ACCTG 211 1st Edition Lecture 16Outline of Last Lecture I. Recap of Direct MethodII. Introducing Indirect Method III. Example of Indirect Method Outline of Current Lecture I. Indirect and Direct CFFO ExampleII. Liquidity III. Solvency IV. Profitability V. Market Indicators Current LectureI. Indirect Method Examplea. The following information is from the Comparative Balance Sheets of Cabin FeverCorporation at 06/30/11 and 06/30/10. Net Income for the year ended 06/30/11was $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.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 CFFOd. 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/Ah. Step 4: Deal With Changes in CA or CL Accrual Accountsi. In thousandsi. Step 1: Net Income $425ii. Step 2: Add Depreciation Expense 105iii. Step 4: Deduct Increase in A/R (250)iv. Step 4: Deduct Increase in Inventory (675)v. Step 4: Add Decrease in Prepaid Insurance 50vi. Step 4: Add Increase in A/P 50vii. Step 4: Add Increase in Salaries Payable 600viii. Net Cash Provided by Operating Activities $305II. Direct Method Examplea. The following information is from the Comparative Financial Statements of SpringFever 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 $8,800ii. Plus: Credit Sales $67,000iii. Minus: Cash Collections $72,300iv. Equals: Ending A/R $3,500v. Cash Collections from Customers: $72,300 Inflowd. Next: Salaries Expense (accrual account Salaries Payable)i. Beginning Salaries Payable $3,000ii. Plus: Salaries Expense $18,750iii. Minus: Cash Payments $18,500iv. Equals: Ending Salaries Payable $3,250v. Cash Payments for Salaries: $(18,500) Outflowe. Next: Cost of Goods Sold (accrual accounts Inventory then A/P)i. Beginning Inventory $11,600ii. Plus: Purchases $29,100iii. Minus: COGS $31,200iv. Equals: Ending Inventory $9,500v. Beginning A/P $1,500vi. Plus: Purchases $29,100vii. Minus: Cash Payments $28,850viii. Equals: Ending A/P $1,750ix. Cash Payments for Inventory: $(28,850) Outflowf. Finally: Income Tax Expense (accrual account Taxes Payable)i. Beginning Income Taxes Payable $1,500ii. Plus: Income Tax Expense $7,500iii. Minus: Cash Payments $7,400iv. Equals: Ending Income Taxes Payable $1,600v. Cash Payments for Income Taxes: $(7,400) Outflowg. Answer:i. Cash collected from customers $72,300ii. 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 $17,550III. Ratio Analysisa. 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 short-term 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 Ratioi. 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 Ratioi. 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 Capitali. 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 Liabilitiesh. Liquidity: Inventory Turn Overi. This ratio measures how quickly a company is turning over its inventory. Ahigh number indicates an ability to quickly sell inventory.ii. Inventory Turn Over = (COGS)/(Average Inventory)i. Solvency: Debt-to-equity Ratioi. 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 equityj. Profitability: Return on Assetsi. 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 Assetsk. Profitability: Asset Turnoveri. 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 Assetsl. Profitability: Gross Margin Ratioi. 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 Salesm. Profitability: Profit Margin Ratioi. This ratio measures Net Income as a percentage of Net Sales. ii. Profit Margin Ratio = Net Income / Net Salesn. Profitability: Return on Equityi. 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 Sharei. 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