Session 19
Cash Flows, The Perfect
Storm & Financial
Statement Analysis
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Businesses are like Fruit
Trees
Fruit = Operating Activities
Trunk & Branches = Investing Activities
Roots = Financing Activities
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Statement of Cash Flows
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Operating
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Investing
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Working capital, day-to-day transactions
Direct versus indirect methods
Non-current assets—mainly PP&E and
marketable securities
Financing

Debt, equity and dividends paid
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Accounting’s Perfect
Storm
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IFRS Adoption
Convergence Completion
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Including Financial Statement
Reformating
Private Company Financial
Reporting


PCC
FRF
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Target Your Efforts

Solvency assurance

Wealth enhancement

Performance improvement
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Start with the 3 P’s
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Planning

Processing

Presenting
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Include the Trifecta:
Q-S-T
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Q: Quantitative analysis
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S: Strategic assessment
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T: Tactical feasibility
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Tools for Financial
Statement Analysis
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Ratio analysis
Trend analysis
Common-size analysis
Base period analysis
Comparative analysis
Horizontal and vertical analyses
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
A Financial Statement
Approach
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Look for key relationships
Focus on spending drivers
Don’t overlook the Statement of
Cash Flows
Remember to measure trends
Tell a story
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Guidelines for a
Presentation

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Clarity
Accuracy
Simplicity
Visually friendly
Limit page content
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Cash Flow Red-Flags
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Receivable and inventory growth
rate exceeds sales growth rate
Payables growth rate exceeds
inventory growth rate
Current liabilities grow faster than
sales
Sustained operating losses (negative
net income)
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Cash Flow Red-Flags
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(cont’d)
Negative operating cash flow
Capital expenditures exceed operating
cash flow
Sustained capital expenditures
reductions
Sustained sales of marketable securities
in excess of purchases
Substantial shift from long to short
term borrowing
Dividend reduction or elimination
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Cash Sufficiency Ratio

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Cash Flow From Operations + Interest +
Taxes
PPE + Debt Servicing + Taxes + Dividends
Should be greater than 1
Can easily disaggregate
Different footprints for different
development stages
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Cash Conversion Cycle

Cash conversion cycle

Days in payables ≥ DSO + Days in
inventory
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Typical Common Ratios



Solvency & liquidity
Earnings
Performance
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Ratio Analysis

General guidelines:

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Be consistent
Ascertain contents of numerator
and denominator
Apply common sense…
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Trend Analysis
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Static analysis is virtually useless
Trend direction is key
Combine with other approaches
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Common-size Analysis
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Helpful for size discrepancies
Keyed to sales or total assets
Helpful for industry comparisons
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Base Period Analysis
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Combines trending and
percentage analysis
Select representative base year
and set the index at 100
Measure subsequent periods in
terms of the base year
Helpful for industry comparisons

Eliminates size bias
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Comparative Analysis
Cautions
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Timing variances
GAAP variances
Conservative vs. Aggressive GAAP
Management attitude…”win at all
cost!”
Size
Geographic venues
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Horizontal and Vertical
Analysis
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
The most basic…and most
powerful analytical tool
Key element in fraud detection
Keeps the organization under
control
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Horizontal Analysis

Period versus period changes
Value changes
 Percentage changes


Look for irregularities
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Horizontal Analysis Example
ABC Company
Partial Balance Sheets
2008 and 2009
2009
Current Assets
Total Assets
Current Liabilities
Long-term Debt
Equity
Total Liabilities & Equity
2008
$ Change
% Change
$400
$300
$100
33%
$2,500
$2,200
$300
14%
$200
$150
$50
33%
$1,600
$1,500
$100
7%
$700
$550
$150
27%
$2,500
$2,200
$300
14%
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Vertical Analysis

Relationships within the same
period:
Numerical relationships
 Percentage relationships


Look for irregularities
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015
Vertical Analysis - Example
ABC Company
Partial Balance Sheets
2008 and 2009
2009
$
Current Assets
Total Assets
Current Liabilities
Long-term Debt
Equity
Total Liabilities & Equity
2008
%
$
%
$400
16%
$300
14%
$2,500
100%
$2,200
100%
$200
8%
$150
7%
$1,600
64%
$1,500
68%
$700
28%
$550
25%
$2,500
100%
$2,200
100%
FINANCIAL ACCOUNTING - BUS 020 - SPRING 2015