Tutorial 10 Flashcards
The statement of cash flows
The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities during a period.
Operating activities
Operating activities include the cash eff ects of transactions that create revenues and
expenses. They thus enter into the determination of net income.
Investing activities
Investing activities include (a) acquiring and disposing of investments and property, plant,
and equipment, and (b) lending money and collecting the loans.
Financing activities
Financing activities include (a) obtaining cash from issuing debt and repaying the
amounts borrowed, and (b) obtaining cash from shareholders, repurchasing shares, and
paying dividends.
The indirect method
The indirect method adjusts net income for items that do not affect cash. A great majority of companies use this method. Companies favor the indirect method for two reasons:
(1) it is easier and less costly to prepare, and (2) it focuses on the differences between net income and net cash flow from operating activities.
The direct method
The direct method shows operating cash receipts and payments, making it more consistent with the objective of a statement of cash fl ows. The IASB has expressed a preference for
the direct method but allows the use of either method
Free Cash Flow Formula
Net Cash Provided by Operating Activities − Capital Expenditures − Cash Dividends
Intracompany Analysis.
Comparisons within a company are often useful to detect changes
in fi nancial relationships and signifi cant trends.
Industry averages.
Comparisons with industry averages provide information about a
company’s relative position within the industry.
Intercompany basis.
Comparisons with other companies provide insight into a company’s competitive position.
Horizontal analysis
Horizontal analysis, also called trendanalysis, is a technique for evaluating a series of fi nancial statement data over a period of time. Its purpose is to determine the increase or decrease
that has taken place. This change may be expressed as either an amount or a percentage.
Vertical analysis
Vertical analysis, also called common-size analysis, is a technique that expresses each financial statement item as a percentage of a base amount
Ratio analysis
Ratio analysis expresses the relationship among selected items of financial statement data. The relationship is expressed in terms of either a percentage, a rate, or a simple proportion.
Change Since Base Period Formula
(Current Year Amount − Base Year Amount) / Base Year Amount
Current Results in Relation to Base Period
Current Year Amount / Base Period Amount
Liquidity Ratios
Measure short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash
Profitability Ratios
Measure the income or
operating success of a company
for a given period of time
Solvency Ratios
Measure the ability of
the company to survive
over a long period of time
Current Ratio Formula
Current Assets / Current Liabilities
Current Ratio meaning
The current ratio is a widely used measure for evaluating a company’s liquidity and
short-term debt-paying ability.
Acid-Test ratio meaning
The acid-test (quick) ratio is a measure of a company’s immediate short-term liquidity.
Acid-Test ratio formula
(Cash + Short-Term Investments + Accounts Receivable (Net) ) / Current Liabilities
Accounts Receivable Turnover meaning
It measures the number of times, on average,
the company collects receivables during the period
Accounts Receivable Turnover Formula
Net Credit Sales / Average Net Accounts Receivable
Inventory turnover meaning
Inventory turnover measures the number of times, on average, the inventory is sold during
the period. Its purpose is to measure the liquidity of the inventory.
Inventory turnover formula
Cost of Goods Sold / Average Inventory
Profit Margin formula
Net Income / Net Sales
Asset Turnover Meaning
Asset turnover measures how effi ciently a company uses its assets to generate sales.
Asset Turnover Formula
Net Sales / Average Total Assets
Return on Assets
An overall measure of profitability is return on assets. We compute this ratio by dividing net income by average total assets.
Return on Ordinary Shareholders’ Equity Meaning
Another widely used profi tability ratio is return on ordinary shareholders’ equity. It measures profi tability from the ordinary shareholders’ viewpoint. This ratio shows how many
euros of net income the company earned for each euro invested by the owners.
Return on Ordinary Shareholders’ Equity Formula
(Net Income − Preference Dividends) /
Average Ordinary Shareholders’ Equity
EPS meaning
Earnings per share (EPS) is a measure of the net income earned on each ordinary share.
EPS Formula
(Net Income − Preference Dividends) / Weighted-Average Ordinary Shares Outstanding
(P-E) ratio meaning
The price-earnings (P-E) ratio is a widely used measure of the ratio of the market price of
each ordinary share to the earnings per share. The price-earnings (P-E) ratio refl ects investors’
assessments of a company’s future earnings
(P-E) ratio formula
Market Price per Share / Earnings per Share
Payout Ratio meaning
The payout ratio measures the percentage of earnings distributed in the form of cash dividends.
Payout Ratio formula
Cash Dividends Declared on Ordinary Shares / Net Income
Debt to Assets Ratio meaning
he debt to assets ratio measures the percentage of the total assets that creditors provide.
Debt to Assets Ratio formula
Total Liabilities / Total Assets
(Net Income + Interest Expense + Income Tax Expense) / Interest Expense
Times interest earned provides an indication of the company’s ability to meet interest payments as they come due.
Discontinued operations
Discontinued operations refers to the disposal of a signifi cant component of a business, such
as the elimination of a major class of customers or an entire activity.
Change in accounting principle
A change in accounting principle occurs when the principle used in the current year is diff erent from the one used in the preceding
year. Accounting rules permit a change when management can show that the new principle is
preferable to the old principle
Comprehensive Income
Instead, these items are reported as part of a more inclusive
earnings measure called comprehensive income. The IASB requires companies to report not
only net income but also comprehensive income. Comprehensive income is the sum of net
income and other comprehensive income items.
