2. 7 - 1 © 2005 Accounting 1/e, Terrell/Terrell Using Analytical Review for Internal Financial Decisions and Planning for Cash Chapter 7

3. 7 - 2 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 1 Identify the internal users of analytical review techniques and the types of decision information the techniques provide.

4. 7 - 3 © 2005 Accounting 1/e, Terrell/Terrell Internal Analysts of Financial Information Their first objective is to ensure the integrity of the financial statements. Their first objective is to ensure the integrity of the financial statements. Their second objective is to monitor the overall performance of the business. As financial decision makers, managers share some objectives of external analysts, but they also have distinctive objectives in performing financial statement analysis.

5. 7 - 4 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 2 Distinguish between trend analysis and common-size statement techniques.

6. 7 - 5 © 2005 Accounting 1/e, Terrell/Terrell Analyzing Information from Financial Statements It also converts each element of an income statement from dollar amounts to percentages of sales. It also converts each element of an income statement from dollar amounts to percentages of sales. Trend analysis is a technique that indicates the amount of changes in key financial data over time. A common-size statement is an analysis that converts each element of the balance sheet from dollar amounts to percentages of total assets.

7. 7 - 6 © 2005 Accounting 1/e, Terrell/Terrell Limitations of Analytical Review Analysis 1. The ability to predict the future using past results depends upon the predictive value of the information. 2. The financial statements used for the analysis are based on historical cost.

8. 7 - 7 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 3 Perform analytical reviews in the forms of trend analysis and common-size statements.

9. 7 - 8 © 2005 Accounting 1/e, Terrell/Terrell Consolidated Statements of Cash Flow Operating cash flows Investing cash flows Financing cash flows Net change in cash Cash, beg. of year Cash, end of year $402,603(184,040) (20,051) (20,051) 198,512 198,512 21,753 21,753$220,265$165,910(160,170) (27,545) (27,545) (21,805) (21,805) 43,558 43,558 $ 21,753 $183,556(171,371) (63,928) (63,928) (51,743) (51,743) 95,301 95,301 $ 43,558 Family Dollar Stores, Inc. and Subsidiaries Consolidated Statements of Cash Flow For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000

10. 7 - 9 © 2005 Accounting 1/e, Terrell/Terrell Consolidated Statements of Cash Flow Operating cash flows Investing cash flows Financing cash flows Net change in cash Cash, beg. of year Cash, end of year $211,538 (95,330) (95,330) (24,455) (24,455) 91,753 91,753 42,468 42,468$134,221$123,242 (75,783) (75,783) (23,836) (23,836) 23,623 23,623 18,845 18,845 $ 42,468 $81,241(52,845)(18,404) 9,992 9,992 8,853 8,853$18,845$110,883(123,112) (26,691) (26,691) (38,920) (38,920) 134,221 134,221 $ 95,301 Aug 28 1999 Aug 29 1998 Aug 31 1997 1996 Family Dollar Stores, Inc. and Subsidiaries Consolidated Statements of Cash Flow For the Year Ended (in thousands)

11. 7 - 10 © 2005 Accounting 1/e, Terrell/Terrell Trend Computations for Cash 1996 $ 18,845 ÷ $18,845 1997 $ 42,468 ÷ $18,845 1998 $134,221 ÷ $18,845 1999 $ 95,301 ÷ $18,845 2000 $ 43,558 ÷ $18,845 2001 $ 21,753 ÷ $18,845 2002 $220,265 ÷ $18,845 = = = = = = = 100.00 100.00 225.35 225.35 712.24 712.24 505.71 505.71 231.14 231.14 115.43 115.43 1,168.82YearComputation Trend Value

12. 7 - 11 © 2005 Accounting 1/e, Terrell/Terrell Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets ASSETS Cash and cash equivalents Merchandise inventories Other current assets Property and equipment (net) Other assets Total assets 1168.82 165.64 165.64 263.07 263.07 371.39 371.39 301.72 301.72 251.81 251.81115.43155.90243.95314.66269.73200.88231.14139.27238.41264.12126.88178.49 For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000

13. 7 - 12 © 2005 Accounting 1/e, Terrell/Terrell Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets ASSETS Cash and cash equivalents Merchandise inventories Other current assets Property and equipment (net) Other assets Total assets 505.71122.89213.13201.04 96.63 96.63157.18712.24100.59178.72158.04 88.14 88.14135.21225.35101.10130.80125.26101.28111.98 For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 100.00100.00100.00100.00100.00100.00 1996

14. 7 - 13 © 2005 Accounting 1/e, Terrell/Terrell Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities: Accounts payable Accounts payable Other current liabilities Other current liabilities Deferred income taxes Deferred income taxes Total liabilities Shareholders’ equity Total liabilities and equity 242.76155.73390.43238.11259.56251.81168.75162.36285.84175.00215.53200.88176.59174.56191.18176.99179.34178.49 For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000

15. 7 - 14 © 2005 Accounting 1/e, Terrell/Terrell Trend Balance Sheet Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Balance Sheets LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities: Accounts payable Accounts payable Other current liabilities Other current liabilities Deferred income taxes Deferred income taxes Total liabilities Shareholders’ equity Total liabilities and equity 155.92173.25147.66160.65155.22157.18136.36167.34117.62144.54129.93135.21105.18124.46106.94111.21112.41111.98 For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 100.00100.00100.00100.00100.00100.00 1996

16. 7 - 15 © 2005 Accounting 1/e, Terrell/Terrell Trend Income Statements Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Income Statements Net sales Costs and expenses: Cost of sales Cost of sales Selling, general, and admin. Selling, general, and admin. Total expenses Income before income taxes Income taxes Net income Net income/common share 242.77239.30229.36236.47345.89326.61358.04357.14213.77210.97201.82208.37302.15285.29312.78314.29182.7179.63170.74177.10274.30259.03283.91285.71 For the Year Ended (in thousands) Aug 31 2002 Sep 1 2001 Aug 26 2000

17. 7 - 16 © 2005 Accounting 1/e, Terrell/Terrell Trend Income Statements Family Dollar Stores, Inc. and Subsidiaries Trend Consolidated Income Statements Net sales Costs and expenses: Cost of sales Cost of sales Selling, general, and admin. Selling, general, and admin. Total expenses Income before income taxes Income taxes Net income Net income/common share 160.45158.58151.21156.48225.46216.35231.20231.43137.75137.40132.11135.90168.06164.23170.48171.43116.35116.78113.85115.94122.99122.58123.25125.71 For the Year Ended (in thousands) Aug 28 1999 Aug 29 1998 Aug 31 1997 100.00100.00100.00100.00100.00100.00100.00100.00 1996

18. 7 - 17 © 2005 Accounting 1/e, Terrell/Terrell Earnings per Share (EPS) Did EPS rise in proportion to the increase in sales? Did EPS rise in proportion to the increase in sales? A publicly traded company will carefully watch its earnings per share. Did EPS rise steadily each year during the period?

19. 7 - 18 © 2005 Accounting 1/e, Terrell/Terrell The Trend Cash Flow Statement Are the operating cash flows sufficient to cover any negative cash flows from investing and financing activities? Are the operating cash flows sufficient to cover any negative cash flows from investing and financing activities? The trend cash flow statement helps in determining the sources and uses of cash. Are the operating cash flows positive for all years?

20. 7 - 19 © 2005 Accounting 1/e, Terrell/Terrell Trend Lines of Cash Flows -300 -200 -100 0 100 200 300 400 500 Operating Investing Financing 1996199719981999200020012002 $ (thousands) Family Dollar Stores, Inc. Trend Lines of Cash Flows

21. 7 - 20 © 2005 Accounting 1/e, Terrell/Terrell Common-Size Statements These statements present the relationship of data within a fiscal period. To compute the common-size balance sheet, each element of the balance sheet is shown as a percentage of total assets.

22. 7 - 21 © 2005 Accounting 1/e, Terrell/Terrell Consolidated Balance Sheets ASSETS Cash and cash equivalents$ 220,265$ 21,753 Merchandise inventories 766,631 721,560 Other current assets 68,963 63,952 Property and equipment (net) 685,617 580,879 Other assets 13,143 11,601 Total assets$1,754,619$1,399,745 Family Dollar Stores, Inc. and Subsidiaries Consolidated Balance Sheets For the Year Ended (in thousands) August 31 2002 September 1 2001

23. 7 - 22 © 2005 Accounting 1/e, Terrell/Terrell Common-Size Balance Sheets ASSETS Cash and cash equivalents 12.55 1.55 Merchandise inventories 43.69 51.55 Other current assets 3.93 4.57 Property and equipment (net) 39.08 41.50 Other assets 0.75 0.83 Total assets100.00100.00 Family Dollar Stores, Inc. and Subsidiaries Common-Size Consolidated Balance Sheets For the Year Ended (in thousands) August 31 2002 September 1 2001

24. 7 - 23 © 2005 Accounting 1/e, Terrell/Terrell Composition of Assets Family Dollar Stores, Inc. Composition of Assets 0 10 20 30 40 50 60 20012002 Percentage of Total Assets Cash Inventory Other current Fixed assets Other assets

25. 7 - 24 © 2005 Accounting 1/e, Terrell/Terrell Composition of Capital Family Dollar Stores, Inc. Composition of Capital 0 10 20 30 40 50 60 70 80 20012002 Percentage of Total Assets Liabilities Equity

26. 7 - 25 © 2005 Accounting 1/e, Terrell/Terrell Common-Size Income Statements Net sales100.00100.00 Costs and expenses: Cost of sales 66.46 66.55 Cost of sales 66.46 66.55 Selling, general, and admin. 25.33 25.31 Selling, general, and admin. 25.33 25.31 Total expenses 91.79 91.86 Income before income taxes 8.21 8.14 Income taxes 3.00 2.97 Net income 5.21 5.17 Family Dollar Stores, Inc. and Subsidiaries Common-Size Consolidated Income Statements For the Year Ended (in thousands) August 31 2002 September 1 2001

27. 7 - 26 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 4 Prepare a cash flow statement.

28. 7 - 27 © 2005 Accounting 1/e, Terrell/Terrell The Statement of Cash Flows It helps internal and external parties to: 1.Assess a company’s ability to generate positive future net cash flows. 2.Assess a company’s need for external financing and its ability to pay its debts and pay dividends. 3.Assess a company’s overall financial health. 4.Reconcile the differences between net income and the change in cash.

29. 7 - 28 © 2005 Accounting 1/e, Terrell/Terrell The Statement of Cash Flows Operating activities (income statement items) Investing activities (long-term asset items) Financing activities (long-term liability and stockholders’ equity items)

30. 7 - 29 © 2005 Accounting 1/e, Terrell/Terrell Direct Method versus Indirect Method The indirect method begins with net income and adjusts it for all items that did not generate or use cash. The indirect method begins with net income and adjusts it for all items that did not generate or use cash. The direct method presents the amount of cash inflows from customers, interest earned on loans, and dividends received and the cash outflows for merchandise, wages, operating expenses, taxes, and interest.

31. 7 - 30 © 2005 Accounting 1/e, Terrell/Terrell Direct Method versus Indirect Method Direct method: Operating activities: Cash received from customers$455,000 Cash paid for: Merchandise$160,000 Merchandise$160,000 Operating expenses 150,000 Operating expenses 150,000 Income taxes 21,000 331,000 Income taxes 21,000 331,000 Cash provided by operating activities$124,000 Jason’s Furniture Gallery, Inc. Partial Statement of Cash Flows For the Year Ended December 31, 2004

32. 7 - 31 © 2005 Accounting 1/e, Terrell/Terrell Direct Method versus Indirect Method Indirect method: Operating activities: Net income$ 41,000 Adjustments: Depreciation$15,000 Loss on sale of equipment 8,000 Deduct: Gain on sale of securities(25,000) Decrease in inventory 45,000 Increase in accounts payable 40,000 83,000 Cash provided by operating activities$124,000 Jason’s Furniture Gallery, Inc. Partial Statement of Cash Flows For the Year Ended December 31, 2004

33. 7 - 32 © 2005 Accounting 1/e, Terrell/Terrell Preparing the Statement of Cash Flows: Indirect Method Cash + Other assets = Liabilities + Equity  Cash +  Other assets =  Liabilities +  Equity  Cash =  Liabilities +  Equity –  Other assets

34. 7 - 33 © 2005 Accounting 1/e, Terrell/Terrell Preparing the Statement of Cash Flows: Indirect Method Step 1: Gather the information needed to prepare the statement: a.Consecutive, comparative balance sheets b.The income statement for the period between the two balance sheets c. Any information needed about noncash transactions

35. 7 - 34 © 2005 Accounting 1/e, Terrell/Terrell Preparing the Statement of Cash Flows: Indirect Method Step 2: Determine the net change in each account of the balance sheet Step 3: Complete the operating activities section. Step 4: Complete the investing activities section.

36. 7 - 35 © 2005 Accounting 1/e, Terrell/Terrell Preparing the Statement of Cash Flows: Indirect Method Step 5: Complete the financing activities section. Step 6: Add the operating, investing, and financing activities to derive the net change in cash, and add it to the beginning balance to derive the ending balance.

37. 7 - 36 © 2005 Accounting 1/e, Terrell/Terrell Preparing the Statement of Cash Flows: Indirect Method Cash flows from operating activities: Net income$ 63,181 Adjustments: Depreciation expense$17,800 Amortization expense 1,022 Increase in accounts receivable (9,450) Increase in inventories (35,803) Increase in prepaid expenses (17,000) Increase in other accounts payable 6,942 Increase in accounts payable 13,772 Increase in interest payable 6,000 Increase in taxes payable 42,120 25,403 Net cash provided by operating activities$ 88,584 Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended May 31, 2004

38. 7 - 37 © 2005 Accounting 1/e, Terrell/Terrell Preparing the Statement of Cash Flows: Indirect Method Cash flows from investing activities: Purchase of equipment and furniture $(43,100) Investment in intangible assets (13,100) Net cash used by operating activities (56,200) Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended May 31, 2004 Cash flows from financing activities: Sale of common stock $100,000 Payment of dividends (4,000) Net cash provided (used) by financing activities 96,000 Net change in cash$128,384 Beginning cash, June 1, 2003 -0- Ending cash, May 31, 2004$128,384

39. 7 - 38 © 2005 Accounting 1/e, Terrell/Terrell Supplemental Schedules The first indicates the amount paid for interest and income taxes. The second outlines any significant noncash investing and financing activities.

40. 7 - 39 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 5 Analyze the information provided on a cash flow statement.

41. 7 - 40 © 2005 Accounting 1/e, Terrell/Terrell Using information from the Statement of Cash Flows The purpose of the statement of cash flows is to disclose the company’s sources and uses of cash during a specific time period. In the long run, all investments must be financed through operations because operations is the only renewable source of cash.

42. 7 - 41 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 6 Compute cash ratios and describe the decision information provided by cash ratio analysis.

43. 7 - 42 © 2005 Accounting 1/e, Terrell/Terrell Cash Ratios Cash to total assets Free cash flows Operating cash flows to average current liabilities Operating cash flows to average total liabilities

44. 7 - 43 © 2005 Accounting 1/e, Terrell/Terrell Cash Ratios Cash to total assets = Cash ÷ Total assets $128,384 ÷ $288,015 = 44.58% $128,384 ÷ $288,015 = 44.58% Free cash flows = Operating cash flows – Capital expenditures – Dividends $28,384 = $88,584 – $56,200 – $4,000

45. 7 - 44 © 2005 Accounting 1/e, Terrell/Terrell Cash Ratios Operating cash flow ÷ Average current liabilities $88,584 ÷ $41,917 = 2.11 times Operating cash flow ÷ Average total liabilities $88,584 ÷$64,417 = 1.37 times

46. 7 - 45 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 7 Describe the importance of cash management.

47. 7 - 46 © 2005 Accounting 1/e, Terrell/Terrell Importance of Cash Management Management might have to pass up opportunities to lower operating costs by taking advantage of bargains. Management might have to pass up opportunities to lower operating costs by taking advantage of bargains. Lack of cash can cause the loss of future revenues. Improper cash management can reduce profits in several ways. The cash manager fails to take discounts on purchases.

48. 7 - 47 © 2005 Accounting 1/e, Terrell/Terrell End of Chapter 7