Notes Flashcards
Introductory Phase characteristics:
Purchasing fixed assets and beginning to produce/sell products
Operating = Negative because there are no profits yet
Investing = Negative
Financing = Positive because we need to raise cash through stock and/or debt
Growth Phase Characteristics
Striving to expand production and sales
Operating = becoming less negative/small positive since we are starting to make profits
Investing = Negative
Financing = becoming less positive since we are starting to make more from operations than we were before
Maturity Phase Characteristics:
Sales and production level off
Operating = Positive
Investing = less negative and perhaps even positive if we begin to sell off assets
Financing = less positive for sure and most likely negative since we are paying off debts and paying out dividends
Decline Phase Characteristics:
Sales of product fall due to a weakening consumer demand
Operating = smaller positive since sales are decreasing
Investing = positive since we are selling off assets at this point
Financing = Negative since we are now buying back shares, paying off any remaining debt, and maybe paying dividends as well
What is the weakness of the current ratio?
Current ratio uses year-end balances of current asset and current liability accounts. These year-end balances may not be representative of company’s position during most of the year.
What does the current cash debt coverage ratio tell us?
Better representation of liquidity on the average day because cash provided by operating activities involves the entire year
What does the cash debt coverage ratio tell us?
Ability to repay its liabilities from cash generated from operations without having to liquidate productive assets such as PP & E
Statement of Cash flows header
Wellmeyer Company
Statement of Cash Flows
For the Year Ended December 31, 1012
Header right under net income on statement of cash flows
Adjustments to reconcile net income to net cash provided by operating activities
What does a low payout ratio mean?
A low ratio may suggest that the company is retaining its earnings for future growth, or the company may not be stable enough to pay out dividends.
What does a high payout ratio mean?
A high ratio may suggest that the company is well established and stable. It could alarm investors that the company is not retaining enough earnings in order to grow.
Where is the unrealized gain or loss on trading securities reported?
Income Statement: Other revenues and gains
Where is the unrealized gain/loss on avaiable for sale securities reported?
Stockholder’s Equity – Unrealized gain or loss on available for sale securites
d. (30 % ownership)For 2012 Matt Forte Corp reports net income of $100,000. It declares a $50,000 cash dividend. Record the entries for Antoine Winfield Corp.
1) Net Income: 100,000 * 30%
Dr. Stock Investment 30,000
Cr. Revenue from Investment in Matt Forte Corp 30,000
2) Dividends: 50,000 * 30%
Dr. Cash 15,000
Cr. Stock Investment 15,000
e. (10 % Ownership)Antoine Winfield Corp receives net proceeds of $85,000 on the sale of its Matt Forte Corp stock on February 14th, 2013. Record the entry of the sale.
Dr. Cash 85,000
Dr. Loss on Sale of Stock Investment of Matt Forte 15,500
Cr. Stock Investment 100,500
Potential reasons to buy or effects of buying back treasury stock?
Will help fund stock compensation plans
Will reduce excess cash
Will increase EPS
Some reasons for companies to pay dividends
Have consistent and sustainable cash flows
They are big, mature, and stable
Choose to pay dividends, but are not required
Debt Advatnages
-Stockholder control is not affected. Debt issuers do not get voting rights
-The company saves taxes because interest expense lowers taxable income
-Using debt increases leverage, which may increase return on stockholder equity
-Considered cheaper than equity, because interest payments are lower than
stockholders’ expected return
Debt Disadvantages
- Debt holders will have first claim to the company’s assets during liquidation
- Interest payments may be hard to pay, and they are required
- Too much debt worries investors
Equity Advantages
- Often easy, due to the liquidity of the market
- You don’t have to make payments to shareholders
Equity Disadvantages
-Stockholders demand a higher return than debt holders
What does buying back stock communicate to investors?
Investors tend to like when companies repurchase stock, because it usually means that the
company has a lot of excess cash, and is therefore operating well. Also, it usually means the
company thinks it will continue to do well and the share price will rise.
Differences betwen common stock and preferred stock:
Preferred stock usually has priority with dividends and with receiving value during
liquidation/bankruptcy. However, common shareholders have voting rights, while preferred
shareholders almost always do not.
With dividends, preferred shareholders are often guaranteed dividends and have a stated
dividend rte. For common shareholders, dividends are optional.
During liquidation, debt holders get paid first, then preferred shareholders’, then common
shareholders.
Effect of Cash Dividend
Cash Dividends: cash is going from the company to the investor, so there is value being
exchanged. No change in the number of shares or the par value etc.
Stock Dividend effects
Stock Dividends: no real value is being exchanged. The amount of shares will increase by the %
stock dividend, and the price/share will decrease by that same percentage. Total stockholder’s
equity does not change, hpwever. Also, par value does not change.
Stock Split information
Stock Splits: no value is being exchanged. Shares increase by the magnitude of the stock split.
Share price is divided by the magnitude of the stock split, as is par value.
What does the payout ratio tell us?
It is usually expressed in a percentage. It tells us what % of the company’s earnings or profits
are being directly passed onto investors. Investors who like receiving dividends, look closely
at a company’s payout raito.
What does Return on common stockholders’ equity tell us?
Also expressed as a %. This tells us how much profit the company made/earned per dollar of
equity provided by investors. For instance, if net income= 200 and avg common stock=
1,000, then that is a 20% return on common stock. This means that as an investor, if you
paid $1 to invest in the company, you essentially just made 20 cents
Free Cash Flow provides an indication of a company’s ability to:
Generate cash to pay dividends
Generate cash to invest in new capital expenditures
Significant investing and financing activities that do not affect cash are reported:
In a seperate schedule at the bottom of the statement of cash flows
In the notes of the financial statements
The payment of cash dividends is a __________________
financing activity
Amortization expense of intangibles is an ______________
operating activity
Using a loan to purchase land is a(n)
noncash activity
A company has high cash inflows from financing activities, and high cash outflows from both operating and investing activities.
Introductory phase
A company has positive operating and investing cash flows, but has seen its net financing cash flows decrease to roughly even.
Maturity phase
Companies in the growth stage often have positive cash flows from financing activities, yet negative cash flows from both investing and operating activities. Why?
Companies that are growing need to buy assets, so therefore they have net cash outflows for
investing. As for operations, the net cash outflows are because they have high expenses because of
paying larger rent, hiring employees, and selling products cheaper than they would like to in order
to attract customers. In order to fund operations and the need to grow their asset base, they must raise money from
outside investors. They do this through financing issuances of debt and equity.
What operating activities tells investors:
Operating cash flows are the core of the business. It involves their revenues from selling goods,
selling expenses, salaries, rent etc. It also incorporates the changes in stuff like receivables and
inventories and payables, all that are needed to run a company. It tells us how much cash they are
making from their core operations.
What investing activities tells investors:
Investing cash flows deal with fixed assets, mostly PP&E. This tells us whether a company is buying
or selling more of these items. If they are buying more, they are probably growing, expanding their
abilities. If they are selling more, they are probably a mature or declining company that is finding
ways to get rid of excess assets. Also, they may need the money and are selling non-essential assets
for cash.
What financing activities tells investors:
Financing activities focuses on cash flows between the company and outsiders. If the cash flows are
positive, they are still raising money, which means they probably are growing and need to fund
operations and the purchase of assets. Negative financing is for mature companies who are paying
dividends, or buying back stock and debt.
Why are free cash flows important?
Free cash flow includes cash from operations, which is cash flows from core operations. CAPEX is
expenses to purchase required assets to continue operations. And dividends are direct cash
payments to investors.
When you calculate free cash flow, it is considered the left-over excess cash for the company to
make any decision they want. I they want to grow, acquire a company, pay more dividends, buy
back stock etc., they must have free cash flow.
What is true regarding trading securities?
Recorded at fair value
Bought and held primarily for short-term gains
Impact the income statement with changes in fair value
Trading securities effects
Trading securities: the changes in fair value are journalized to two accounts. The “Market
adjustment-trading” account and the “unrealized G/L-income” account. Therefore, any changes in
the fair value of trading securities is shown on the income statement and affects net income.
Because of this, trading securities lead to net income being more volatile.
Available-for-sale securities effects
AFS securities: the two accounts for AFS securities are “market adjustment-AFS” and “Unrealized
g/l-equity”. As you can see, the unrealized g/l goes to stockholders’ equity and not the income
statement. Therefore, gains and losses do not impact net income until the securities are sold.
short-term stock investments =
trading securities
Dividend Revenue reported under:
“Other gains and Revenues”
Loss on sale of stock investments
“Other expenses and losses”
What would be included in “Other comprehensive income”
example
Unrealized loss on AFS securities
What is an example of something found in the Stockholders’ Equity section on the balance sheet?
Unrealized gains and losses on AFS securities
Where are discontinued operations shown?
Discontinued operations are shown after “income before irregular items” and before
net income. They are shown, net of tax, meaning you take out the amount impacted by the tax rate.
Two characteristics of extraordinary items
Unusual in nature
Infrequent in occurrence
What do high and low quality of earnings mean?
High quality of earnings means that the financial information is clear, transparent, and reflective of
how the company is doing. You can trust the net income numbers.
Poor Quality of earnings arises
when companies alter the numbers. Therefore, net income isn’t reflective of how the company is
doing.
Some things that may lower quality of earnings
Companies often alter revenues by changing revenue recognition. Most companies who do this try
to boost revenues by recognizing them early. As for expenses, companies can do a lot of things. Stuff
like bad debt expense and depreciation expense are management estimates. Also, companies may
choose to defer an impairment loss
