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Using Analytical Review for Internal Financial Decisions and Planning for Cash

Using Analytical Review for Internal Financial Decisions and Planning for Cash. Chapter 7. Learning Objective 1. Identify the internal users of analytical review techniques and the types of decision information the techniques provide. Internal Analysts of Financial Information.

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Using Analytical Review for Internal Financial Decisions and Planning for Cash

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  1. Using Analytical Review for Internal Financial Decisions and Planning for Cash Chapter 7

  2. Learning Objective 1 • Identify the internal users of analytical review techniques and the types of decision • information the • techniques provide.

  3. Internal Analysts ofFinancial Information As financial decision makers, managers share some objectives of external analysts, but they also have distinctive objectives in performing financial statement analysis. Their first objective is to ensure the integrity of the financial statements. Their second objective is to monitor the overall performance of the business.

  4. Learning Objective 2 • Distinguish between trend • analysis and common-size • statement techniques.

  5. Analyzing Information from Financial Statements Trend analysis is a technique that indicates the amount of changes in key financial data over time. A common-size statement is an analysis that converts each element of the balance sheet from dollar amounts to percentages of total assets. It also converts each element of an income statement from dollar amounts to percentages of sales.

  6. Limitations of AnalyticalReview Analysis 1. The ability to predict the future using past results depends upon the predictive value of the information. 2. The financial statements used for the analysis are based on historical cost.

  7. Learning Objective 3 • Perform analytical reviews in the forms of trend analysis and common-size statements.

  8. Family Dollar Stores, Inc. and Subsidiaries Consolidated Statements of Cash Flow For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000 Operating cash flows Investing cash flows Financing cash flows Net change in cash Cash, beg. of year Cash, end of year $402,603 (184,040) (20,051) 198,512 21,753 $220,265 $165,910 (160,170) (27,545) (21,805) 43,558 $ 21,753 $183,556 (171,371) (63,928) (51,743) 95,301 $ 43,558 Consolidated Statementsof Cash Flow

  9. Consolidated Statementsof Cash Flow Family Dollar Stores, Inc. and Subsidiaries Consolidated Statements of Cash Flow For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 Aug 31 1996 Operating cash flows Investing cash flows Financing cash flows Net change in cash Cash, beg. of year Cash, end of year $110,883 (123,112) (26,691) (38,920) 134,221 $ 95,301 $211,538 (95,330) (24,455) 91,753 42,468 $134,221 $123,242 (75,783) (23,836) 23,623 18,845 $ 42,468 $81,241 (52,845) (18,404) 9,992 8,853 $18,845

  10. Year Computation Trend Value 1996 $ 18,845 ÷ $18,845 = 100.00 1997 $ 42,468 ÷ $18,845 = 225.35 1998 $134,221 ÷ $18,845 = 712.24 1999 $ 95,301 ÷ $18,845 = 505.71 = 2000 $ 43,558 ÷ $18,845 231.14 2001 $ 21,753 ÷ $18,845 = 115.43 2002 $220,265 ÷ $18,845 = 1,168.82 Trend Computations for Cash

  11. Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000 ASSETS Cash and cash equivalents Merchandise inventories Other current assets Property and equipment (net) Other assets Total assets 1168.82 165.64 263.07 371.39 301.72 251.81 115.43 155.90 243.95 314.66 269.73 200.88 231.14 139.27 238.41 264.12 126.88 178.49 Trend Balance Sheet

  12. Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 Aug 31 1996 ASSETS Cash and cash equivalents Merchandise inventories Other current assets Property and equipment (net) Other assets Total assets 505.71 122.89 213.13 201.04 96.63 157.18 712.24 100.59 178.72 158.04 88.14 135.21 225.35 101.10 130.80 125.26 101.28 111.98 100.00 100.00 100.00 100.00 100.00 100.00

  13. Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000 LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities: Accounts payable Other current liabilities Deferred income taxes Total liabilities Shareholders’ equity Total liabilities and equity 242.76 155.73 390.43 238.11 259.56 251.81 168.75 162.36 285.84 175.00 215.53 200.88 176.59 174.56 191.18 176.99 179.34 178.49

  14. Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 Aug 31 1996 LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities: Accounts payable Other current liabilities Deferred income taxes Total liabilities Shareholders’ equity Total liabilities and equity 155.92 173.25 147.66 160.65 155.22 157.18 136.36 167.34 117.62 144.54 129.93 135.21 105.18 124.46 106.94 111.21 112.41 111.98 100.00 100.00 100.00 100.00 100.00 100.00

  15. Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Income Statements For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000 Net sales Costs and expenses: Cost of sales Selling, general, and admin. Total expenses Income before income taxes Income taxes Net income Net income/common share 242.77 239.30 229.36 236.47 345.89 326.61 358.04 357.14 213.77 210.97 201.82 208.37 302.15 285.29 312.78 314.29 182.7 179.63 170.74 177.10 274.30 259.03 283.91 285.71 Trend Income Statements

  16. Trend Income Statements Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Income Statements For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 Aug 31 1996 Net sales Costs and expenses: Cost of sales Selling, general, and admin. Total expenses Income before income taxes Income taxes Net income Net income/common share 160.45 158.58 151.21 156.48 225.46 216.35 231.20 231.43 137.75 137.40 132.11 135.90 168.06 164.23 170.48 171.43 116.35 116.78 113.85 115.94 122.99 122.58 123.25 125.71 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00

  17. Earnings per Share (EPS) A publicly traded company will carefully watch its earnings per share. Did EPS rise steadily each year during the period? Did EPS rise in proportion to the increase in sales?

  18. The Trend Cash Flow Statement The trend cash flow statement helps in determining the sources and uses of cash. Are the operating cash flows positive for all years? Are the operating cash flows sufficient to cover any negative cash flows from investing and financing activities?

  19. Family Dollar Stores, Inc. Trend Lines of Cash Flows 500 400 300 200 Operating $ (thousands) 100 Investing Financing 0 -100 -200 -300 1996 1997 1998 1999 2000 2001 2002 Trend Lines of Cash Flows

  20. Common-Size Statements These statements present the relationship of data within a fiscal period. To compute the common-size balance sheet, each element of the balance sheet is shown as a percentage of total assets.

  21. Family Dollar Stores, Inc. and Subsidiaries Consolidated Balance Sheets August 31 2002 September 1 2001 For the Year Ended (in thousands) ASSETS Cash and cash equivalents $ 220,265 $ 21,753 Merchandise inventories 766,631 721,560 Other current assets 68,963 63,952 Property and equipment (net) 685,617 580,879 Other assets 13,143 11,601 Total assets $1,754,619 $1,399,745 Consolidated Balance Sheets

  22. Common-Size Balance Sheets Family Dollar Stores, Inc. and Subsidiaries Common-Size Consolidated Balance Sheets August 31 2002 September 1 2001 For the Year Ended (in thousands) ASSETS Cash and cash equivalents 12.55 1.55 Merchandise inventories 43.69 51.55 Other current assets 3.93 4.57 Property and equipment (net) 39.08 41.50 Other assets 0.75 0.83 Total assets 100.00 100.00

  23. Family Dollar Stores, Inc. Composition of Assets 60 50 Cash 40 Inventory Percentage of Total Assets 30 Other current Fixed assets 20 Other assets 10 0 2001 2002 Composition of Assets

  24. Family Dollar Stores, Inc. Composition of Capital 80 70 60 50 Liabilities Percentage of Total Assets 40 Equity 30 20 10 0 2001 2002 Composition of Capital

  25. Family Dollar Stores, Inc. and Subsidiaries Common-Size Consolidated Income Statements For the Year Ended (in thousands) August 31 2002 September 1 2001 Net sales 100.00 100.00 Costs and expenses: Cost of sales 66.46 66.55 Selling, general, and admin. 25.33 25.31 Total expenses 91.79 91.86 Income before income taxes 8.21 8.14 Income taxes 3.00 2.97 Net income 5.21 5.17 Common-Size Income Statements

  26. Learning Objective 4 • Prepare a cash flow statement.

  27. The Statement of Cash Flows It helps internal and external parties to: 1. Assess a company’s ability to generate positive future net cash flows. 2. Assess a company’s need for external financing and its ability to pay its debts and pay dividends. 3. Assess a company’s overall financial health. 4. Reconcile the differences between net income and the change in cash.

  28. The Statement of Cash Flows Operating activities (income statement items) Investing activities (long-term asset items) Financing activities (long-term liability and stockholders’ equity items)

  29. Direct Method versusIndirect Method The direct method presents the amount of cash inflows from customers, interest earned on loans, and dividends received and the cash outflows for merchandise, wages, operating expenses, taxes, and interest. The indirect method begins with net income and adjusts it for all items that did not generate or use cash.

  30. Direct Method versusIndirect Method Jason’s Furniture Gallery, Inc. Partial Statement of Cash Flows For the Year Ended December 31, 2004 Direct method: Operating activities: Cash received from customers $455,000 Cash paid for: Merchandise $160,000 Operating expenses 150,000 Income taxes 21,000 331,000 Cash provided by operating activities $124,000

  31. Direct Method versusIndirect Method Jason’s Furniture Gallery, Inc. Partial Statement of Cash Flows For the Year Ended December 31, 2004 Indirect method: Operating activities: Net income $ 41,000 Adjustments: Depreciation $15,000 Loss on sale of equipment 8,000 Deduct: Gain on sale of securities (25,000) Decrease in inventory 45,000 Increase in accounts payable 40,000 83,000 Cash provided by operating activities $124,000

  32. Preparing the Statement of Cash Flows: Indirect Method Cash + Other assets = Liabilities + Equity Cash +Other assets = Liabilities + Equity Cash = Liabilities + Equity – Other assets

  33. Preparing the Statement of Cash Flows: Indirect Method Step 1: Gather the information needed to prepare the statement: a. Consecutive, comparative balance sheets b. The income statement for the period between the two balance sheets c. Any information needed about noncash transactions

  34. Preparing the Statement of Cash Flows: Indirect Method Step 2: Determine the net change in each account of the balance sheet Step 3: Complete the operating activities section. Step 4: Complete the investing activities section.

  35. Preparing the Statement of Cash Flows: Indirect Method Step 5: Complete the financing activities section. Step 6: Add the operating, investing, and financing activities to derive the net change in cash, and add it to the beginning balance to derive the ending balance.

  36. Preparing the Statement of Cash Flows: Indirect Method Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended May 31, 2004 Cash flows from operating activities: Net income $ 63,181 Adjustments: Depreciation expense $17,800 Amortization expense 1,022 Increase in accounts receivable (9,450) Increase in inventories (35,803) Increase in prepaid expenses (17,000) Increase in other accounts payable 6,942 Increase in accounts payable 13,772 Increase in interest payable 6,000 Increase in taxes payable 42,120 25,403 Net cash provided by operating activities $ 88,584

  37. Preparing the Statement of Cash Flows: Indirect Method Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended May 31, 2004 Cash flows from investing activities: Purchase of equipment and furniture $(43,100) Investment in intangible assets (13,100) Net cash used by operating activities (56,200) Cash flows from financing activities: Sale of common stock $100,000 Payment of dividends (4,000) Net cash provided (used) by financing activities 96,000 Net change in cash $128,384 Beginning cash, June 1, 2003 -0- Ending cash, May 31, 2004 $128,384

  38. Supplemental Schedules The first indicates the amount paid for interest and income taxes. The second outlines any significant noncash investing and financing activities.

  39. Learning Objective 5 • Analyze the information provided on a • cash flow statement.

  40. Using information from the Statement of Cash Flows The purpose of the statement of cash flows is to disclose the company’s sources and uses of cash during a specific time period. In the long run, all investments must be financed through operations because operations is the only renewable source of cash.

  41. Learning Objective 6 • Compute cash ratios and • describe the decision • information provided by • cash ratio analysis.

  42. Cash Ratios Measures for cash: Cash to total assets Free cash flows Operating cash flows to average current liabilities Operating cash flows to average total liabilities

  43. Cash Ratios Cash to total assets = Cash ÷ Total assets $128,384 ÷ $288,015 = 44.58% Free cash flows = Operating cash flows – Capital expenditures – Dividends $28,384 = $88,584 – $56,200 – $4,000

  44. Cash Ratios Operating cash flow ÷ Average current liabilities $88,584 ÷ $41,917 = 2.11 times Operating cash flow ÷ Average total liabilities $88,584 ÷$64,417 = 1.37 times

  45. Learning Objective 7 • Describe the importance • of cash management.

  46. Importance of Cash Management Improper cash management can reduce profits in several ways. The cash manager fails to take discounts on purchases. Management might have to pass up opportunities to lower operating costs by taking advantage of bargains. Lack of cash can cause the loss of future revenues.

  47. End of Chapter 7

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