Revenue 1600+28-18 1,610 T L+SHE 1,615
Expenses 1,352
Net Income 258
Statement of Shareholders’ Equity
Contributed Capital Retained Earnings
Beginning 95+40=135 160
NI XXXXXXXXXXXXXX 258
Dividends XXXXXXXXXXXXXX 16
Stock Issue XXXXXXXXXXXXXXXXX
Ending 135 402
Financial statement relationships: Vertical AnalysisBalance Sheet 12.31.Begin Balance Sheet 12.31.End
Cash Cash/TA Statement of Cash Flows 12.31.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-12.31.Begin ? C Liab. CL/TL+SHE
LT Liab. LTL/TL+SHE Cash-12.31.End ? LT Liab. LTL/TL+SHE
CC CC/TL+SHE CC CC/TL+SHE
RE RE/TL+SHE Income Statement (year ending 12.31.) RE RE/TL+SHE
T L+SHE 100% Revenue 100% T L+SHE 100%
Expenses COGS,Oper.,Other/Sales
Net Income NI/Sales
Statement of Shareholders’ Equity (year ended 12.31.)
Contributed Capital Retained Earnings
12.31.Begin
NI XXXXXXXXXXXXXXX
Dividends XXXXXXXXXXXXXXX
Stock Issue XXXXXXXXXXXXXXXXX
12.31.End ? ?
Emory Inc. Solution: Common Sized FSBalance Sheet- Beginning Balance Sheet -Ending
Cash ? Computations Cash 7% 110
Other CA ? Other CA 42% 675
LT Assets ? LT Assets 51% 830
T Assets ? T Assets 100% 1,615
C Liab. ? C Liab. 36% 572
LT Liab. ? LT Liab. 649 + (?=101) 31% 506
CC ? CC 8% 135
RE ? Income Statement RE 25% 402
T L+SHE ? Revenue 100% 1,610 T L+SHE 100% 1,615
Expenses 84 % 1,352
Net Income 16% 258
Statement of Shareholders’ Equity
Contributed Capital Retained Earnings
Beginning 95+135 160
NI XXXXXXXXXXXXXX 258
Dividends XXXXXXXXXXXXXX 16
Stock Issue XXXXXXXXXXXXXXXXX
Ending 135 402
ID5-1 Common Sized Financial StatementsBed, Bath & Beyond; Kelly Services; Bank of America; or Hewlett-Packard
Balance Sheet 1 2 3 4
Cash 34% 16% 9% 8%
Accounts Receivable 50 0 15 56
Inventories 0 39 7 0
Long-term Assets 1 32 19 10
Other Assets 15 13 50 26
Current Liabilities 76 22 47 41
Long-term Liabilities 15 7 19 14
Shareholders’ Equity 9 71 34 45
Sales of Goods 0% 100% 77% 0%
Sales of Services 100% 0 23 100
Cost of Goods Sold 0 60 59 0
Operating Expenses 96 34 31 101
Net Income 4 6 7 (1)
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
Six key numbers
Total Assets
Total Liabilities
Total Equity
Revenue
Net Income (Loss)
Cash Flowfrom (used by)OperatingActivities
IncomeStatement
Balance Sheet
Statement of Cash flows
Four Key Ratios: Profit MarginPROFITABILITY: Ability to earn a satisfactory net income
TotalAssets
Total Liabilities
Total Equity
RevenueNetIncome (Loss)
Cash Flowfrom (used by)OperatingActivities
Revenue
Net Income
How well does management control expenses?
Four Key Ratios: Asset TurnoverTOTAL ASSET MANAGEMENT: Ability to utilize all the assets of a company
in a way that maximizes revenue and minimizes investment.
TotalAssets
Total Liabilities
Total Equity
RevenueNetIncome (Loss)
Cash Flowfrom (used by)OperatingActivities
Revenue
Average Total Assets*
How efficiently do assets generate revenue?
* Beginning + Ending Total Assets/2
Return on Assets
Profit Margin x Asset Turnover = Return on Assets
Revenue
Net Income Revenue
Average Total AssetsX =
Net Income
Average Total Assets
Income
Average Total Assets
Return on EquityNet Income
Average Total SHE
Revenue
Net Income Revenue
Average Total SHEX =
Income
Average Total SHE
Four Key Ratios: Debt to EquityFINANCIAL RISK: Ability to use debt effectively without jeopardizing the
future of the company.
TotalAssets
Total Liabilities
Total Equity
RevenueNetIncome (Loss)
Cash Flowfrom (used by)OperatingActivities
Total Liabilities
Total Equity
Who controls the company? What is the company’s level of financial risk?
BE 5-1 Ratio Analysis Coca-Cola & PepsiCoCompute profit margin, asset turnover, return on assets, return on equity, and debt to equity ratios for 2008. Comment on your findings.
Company 2008 2007
Coca-Cola Income Statement:
Sales $31,944 $28,857
Net Income 5,807 5,981
Coca-Cola Balance Sheet:
Assets $40,519 $43,269
Shareholders’ equity 20,472 21,744
PepsiCo Income Statement
Sales $43,251 $39,474
Net Income 5,142 5,658
PepsiCo Balance Sheet:
Assets $35,994 $34,628
Shareholders’ equity 12,203 17,325
Transactions Impact on RatiosTransactions: Current Ratio
Profit
Margin
Asset
Turnover
Debt to Equity Earnings per
Share
Paid rent on building.
Received an advance payment from a client for services to be
rendered over next six months.
Paid salaries of employees
Bought a three-year insurance policy and paid in full.
Performed services for a client; received part of fee in cash,
remainder to be collected in 30 days.
Purchased office equipment. Paid part in cash, balance payable in
60 days.
Purchased a large amount of office supplies on credit.
The owners invested cash in the corporation and received stock.
Made an adjusting entry for the portion of the insurance premium
which has expired.
Paid off office supplies purchased earlier.
Made an adjusting entry for depreciation.
Made an adjusting entry for office supplies used during this
period.
Made an adjusting entry to recognize that a portion of the fee
received in advance had been earned.
Cash Conversion CycleOPERATING 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 If Operating Cycle is > Days Payables then Financing GapIf Operating Cycle is < Days Payables then able to Self-finance
Operating Cycle
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?
Financial statement relationships: Vertical AnalysisBalance Sheet 12.31.Begin Balance Sheet 12.31.End
Cash Statement of Cash Flows 12.31.End Cash
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-12.31.Begin ? C Liab.
LT Liab. Cash-12.31.End ? LT Liab.
CC CC
RE Income Statement (year ending 12.31.) RE
T L+SHE Revenue T L+SHE
Expenses COGS,Oper.,Other
Net Income
Statement of Shareholders’ Equity (year ended 12.31.)
Contributed Capital Retained Earnings
12.31.Begin
NI XXXXXXXXXXXXXXX
Dividends XXXXXXXXXXXXXXX
Stock Issue XXXXXXXXXXXXXXXXX
12.31.End ? ?
E14-4 Cash Management PoliciesKraft 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 $5,084 ? ($2,988) $857
Kellogg’s 1,643 (370) (1,194) ?
General Mills ? (289) (1,450) 89
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.
2. 20 units of inventory are purchased from suppliers on account for $12,000.
3. The utility bill is paid at the end of the month, $5,200.4. Services are performed, and customers are billed for $13,000.5. 5 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.
E4-9 Preparing journal entries and T-account for cashPrepare 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 $4,000.
3. Paid wages of $1,600.
4. Purchased land as a long-term investment for $9,000.
5. Paid a $2,000 dividend.
6. Sold land with a book value of $3,000 for $3,500.
7. 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.
E14-9 Cash Flows from Transactions-Direct method
Prepare a statement of Cash flows (direct method) fromDriftwood Shipbuilders following transactions during 2012:1. 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 $10,000.5. Made payments of $5,000 to suppliers.6. Declared and paid dividends of $2,000.7. Paid rent of $6,000 for the last six months of 2011 and
$6,000 for the first six months of 2012.8. 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.
E4-16 The difference between cash and accrual accounting
Washington Forest Products began operations on January 1, 2011. On December 31, 2011, the company accountant ascertains that the following amounts should be reported as expenses on the income statement: Insurance Expense $20,000; Supplies Expense $11,000; Rent Expense $14,000.
A Review of the company’s cash disbursements indicates the company made related cash payments during 2011 as follows:Insurance $29,000; Supplies $27,000; Rent $8,000
Explain why the amounts shown as expenses do not equal the cash paid.For each expense account, compute the amount that should be shown in the related balance sheet account as of December 31, 2011 (remember the company begin operations this year).
E14-11Cash effectsGiven the following information and that a machine with a cost of $8,000 was sold during 2012, answer the following questions;
1. How much machinery was purchased during 2012?
2. How much cash was collected on the sale of the machine?
2012 2011
Machinery $45,000 $20,000
Accumulated depreciation ($15,000) ($10,000)
Depreciation expense 7,000 6,000
Gain on sale of machine 2,000 500
Four Key Ratios: Cash Flow YieldLIQUIDITY: Ability to generate sufficient cash to pay bills when due and to meet
unexpected needs for cash.
TotalAssets
Total Liabilities
Total Equity
RevenueNetIncome (Loss)
Cash Flowfrom (used by)OperatingActivities
Cash Flow Operating Activities
Net Income
Are operating activities generating sufficient cash flows?
Link between income statement and cash flow from operating activities:
Indirect Approach to Cash Flow Statement
TotalAssets
Total Liabilities
Total Equity
RevenueNetIncome (Loss)
Cash Flowfrom (used by)OperatingActivities
Cash Flow Operating Activities
Net Income (Loss)
Revenue-Expenses=+Non-cash Expenses+Operating Working Capital (CA-CL)
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
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.
Financial statement relationships: Vertical AnalysisBalance Sheet 12.31.Begin Balance Sheet 12.31.End
Cash Statement of Cash Flows 12.31.End Cash
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-12.31.Begin ? C Liab.
LT Liab. Cash-12.31.End ? LT Liab.
CC CC
RE Income Statement (year ending 12.31.) 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 ANSWER2. Net Income, non-cash expenses, gains, & losses on the IS go to CF-Operating3. Change in Current Assets and Current Liabilities accounts go to CF-Operating4. Analyze Noncurrent Asset accounts for what goes in CF-Investing5. Analyze Long-term Liabilities accounts for what goes in CF-Financing6. Analyze Contributed Capital and Retained Earnings accounts for what goes in
CF-Financing.
P14-13 Statement of Cash Flows-Indirect methodpage 686 in text
E14-22 Cash from Operating Activities-Indirect methodpage 679 in text
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