Accounting: Financial Ratios and Cash Flow Essay

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Free Cash Flow (Cash flow after paying operating expenses & investments.) results from:
Free Cash Flow = [after-tax cash flow from operations] – [inc/dec in net working capital] – [inc/dec in gross fixed assets]
▪ Cash Flow from Operations – normal operating activities
▪ Assets investments – (1) net working capital (2) fixed assets
Calculating Cash Flow
1) Calc Cash flow from operations: [OP Income] + [Dep Exp] – [inc tax exp] = [after-tax cash flow from operations]
2) Calc Net working capital: [change in current assets] – [change in current liabilities]
3) Calc change in fixed assets: [this year’s fixed assets – last year’s fixed assets]
4) Compile Cash flow: After-tax cash flow from operations (1) Less current year investments: Investment in net working capital (2) Investment in long-term assets (3) Total Investments (2)+(3) Free Cash Flows total inv + (1)

Financing Cash Flow: CF btw investors & firm, can occur:
▪ Pay interest to lenders
▪ Pay dividends to stock holders
▪ Increase or decrease long-term debt
▪ Issue stock to new shareholders or repurchase stock
Use of cash: (negative) , Source of cash: positive

▪ Profit Margin – profit to sales (profit ÷ sales) used to measure firm’s performance.
▪ Treasury Stock – stock that was re-purchased by the company (once outstanding) ▪ Accrual Basis Accounting - Recording revenues when earned and expenses when incurred, rather than when cash is exchanged
▪ Free Cash Flows - Cash flow that is free and available to be distributed to the firm’s investors.
▪ Cash Flow Statements: Operating Activities, Investing Activities, Financing Activities

Income Statement (Profit & Loss Statemt) (period)
REVENUE – EXPENSES = PROFIT Operating Activities Sales (revenues) – Cost of Goods Sold (production cost) = Gross Profit – Operating Expense (Mktg, Admin, Rent, OH, Dep exp) = Operating Income (EBIT – earning before int & tax) – interest expense (cost of borrowing $) ( financing actvty = Earnings Before Tax – Income taxes paid = Net Income (can use for dividend or retained earn)

Balance Sheet (point) Total assets = Total liabilities (debt) + Total Shareholder’s equity

Current Assets – turn to cash in 12mo. ▪ Cash/AR/Inv/Other Current Assets/ Marketable security/prepaid exp.
+ Fixed Assets ▪ Machine/Equip/Land/ Build
+ Other Assets ▪ Goodwill/Patents/Copyrights

Current Liabilities (debt) – (less 12mo) ▪ AP/Accrued exp/Short-term Notes
+ Long Term Liabilities (debt) – (+12mo) ▪ Mortgages, Long-term notes
+ Stockholder’s Equity ▪ Preferred stock/ common stock/ retained earnings

▪ Net Working Capital = current assets – current liabilities Shows ability to pay loan. Larger the Net Working Capital, better ability to repay.
▪ Debt Ratio = total liabilities ÷ total assets % of assets financed by debt. Shows amt of financial risk. Higher debt ratio, more risk.

Chapter 3 – Understanding Financial Statements and Cash Flows

Interest Rate Determinants (1 basis pt = 1/100%) k = k* + IRP + DRP + LP + MP
Nominal rate (k) = + Real Risk Free Rate (k*) 3 mo. T-Bills – Inflation + Inflation Rate (IRP) + Default Premium (DRP) AAA Corp Bonds – 30 yr. T-Bonds + Maturity Premium (MP) 30 yr. T-Bonds – 3 mo. T-Bills + Liquidity Prem. (LP) How easy to convert to cash
Fisher Effect krf= k* + IRP + (k* " IRP)
Nominal rate (krf) = + Real Risk Free Ra∙ IRP)
Nominal rate (krf) = + Real Risk Free Rate (k*) 3 mo. T-Bills – Inflation + Inflation Rate (IRP)

Distribution Methods
1. Negotiated purchase – most profitable for IB (underwrite)
2. Competitive Bid Purchase (underwrite)
3. Commission/ Best Efforts Basis – commission, no underwtg
4. Privileged Subscription – new security issue to select people
5. Direct Sale