Chapter 8 Flashcards
1. Communicate what happened to cash during a period. 2. Compute and interpret liquidity and solvency ratios. 3. Prepare a cash flow budget.
Why does management monitor cash flows?
1) make investments required for continued growth;
2) cover financing activities such as loan repayments and/or dividend payments.
what are operating activities
Activities related to operating the core business.
what are investing activities
Business activities related to purchasing or disposing of long-term assets and investments that are not cash equivalents or held for trading. Activities related to making cash advances and loans to other parties are also investing activities.
what are financing activities
Business activities related to raising capital.
Under IFRS how can interest and dividends be represented:
- Interest and dividends received can be classified as operating or investing activities since they flow through the income statement but also represent a return on investment
- Interest and dividends paid can be classified as operating or financing activities since they flow through the income statement but also represent a cost of obtaining financial resources
What 4 questions can we use to analyze the statement of cash flows
- What was the net change in cash during the period?
- What were the major SOURCES of cash (i.e., big inflows, positive numbers )?
- What were the major USES of cash (i.e., big outflows, negative numbers)?
- What overall strengths and/or weaknesses do you see?
what does liquidity mean
The term liquidity refers to a company’s ability to convert assets to cash
what is the current ratio
measures the company’s ability to pay current obligations (those payable within one year).
Current ratio = current assets / current liabilities
*value greater than 1 is best
what is the quick / acid-test ratio
measures the company’s ability to pay current obligations without selling or liquidating its inventory- in an immediately critical situation, the company should be able to pay all its short-term liabilities without relying on the sale of inventory
quick ratio = (current assets - inventory) / current liabilities
- ratio greater than 1 is best
what is the cash conversion cycle
which is essentially the number of days it takes for a company to convert inventory and sales into cash.
= days in inventory + days in AR - days in AP
what is inventory turnover
measures a company’s effectiveness in selling its inventory throughout the period.
inventory turnover = COGS / average inventory
what is days inventory outstanding (DIO)
tells us how long, in days, it takes to sell the average level of inventory.
DIO = 365 / inventory turnover
what is accounts receivable turnover
measures a company’s effectiveness in collecting its accounts receivable or, looked at another way, how efficiently a company collects its revenue.
AR turnover = net credit sales / average AR
what is days sales outstanding (DSO)
which indicates how long, in days, it takes the for company to collect its receivables.
DSO = 365 / AR turnover
what is the accounts payable turnover ratio
measures the number of times a company pays its creditors in a specified period
AP turnover = COGS / average AP
what is days in payables outstanding (DPO)
which indicates how long, in days, it takes for the company pay off its accounts payable.
DPO = 365 / AP turnover
what are solvency ratios
assess a company’s ability to take on additional debt in the future
what is a debt ratio
is the most basic leverage ratio which measures the extent to which a company’s assets are financed by debt
debt ratio = total liabilities / total assets
*higher ratio = higher credit risk
implies company financed growth through debt
what is times-interest-earned ratio
number of times a company can pay its interest expense with the operating income that it generates.
= operating income / interest expense
*higher the better
