accounting chapter 11 and chapter 12

acid test ratio

(cash +current investments + accounts receivable)/current liabilities

% increase (decrease) equation

(current-year amount - prior-year amount)/prior-year amount

times interest earned ratio

(net income + interest expense + tax expense)/interest expense

indirect method

1. calculate net cash flows from operating activities, using information from the income statement and changes in current assets (other than cash) and current liabilities from the balance sheet 2. determine the net cash flows from investing activities by analyzing changes in long-term assets accounts from the balance sheet 3. determine the net cash flows from financing activities, by analyzing changes in long-term liabilities and stockholders' equity accounts from the balance sheet 4. combine the operating, investing, and financing activities, and make sure the total from these three activities equals the amount of cash reported in the balance sheet this year versus last year (the change in cash)

average days in inventory

365 days/inventory turnover ratio

average collection period

365 days/receivables turnover ratio

discontinued operations

a business, or a component of a business, that the organization has already discontinued or plants to discontinue, we report any gains or losses in the current year, separately from gains and losses on the portion of the business that will continue

changes in current assets and current liabilities

adjust for the increases or decreases in that balances of all current operating assets (other than cash) and current liabilities using the rules

direct method

adjust the items in the income statement to directly show the cash inflows and outflows from operations such as cash received from customers and cash paid for inventory, salaries, rent, interest, and taxes - if a company decides to use the direct method to report operating activities, it must also report the indirect method either along with the statement of cash flows or in a separate note to the financial statements

non-operating events

adjusting the accrual net income for any non-operating activities that are included in it, like subtracting out gains that may have been added in and adding back in any subtraction for losses, when those gains/losses relate to disposal of long-term (non-operating) assets

cash flow ratio for financial analysis

analysts often supplement their investigation of income statement and balance sheet amounts with cash flow ratios, some cash flow ratios are derived by substituting net cash flows from operating activities in place of net income - not to replace those ratios but to complement them

long term liability decrease

assume that cash was used, outflow, so you subtract to pay off the debt

operating activities section

begin with net income and then list adjustments to net income, in order to arrive at operating cash flows - adjustments to net income include: non-cash adjustments, non-operating events, changes in current assets and current liabilities

cash flows from financing activities

cash inflows: issuance of bonds or notes payable, issuance of stock, cash outflows: repayment of bonds or notes payable, acquisition of treasury stock, payment of dividends

inventory turnover ratio

cost of goods sold/average inventory

current ratio

current assets/current liabilities

net cash flows

difference between cash inflows and cash outflows during the period

risk ratios

divided between those that measure liquidity and solvency

conservative accounting

estimates and practices are those that result in reporting lower income, lower assets, and higher liabilities

aggressive accounting

estimates and practices result in reporting higher income, higher assets, and lower liabilities

investing activities section

in the absence of contrary evidence, its logical to assume that any increase in Long Term Assets is due to the purchase or investments in new long term assets during the year, a use of cash (outflow...subtraction), if the Long-Term Asset account decreases...we assume (in absence of any contrary evidence) that is decreased due to long term assets being sold..a source (inflow...addition) of cash

operating activities

include activities reported in the income statement and changes in the balances of current operating assets and current liabilities, inflows and outflows of cash related to these transactions

financing activities

include changes in the balances of long term liabilities and equity accounts including dividends paid to owners, new debt for cash or issuance or repurchase of stock

investing activities

include changes in the balances of long-term assets, purchase and sale of long term assets

profitability ratios

measure the earnings or operating effectiveness of a company

receivables turnover ratio

net credit sales/average accounts receivable

return on equity

net income/average stockholders' equity

return on assets

net income/average total assets

profit margin

net income/net sales

asset turnover

net sales/average total assets

three primary sections of the statement of cash flows

operating, investing, and financial activities

examples of significant non cash investing and financing activities include:

purchase of long-term assets by issuing debt, purchase of long-term assets by issuing stock, conversion of bonds payable into common stock, exchange of long-term assets

quality of earnings

refers to the ability of reported earnings to reflect the company's true earnings, as well as the usefulness of reported earnings to predict the future earnings

solvency

refers to the ability of the company to pay off its long-term liabilities

dividends paid to owners

results in outflow of cash, subtraction

cash inflow

simply means cash received by the company during the period

one-time income items

some items that are part of net income in the current year are not expected to persist

price-earnings ratio

stock price/earnings per share

if there is a decrease in the balance of the current asset

the amount of decrease is added

if there is an increase in the balance of the current liability

the amount of increase is added

if there is an increase in the balance of the current asset

the amount of increase is subtracted

if there is a decrease in the balance of the current liability

the amount of the decrease is subtracted

other revenues and expenses

the sale or disposal of most assets is reported, not as discontinued operations, but rather as other revenues and expenses

direct vs. indirect methods of presenting operating activities in the cash flow statement

the total net cash flows from operating activities are identical under both methods, the methods differ only in presentation format for operating activities, we report investing, financing, and non cash activities identically under both methods

earnings persistence

to make predictions of future earnings, investors look for current earnings that will continue or persist into future years

debt to equity ratio

total liabilities/stockholders' equity

non-cash transactions

transactions that do not increase or decrease cash, but that result in significant investing and financing activities, are reported as non cash activities either directly after the cash flow statement or in a note to the financial statements

if the equity accounts increase (like due to issuance of stock)

we assume source of cash and add as an inflow

if equity accounts decrease (like in repurchase of stock...treasury stock)

we assume use of cash and subtract as an outflow

vertical analysis/common size analysis

we express each item in a financial statement as a percentage of the same base amount, in an income statement, we express each line as a percentage of sales, in a balance sheet, we can express each line item as a percentage of total assets, helpful in comparing two companies in same industry

any increase in long term liabilities

a source of cash inflow, and is added

horizontal analysis

account trend analysis or time-series analysis for a single company, calculate the amount and percentage change in an account from last year to this year, this data can then be used to compare rates of change across accounts

non-cash adjustments

add back any non-cash expenses that have been subtracted from the accrual basis net income, like depreciation expense

cash flows from operating activities

cash inflows: sale of goods or services, collection of interest and dividends, cash outflows: for inventory, operating expenses, interest, income taxes

cash flows from investing activities

cash inflows: sale of investments, sale of long-term assets, collection of notes receivables, cash outflows: purchase of investments, purchase of long-term assets, lending with notes receivables

cash outflow

cash paid by the company during the period

gross profit ratio

gross profit/net sales

cash return on assets

operating cash flows/average total assets

statement of cash flows

provides a summary of cash inflows and cash outflows during the reporting period

liquidity

refers to having adequate cash (or other current assets that can be readily turned into cash) to pay current liabilities that will come due