Financial Reporting and Analysis
• R27: Understanding the C/F
• R28: Financial Analysis Techniques:
Applications
• R31: Income Taxes
• R32: Long-Term Liabilities and Leases
• Overview
Slide 1
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The Statement of Cash Flows
Cash Flow from Operations
Cash Flow from Investing
Cash Flow from Financing
Sum = changes in cash
Add: Cash at start of period
Cash at end of period
Relevance
– assess liquidity, solvency and
financial flexibility
Slide 2
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X
X
X
X
X
X
Free Cash Flow
CFO = NI + NCC - △ WCInv
FCFF = CFO + Int (1-T) – FCInv
FCFE = CFO – FCInv + Net borrowing
IFRS
Interest Rec’d： CFO/CFI
Divs Rec’d： CFO/CFI
Interest Paid： CFO/CFF
Divs Paid： CFF/CFO
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U.S. GAAP
Interest Rec’d：CFO
Divs Rec’d：CFO
Interest Paid：CFO
Divs Paid： CFF
CFO calculation—Direct Method &Indirect Method
Calculation of CFO by Direct method
Cash received from Opening A/R +net sales -Closing A/R=Net sales-△A/R
customers
- Cash paid to
suppliers
Opening A/P + COGS- Closing A/P=-COGS+ △A/P+
Depreciation included in COGS(COGS= Opening
Inventory +purchase- Closing Inventory)
-
Cash paid to
employees
Opening wage payables + wage expense -Closing wage
payables=-wage expense +△wage payables
-
Interests paid
Opening interest payables +interest expense- Closing
interest payables=-interest expense+△interest payables
-
Tax paid
Opening tax payables +income tax expense- Closing tax
payables=-income tax expense+ △tax payables
= CFO
Slide 3
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CFO calculation--Direct Method & Indirect Method
1. An analyst gathered the following information
from a company’s 2004 financial statements ($
millions):
year ended 31 December
2003
2004
net sales
245.8
254.6
Cost of goods sold
168.3
175.9
Accounts receivable
73.2
68.3
39
47.8
20.3
22.9
Inventory
Accounts payable
Slide 4
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CFO calculation--Direct Method & Indirect Method
Based only on the information above, the company’s 2004 statement
of cash flows prepared using the direct method would include
amounts ($millions) for cash received from customers and cash
paid to suppliers, respectively, that are closest to:
A
B
C
Cash received from
customers
249.7
259.5
259.5
Cash paid to suppliers
182.1
169.7
182.1
 Answer：
C is correct.
• Cash received from customers = Sales + The decrease in accounts
receivable = 254.6 + 4.9 = 259.5.
• Cash paid to suppliers = Cost of goods sold + The increase in inventory
-Increase in accounts payable = 175.9 + 8.8 – 2.6 = 182.1
Slide 5
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CFO calculation--Direct Method & Indirect Method
Calculation of CFO by Indirect method
Net income
+ Non-cash expenses or losses
- Non-cash revenues or gains
Income statement items
+/- Non-operating items
- Increase in non-cash
operating asset
accounts(Inventory, A/R)
Balance sheet items(working capital)
+ Increase in operating liability
accounts(A/P)
= CFO
Slide 6
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Computing CFI
CFI
CFI = Cash Additions – Cash Received on Disposal
$
Opening NBV
NBV of Disposals
X
(X)
Depreciation Charge (X)
purchase
X
Closing NBV
X
Slide 7
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$
Proceeds
NBV
X
(X)
Profit/(loss) X/(X)
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Purchase of PP&E
Sales proceeds
Investment in JVs and
affiliates
Purchase and proceeds
from intangibles
Purchase and sale of
marketable securities
(available-for-sale and
held-to-maturity)
Computing CFF
CFF
Issue and redemption of:
Common stock
Pref stock
CFF
 Change in Debt
 Change in Common Stock
 Cash Dividends Paid
$
Treasury stock
Debt
Net Income
Dividend payments
Dividends
Δ in Retained Earnings
FCFF= CFO – CFI +INT(1-t)
Slide 8
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X
(X)
X
FCFE=FCFF - INT(1-t)+net borrowing
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Financial Reporting and Analysis
• R27: Understanding the C/F
• R28: Financial Analysis Techniques:
Applications
• R31: Income Taxes
• R32: Long-Term Liabilities and Leases
• Overview
Slide 9
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Categories of Ratios
 Activity → Efficiency of day-to-day tasks/operations
 Liquidity → Ability to meet short-term liabilities
 Solvency → Ability to meet long-term obligations
 Profitability → Ability to generate profitable sales from asset
base
 Valuation → Quantity of asset or flow associated with an
ownership claim
Slide 10
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Activity and Liquidity Ratios
Liquidity
Current ratio = CA/CL
Quick/Acid test
= (Cash + Marketable Sec + A/R) ÷ CL
Cash ratio
= (Cash + Marketable Sec) ÷ CL
Defensive Interval
= (Cash + Marketable Sec + A/R) ÷
Daily Cash Expenditure
Cash
Conversion
Cycle
=
Days of Sales
Outstanding
+
Days of
Inventory on
Hand
Number of
days of
payables
Receivables turnover
= Revenue ÷ average A/R
Days of Sales Outstanding
DSO
= 365÷ A/R T/O
Inventory turnover
= COGS÷ average INV.
Days of Inventory on Hand
= 365÷ INV. T/O
Payable turnover
= Purchase÷ average A/P
Number of Days of Payables
Slide 11
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= 365÷ A/P T/O
Profitability Ratios
Return on Sales
Return on Investment
Return on Investment
Gross profit margin
Return on Assets ROA
Net Income
Avg Total Assets
Return on total capital
EBIT
Avg Total Capital
EBIT (Operating Income)
Revenue
Return on Assets ROA
NI + Int (1-T)
Avg Total Assets
Return on equity
NI
Avg Equity
Net profit margin
NI
Revenue
Operating ROA
Operating Income
Avg Total Assets
Return on common equity
NI – Pref Div
Avg Common Equity
Rev - COGS (GP)
Revenue
Operating profit margin
Slide 12
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Other Ratios
Common Size Statements
Income statement
Balance sheet
Income Statement Account
Balance Sheet Account
Sales
Total Assets
Solvency
Interest coverage
EBIT
Interest Expense
Fixed Charge Coverage
EBIT + Lease Payments
Interest Expense + Lease Payments
Sustainable growth
g =(Earnings Retention Rate)(ROE)
[1-(Payout Ratio)]
Common Dividend
Net Income – Pref Div
Slide 13
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Activity Ratios
Working Capital = CA – CL
Working Capital Turnover
Revenue
Average Working Capital
Fixed Asset Turnover
Revenue
Average Net Fixed Assets
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DuPont System Analysis
ROE
=
NI
Equity
ROE
=
NI
Revenue
x
Assets
Revenue
x
x
Assets
Equity
Total Asset T/O Financial Leverage Multiplier
=
NI
Revenue
ROE
=
EBIT
Revenue
Slide 14
x
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Equity
EBT
EBIT
Interest Burden
x
NI
x
EBT
Tax Burden
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Revenue
Assets
x
ROE
Revenue
Assets
Equity
Financial Reporting and Analysis
• R27: Understanding the C/F
• R28: Financial Analysis Techniques:
Applications
• R31: Income Taxes
• R32: Long-Term Liabilities and Leases
• Overview
Slide 15
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Tax
Tax Reporting
Taxes payable
Revenue
X
Tax allowable costs (X)
Taxable income
X
Tax @ 30%
(X)
Income Taxes Payable
=
tax
+/expense ∆ Deferred Tax
 Accrual vs modified cash accounting
 Differences in reporting methods & estimates
Deferred Tax Liability
Tax Return > Accounting
Expenses
Expenses
Slide 16
Pay less tax
now but more
on reversal
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Financial Accounting
X
Revenue
Accrual based costs (X)
X
Pre-tax income
(X)
Tax @ 30%
Sources of Differences
 Timing differences
 Permanent differences
Pay more tax
now but less
on reversal
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Deferred Tax Assets
Tax Return < Accounting
Expenses
Expenses
Asset Tax Base
Amounts deductible in future tax
returns
Liability Tax Base
Carrying value – amounts that will
be deductible in future tax returns
Tax base ≠ carrying
value due to
temporary timing
differences
Taxation
Income Tax Expense
Pretax Income
Statutory tax rate ≠ effective tax rate
Tax expense ≠ Pre-tax income x statutory rate
Slide 17
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Changes in Tax Rate
↑tax rate – increase in deferred tax net
liability increase the tax expense
Adjustment in the period when the tax
rate changes (no restatement of prior
periods)
Analyst Adjustments
DTA & DTL: not net
DTA (Non reversal ): valuation allowance
DTL (Non reversal ): Equity
Uncertain reversal – Ignore
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Financial Reporting and Analysis
• R27: Understanding the C/F
• R28: Financial Analysis Techniques:
Applications
• R31: Income Taxes
• R32: Long-Term Liabilities and
Leases
• Overview
Slide 18
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Leases
Reasons to lease:
Cheaper financing
Reduced risk of obsolescence
Less restrictive provisions
Off Balance Sheet reporting
Tax reporting advantages
Operating Lease
All of the lease payment is
expensed when due through
the income statement.
All cash payments pass
through the CFO
Slide 19
Lessee Accounting
Capital Lease Criteria
 Title transferred
 Bargain purchase option
 Lease period  75% of
asset’s useful life
 Present value of lease
payments  90% of fair
market value
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Capital Lease
Asset & liability recognition equal to the
present value of the future lease
payments, discounted at the lower of:
lessor’s implicit lease rate
firm’s incremental borrowing rate
Asset ：depreciated
Liability：current and long term
elements
Income statement：interest charge &
depreciation
Payments split between CFO (interest)
and CFF (principal)
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Leases
Lessor Accounting
Sales-Type Lease
 Lessor is a dealer or seller of the leased
equipment
 At time of lease inception, lessor recognizes
a gross profit on sale
 Interest revenue recognized over period of
lease
PV of minimum lease payments
Cost of asset
Gross Profit
Slide 20
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X
(X)
X
Direct Financing Lease




Lessor is not a dealer of the leased
equipment e.g. finance company
No gross profit is recognized at time
of lease inception
(PV of minimum lease payments =
cost of asset)
All profit is interest revenue
recognized over period of lease
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Financial Reporting and Analysis
• R27: Understanding the C/F
• R28: Financial Analysis Techniques:
Applications
• R31: Income Taxes
• R32: Long-Term Liabilities and Leases
• Overview
Slide 21
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Financial Report Analysis
 SS7
 R22: Financial Statement Analysis: An
Introduction
 R23: Financial Reporting Mechanics
 R24: Financial Reporting Standards
 SS8
 R25: Understanding the I/S
 R26:Understanding the B/S
 R27: Understanding the C/F
 R28: Financial Analysis Techniques:
Applications
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 SS9
 R29: Inventories
 R30: Long-Lived Assets
 R31: Income Taxes
 R32: Long-Term Liabilities and
Leases
 SS10
 R33: Financial Reporting Quality:
Red Flags and Accounting Warning
Signs
 R34: Accounting Shenanigans on
the Cash Flow Statement
 R35: Financial Statement Analysis
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THANK YOU
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