ACCTG 211 1st Edition Lecture 16 Outline of Last Lecture I Recap of Direct Method II Introducing Indirect Method III Example of Indirect Method Outline of Current Lecture I II III IV V Indirect and Direct CFFO Example Liquidity Solvency Profitability Market Indicators Current Lecture I Indirect Method Example a The following information is from the Comparative Balance Sheets of Cabin Fever Corporation at 06 30 11 and 06 30 10 Net Income for the year ended 06 30 11 was 425 000 Depreciation Expense of 105 000 was included in the Operating Expenses for the year ended 06 30 11 Comparative Balance Sheets follow These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute II b Required Using the Indirect Method prepare the Cash From Operations section of the Statement of Cash Flows for Cabin Fever Corporation for the year ended 06 30 11 c Objective reconcile accrual based Net Income to CFFO d Four Steps for Indirect Method Operating Section e Step 1 Start with Net Income accrual based f Step 2 Add Back Depreciation Expense or Amortization Expense or Depletion Expense g Step 3 Add Back Loss or Back out Gain on Sale of F A h Step 4 Deal With Changes in CA or CL Accrual Accounts i In thousands i Step 1 Net Income 425 ii Step 2 Add Depreciation Expense 105 iii Step 4 Deduct Increase in A R 250 iv Step 4 Deduct Increase in Inventory 675 v Step 4 Add Decrease in Prepaid Insurance 50 vi Step 4 Add Increase in A P 50 vii Step 4 Add Increase in Salaries Payable 600 viii Net Cash Provided by Operating Activities 305 Direct Method Example a The following information is from the Comparative Financial Statements of Spring Fever Corporation for two consecutive years Income Statement data is for the second year b Required Using the Direct Method prepare the Cash From Operations section of the Statement of Cash Flows for Spring Fever Corporation for the second year c Start with Sales accrual account A R i Beginning A R 8 800 ii Plus Credit Sales 67 000 iii Minus Cash Collections 72 300 iv Equals Ending A R 3 500 v Cash Collections from Customers 72 300 Inflow d Next Salaries Expense accrual account Salaries Payable i Beginning Salaries Payable 3 000 ii Plus Salaries Expense 18 750 iii Minus Cash Payments 18 500 iv Equals Ending Salaries Payable 3 250 v Cash Payments for Salaries 18 500 Outflow e Next Cost of Goods Sold accrual accounts Inventory then A P i Beginning Inventory 11 600 ii Plus Purchases 29 100 iii Minus COGS 31 200 iv Equals Ending Inventory 9 500 III v Beginning A P 1 500 vi Plus Purchases 29 100 vii Minus Cash Payments 28 850 viii Equals Ending A P 1 750 ix Cash Payments for Inventory 28 850 Outflow f Finally Income Tax Expense accrual account Taxes Payable i Beginning Income Taxes Payable 1 500 ii Plus Income Tax Expense 7 500 iii Minus Cash Payments 7 400 iv Equals Ending Income Taxes Payable 1 600 v Cash Payments for Income Taxes 7 400 Outflow g Answer i Cash collected from customers 72 300 ii Cash paid for inventory 28 850 iii Cash paid for salaries 18 500 iv Cash paid for taxes 7 400 v Net Cash Provided by Operating Activities 17 550 Ratio Analysis a Ratios are standard measures that enable analysts to compare companies of different sizes b A ratio by itself does not give much information c To be useful a ratio must be compared to other ratios from previous periods compared to ratios of other companies in the industry or compared to industry averages d Ratio Classification i Liquidity Can a company pay the bills as they come due This is a shortterm perspective ii Solvency Can the company survive over a long period of time This is a longer term perspective iii Profitability Can a company earn a satisfactory rate of return Satisfactory is subjective though iv Market indicators Is the stock a good investment Good is subjective though e Liquidity Current Ratio i This ratio measures a company s ability to pay current liabilities with current assets ii Current Ratio Current Assets Current Liabilities f Liquidity Acid Test Ratio i This ratio often called the quick ratio shows a company s ability to pay its short term obligations with assets that can be quickly liquidated ii Acid Test Ratio Cash Short Term Investments A R Current Liabilities g Liquidity Working Capital i This is a subtraction formula not a ratio but it is often computed to evaluate a company s ability to pay its current liabilities ii Working Capital Current Assets Current Liabilities h Liquidity Inventory Turn Over i This ratio measures how quickly a company is turning over its inventory A high number indicates an ability to quickly sell inventory ii Inventory Turn Over COGS Average Inventory i Solvency Debt to equity Ratio i This ratio compares the amount of debt a company has with the amount the owners have invested in the company ii Debit to equity ratio total liabilities total equity j Profitability Return on Assets i This ratio measures a company s success in using its assets to earn income for the persons who are financing the business ii Return on Assets Net Income Average Total Assets k Profitability Asset Turnover i This ratio measures a company s success in using its assets to earn income for the persons who are financing the business ii Asset Turnover Net Sales Average Total Assets l Profitability Gross Margin Ratio i This ratio measures Gross Profit as a percentage of Net Sales Sometimes also called the Gross Profit ratio as Gross Profit is the same as Gross Margin ii Gross Margin Ratio Gross Margin Net Sales m Profitability Profit Margin Ratio i This ratio measures Net Income as a percentage of Net Sales ii Profit Margin Ratio Net Income Net Sales n Profitability Return on Equity i This ratio measures how much income is earned with the common shareholders investment in the company ii ROE Net Income Preferred Dividends Average Stockholder s Equity o Profitability Earnings Per Share i This ratio yields the amount of net income per share of common stock It is one of the most widely used measures of a company s profitability ii Earnings Per Share Net income Preferred dividends Average number of shares of common stock outstanding p Market Indicators P E Ratio i This is a ratio of market price per share to earnings per share This ratio indicates the market price for 1 of earnings ii P E Ratio Market Price per share earnings per share q Market Indicators Dividend Yield i This ratio yields the percentage of a stock s market