FINANCIAL ACCOUNTING - BUS SPRING 2015 Session 19 Cash Flows, The Perfect Storm & Financial Statement Analysis

FINANCIAL ACCOUNTING - BUS SPRING 2015 Roots = Financing Activities Trunk & Branches = Investing Activities Fruit = Operating Activities Businesses are like Fruit Trees

FINANCIAL ACCOUNTING - BUS SPRING 2015 Statement of Cash Flows n Operating n Working capital, day-to-day transactions n Direct versus indirect methods n Investing n Non-current assets—mainly PP&E and marketable securities n Financing n Debt, equity and dividends paid

Accounting’s Perfect Storm n IFRS Adoption n Convergence Completion n Including Financial Statement Reformating n Private Company Financial Reporting n PCC n FRF FINANCIAL ACCOUNTING - BUS SPRING 2015

Target Your Efforts n Solvency assurance n Wealth enhancement n Performance improvement FINANCIAL ACCOUNTING - BUS SPRING 2015

Start with the 3 P’s n Planning n Processing n Presenting FINANCIAL ACCOUNTING - BUS SPRING 2015

Include the Trifecta: Q-S-T n Q: Quantitative analysis n S: Strategic assessment n T: Tactical feasibility FINANCIAL ACCOUNTING - BUS SPRING 2015

Tools for Financial Statement Analysis n Ratio analysis n Trend analysis n Common-size analysis n Base period analysis n Comparative analysis n Horizontal and vertical analyses FINANCIAL ACCOUNTING - BUS SPRING 2015

A Financial Statement Approach n Look for key relationships n Focus on spending drivers n Don’t overlook the Statement of Cash Flows n Remember to measure trends n Tell a story FINANCIAL ACCOUNTING - BUS SPRING 2015

Guidelines for a Presentation n Clarity n Accuracy n Simplicity n Visually friendly n Limit page content FINANCIAL ACCOUNTING - BUS SPRING 2015

Cash Flow Red-Flags n Receivable and inventory growth rate exceeds sales growth rate n Payables growth rate exceeds inventory growth rate n Current liabilities grow faster than sales n Sustained operating losses (negative net income) FINANCIAL ACCOUNTING - BUS SPRING 2015

Cash Flow Red-Flags (cont’d) n Negative operating cash flow n Capital expenditures exceed operating cash flow n Sustained capital expenditures reductions n Sustained sales of marketable securities in excess of purchases n Substantial shift from long to short term borrowing n Dividend reduction or elimination FINANCIAL ACCOUNTING - BUS SPRING 2015

Cash Sufficiency Ratio n Cash Flow From Operations + Interest + Taxes PPE + Debt Servicing + Taxes + Dividends n Should be greater than 1 n Can easily disaggregate n Different footprints for different development stages FINANCIAL ACCOUNTING - BUS SPRING 2015

Cash Conversion Cycle n Cash conversion cycle n Days in payables ≥ DSO + Days in inventory FINANCIAL ACCOUNTING - BUS SPRING 2015

Typical Common Ratios n Solvency & liquidity n Earnings n Performance FINANCIAL ACCOUNTING - BUS SPRING 2015

Ratio Analysis n General guidelines: n Be consistent n Ascertain contents of numerator and denominator n Apply common sense… FINANCIAL ACCOUNTING - BUS SPRING 2015

Trend Analysis n Static analysis is virtually useless n Trend direction is key n Combine with other approaches FINANCIAL ACCOUNTING - BUS SPRING 2015

Common-size Analysis n Helpful for size discrepancies n Keyed to sales or total assets n Helpful for industry comparisons FINANCIAL ACCOUNTING - BUS SPRING 2015

Base Period Analysis n Combines trending and percentage analysis n Select representative base year and set the index at 100 n Measure subsequent periods in terms of the base year n Helpful for industry comparisons n Eliminates size bias FINANCIAL ACCOUNTING - BUS SPRING 2015

Comparative Analysis Cautions n Timing variances n GAAP variances n Conservative vs. Aggressive GAAP n Management attitude…”win at all cost!” n Size n Geographic venues FINANCIAL ACCOUNTING - BUS SPRING 2015

Horizontal and Vertical Analysis n The most basic…and most powerful analytical tool n Key element in fraud detection n Keeps the organization under control FINANCIAL ACCOUNTING - BUS SPRING 2015

Horizontal Analysis n Period versus period changes n Value changes n Percentage changes n Look for irregularities FINANCIAL ACCOUNTING - BUS SPRING 2015

Horizontal Analysis - Example FINANCIAL ACCOUNTING - BUS SPRING 2015

Vertical Analysis n Relationships within the same period: n Numerical relationships n Percentage relationships n Look for irregularities FINANCIAL ACCOUNTING - BUS SPRING 2015

Vertical Analysis - Example FINANCIAL ACCOUNTING - BUS SPRING 2015