Analysis of Financial Statements and

Statement of Cash Flows

BUS512M November 21, 2014

Session 2 8:00-11:30

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

Financial statement relationships: Vertical Analysis Balance 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 FS Balance Sheet- Beginning 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

Contributed Capital Retained Earnings

Beginning

NI XXXXXXXXXXXXXX

Dividends XXXXXXXXXXXXXX

Stock Issue XXXXXXXXXXXXXXXXX

Ending

ID5-1 Common Sized Financial Statements Bed, 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 Flow from (used by) Operating Activities

Income Statement

Balance Sheet

Statement of Cash flows

Four Key Ratios: Profit Margin PROFITABILITY: Ability to earn a satisfactory net income

Total Assets

Total Liabilities

Total Equity

Revenue Net Income (Loss)

Cash Flow from (used by) Operating Activities

Revenue

Net Income

How well does management control expenses?

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.

Total Assets

Total Liabilities

Total Equity

Revenue Net Income (Loss)

Cash Flow from (used by) Operating Activities

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 Assets X =

Net Income

Average Total Assets

Income

Average Total Assets

Return on Equity Net Income

Average Total SHE

Revenue

Net Income Revenue

Average Total SHE X =

Income

Average Total SHE

Four Key Ratios: Debt to Equity FINANCIAL RISK: Ability to use debt effectively without jeopardizing the

future of the company.

Total Assets

Total Liabilities

Total Equity

Revenue Net Income (Loss)

Cash Flow from (used by) Operating Activities

Total Liabilities

Total Equity

Who controls the company? What is the company’s level of financial risk?

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 2012. Comment on your findings.

Company 2012 2011

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

Transactions Impact on Ratios

Operating Cycle Ratios Inventory:

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

Is there a Financing Gap?

Accounts Payable:

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

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 If Operating Cycle is > Days Payables then Financing Gap If 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?

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?

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?

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)

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 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 $4,000. 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.

T-account for cash to Statement of Cash Flows

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 $10,000. 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.

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?

2015 2014

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 Yield LIQUIDITY: Ability to generate sufficient cash to pay bills when due and to meet

unexpected needs for cash.

Total Assets

Total Liabilities

Total Equity

Revenue Net Income (Loss)

Cash Flow from (used by) Operating Activities

Cash Flow Operating Activities

Net Income

Are operating activities generating sufficient cash flows?

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.

Link between income statement and cash flow from operating activities:

Indirect Approach to Cash Flow Statement

Total Assets

Total Liabilities

Total Equity

Revenue Net Income (Loss)

Cash Flow from (used by) Operating Activities

Cash Flow Operating Activities

Net Income (Loss)

Revenue -Expenses = +Non-cash Expenses +Operating Working Capital (CA-CL)

Financial statement relationships: Vertical Analysis Balance 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 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.

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

E14-22 Cash from Operating Activities-Indirect method page 627 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