Cash Flow

and Financial
Analysis

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Objectives of Cash
Flow Statement
• Provides users with basis to assess how entity
generates and uses cash
• Users can assess effect activities had on financial
position
• Information has predictive value
– Amounts, timing and certainty of future
cash flows
– Future cash requirements
– Sustainability of activities

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Cash Flow Statement

1 2 3
Operating Activities Investing Activities Financing Activities
This refers to the cash flows This refers to the cash flows This refers to the cash flows
derived from the principal derived from the acquisition derived from the equity and
revenue producing activities and disposal of long term borrowings of the entity.
of the entity. It can be assets and other investments
computed using direct method not included in cash
or indirect method. equivalent.
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 Direct Method
Discloses
• major classes of gross cash
receipts
• gross cash payments
Operating Activities
How to report Operating Activities of the
Company? Indirect Method
Surplus/deficit adjusted for
 noncash transactions
 Deferrals
 accruals

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 Company Name
Consolidated Statement of Cash Flows
For the Year Ended December 31, 20X2
(in thousands of currency units)

Presentation Using
Direct Method
 Company Name
Consolidated Statement of Cash Flows
For the Year Ended December 31, 20X2
(in thousands of currency units)

Presentation Using
Indirect Method
Financial Analysis
Financial analysis is the process of evaluating
businesses, projects, budgets, and other finance-
related transactions to determine their
performance and suitability.

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Financial Analysis

1 2 3
Horizontal Analysis Vertical Analysis Financial Ratio
(Trend Analysis) (Common-Size)

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Horizontal
Analysis
Horizontal analysis (or trend analysis)
shows the changes between years in the
financial data in both currency and
percentage form.

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 Currency Change

Dollar = Current Year – Base Year

Horizontal Analysis
Change Figure Figure

Percentage Change

Percentage Dollar Change

Ändern Sie
=
Base Year Figure × 100%

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 CLOVER CORPORATION
Comparative Balance Sheets
December 31

Increase (Decrease)
2005 2004 Amount %
Assets

Example Current assets:

Cash $ 12,000 $ 23,500
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets $ 315,000 $ 289,700
 CLOVER CORPORATION
Comparative Balance Sheets
December 31

Increase (Decrease)
2005 2004 Amount %
Assets

Answer Current assets:

Cash $ 12,000 $ 23,500 $ (11,500) (48.9)
Accounts receivable, net 60,000 40,000 20,000 50.0
Inventory 80,000 100,000 (20,000) (20.0)
Prepaid expenses 3,000 1,200 1,800 150.0
Total current assets 155,000 164,700 (9,700) (5.9)
Property and equipment:
Land 40,000 40,000 - 0.0
Buildings and equipment, net 120,000 85,000 35,000 41.2
Total property and equipment 160,000 125,000 35,000 28.0
Total assets $ 315,000 $ 289,700 $ 25,300 8.7
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31
Increase
(Decrease)
2005 2004 Amount %
Exercise Sales
Cost of goods sold
$ 520,000
360,000
$ 480,000
315,000
Gross margin 160,000 165,000
Operating expenses 128,600 126,000
Net operating income 31,400 39,000
Interest expense 6,400 7,000
Net income before taxes 25,000 32,000
Less income taxes (30%) 7,500 9,600
Net income $ 17,500 $ 22,400
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31
Increase
(Decrease)
2005 2004 Amount %
Answer Sales
Cost of goods sold
$ 520,000
360,000
$ 480,000
315,000
$ 40,000
45,000
8.3
14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income $ 17,500 $ 22,400 $ (4,900) (21.9)
Vertical Analysis
Vertical analysis focuses on the
relationships among financial statement
items at a given point in time. A common-
size financial statement is a vertical
analysis in which each financial statement
item is expressed as a percentage.

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 Income Statement
All items are usually expressed as a
percentage of sales.

Gross Margin Gross Margin

=
Vertical Analysis Percentage Sales

Balance Sheet
Income statement vs balance sheet

All items are usually expressed as a

percentage of total assets.

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 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31
Common-Size
Percentages
2005 2004 2005 2004

Example
Sales $ 520,000 $ 480,000 100.0 100.0
Cost of goods sold 360,000 315,000
Gross margin 160,000 165,000
Operating expenses 128,600 126,000
Net operating income 31,400 39,000
Interest expense 6,400 7,000
Net income before taxes 25,000 32,000
Less income taxes (30%) 7,500 9,600
Net income $ 17,500 $ 22,400
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31
Common-Size
Percentages
2005 2004 2005 2004
Answer Sales $ 520,000 $ 480,000 100.0 100.0
Cost of goods sold 360,000 315,000 69.2 65.6
Gross margin 160,000 165,000 30.8 34.4
Operating expenses 128,600 126,000 24.8 26.2
Net operating income 31,400 39,000 6.0 8.2
Interest expense 6,400 7,000 1.2 1.5
Net income before taxes 25,000 32,000 4.8 6.7
Less income taxes (30%) 7,500 9,600 1.4 2.0
Net income $ 17,500 $ 22,400 3.4 4.7
Financial Ratio
Financial ratio analysis is the technique of
comparing the relationship (or ratio)
between two or more items of financial data
from a company's financial statements.

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 Internal
Ratios can be useful in planning for the
future, setting goals, and evaluating the
performance of managers.

Purpose
External
Internal and External Purpose of Financial
Ration External analysts use ratios to
decide whether to grant credit, to
monitor financial performance, to
forecast financial performance, and
to decide whether to invest in the
company.

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Categories of Financial Ratio
Profitability
ratios
Leverage ratios
Liquidity ratio
Coverage ratios
 Efficiency ratios

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 Current Ratio

Liquidity Ratio
The term liquidity refers to the speed with which
Quick Ratio
an asset can be converted into cash without large
discounts to its value. Some assets, such as
accounts receivable, can easily be converted to
cash with only small discounts. Other assets,
such as buildings, can be converted into cash
very quickly only if large price concessions are
given.

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 Inventory Turnover Ratio

Accounts Receivable Turnover Ratio

Efficiency Ratio
Average Collection Period
Efficiency ratios provide information about
how well the company is using its assets to
generate sales.

Total Asset Turnover Ratio

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 Debt Ratio

Leverage Ratio Debt to Equity Ratio

This is important information for creditors
and investors in the firm. Creditors might be
concerned that a firm has too much debt and
will therefore have of debt can lead to a large
amount of volatility in the firms earnings.

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 Times Interest Earned Ratio

Coverage Ratio
.The coverage ratios are similar to liquidity ratios in
The Cash Coverage Ratio
that they describe the quantity of funds available to
cover certain expenses. We will examine two very
similar ratios that describe the firm's ability to meet its
interest payment obligations. In both cases, higher
ratios are desirable to a degree. However, if they are too
high, it may indicate that the firm is under-utilizing its
debt capacity, and therefore not maximizing
shareholder wealth.

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 Gross Profit Margin

Profitability Ratio Operating Profit Margin

Profitability ratios are the easiest of all of the
ratios to analyze. Without exception, high
ratios are preferred. However, the definition of
high depends on the industry in which the
firm operates. Generally, firms in mature
industries with lots of competition will have
lower profitability measures than firms in Net Profit Margin
younger industries with less competition.

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 Return on Assets

Profitability Ratio Return on Equity

Profitability ratios are the easiest of all of the
ratios to analyze. Without exception, high
ratios are preferred. However, the definition of
high depends on the industry in which the
firm operates. Generally, firms in mature
industries with lots of competition will have
lower profitability measures than firms in
younger industries with less competition.

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Du Pont Analysis Du Pont
The return on equity (ROE) is important to both
managers and investors. The effectiveness of
managers is often measured by changes in ROE
over time. Therefore, it is important that they
understand what they can do to improve the
firm's ROE, and that requires knowledge of what
causes changes in ROE over time.

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-end-