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