New Lecture 6 Spring 09
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Spring 2009
NBA 5060
Lecture 6 – Liquidity and Solvency Analysis
1. Liquidity risk 2. Solvency risk Supplemental note (not discussed in class): 3. Preparing a statement of cash flows from an income statement and two balance sheets
Change in the syllabus: We will discuss the Just for Feet case on Thursday, Feb. 12. The case will be handed out in class on Tuesday, Feb. 10.
Lecture 6
Page 1 of 7
Liquidity Risk Analysis Liquidity risk refers to the ability of a firm to meet its short term obligations.
Analytical Tools:
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Cash + short term investments + AR) / Current liab.
Operating Cash Flow to Current Liabilities = Cash from operations / Current liabilities
Lecture 6
Page 2 of 7
Long-term solvency risk ratios Solvency risk refers to the ability of a firm to service its external debt. Analytical Tools: 1. Debt and Leverage Ratios: includes debt to equity; liabilities to equity; net debt to equity; debt to capital; net debt to capital.
2. Interest Coverage Ratios Income based = (net income + interest exp + tax exp) / interest exp Cash based = (CFO + interest exp + tax exp) / interest exp Note: interest expense and tax expense are used to approximate interest paid and taxes paid in the cash based ratio.
3. Operating cash to capital expenditures = CFO / Capital Expenditures (acquisitions & purchases of PPE)
Lecture 6
Page 3 of 7
Preparing a statement of cash flows from I/S and B/S Why is this important?
Recall the fundamental Accounting Equation: Assets = Liabilities + Equity Thus:
Assetst = Liabilitiest + Equityt Assetst-1 = Liabilitiest-1 + Equityt-1
and
∆Assets = ∆Liabilities + ∆Equity
∆Cash + ∆Current assets + ∆Non-current assets = ∆Liabilities + ∆Non-current liabilities + ∆Equity ∆Cash = - ∆Current assets - ∆Non-current assets + ∆Current liabilities + ∆Non-current liabilities + ∆Equity where ∆Non-current assets = Asset Purchases – Asset Sales +(-) gain(loss) on sale of assets – depreciation expense ∆Equity = Net Income – Dividends paid +/- stock issued (repurchased)
Lecture 6
Page 4 of 7
Rearranging we get: ∆Cash = Net Income + depreciation - (+) gain (loss) on sale of assets ∆Current assets + ∆Current liabilities - Asset Purchases + Asset Sales - ∆Non-current liabilities +/- stock issued (repurchased) Dividends paid In general, because of the fact that assets equal liabilities plus equity, all changes in the balance sheet other than cash have to be accounted for. This will ensure your statement of cash flows balances. Then, the only remaining concern is classifying the changes as operating, investing, or financing.
Lecture 6
Page 5 of 7
A Skeleton Statement of Cash Flows: Sample Company Consolidated Statement of Cash Flows For year ended Jan. 28, 2000 OPERATING ACTIVITIES Net Income Add: Depreciation Amortization Change in Def Taxes (net) Loss (Gain) on Sale of PPE Decrease (increase) in other assets Decrease (increase) in AR Decrease (increase) in Inventory Decrease (increase) other current assets Increase (decrease) in AP Increase (decrease) in accrued expenses Increase (decrease) in other current liab
These are the changes in ‘working capital’ or ‘non-cash working capital’.
Equals: Cash from (used by) Operations INVESTING ACTIVITIES Subtract: Net Purchases of Property, Plant & Equip. Acquisitions net of divestitures Equals: Cash from (used by) Investing FINANCING ACTIVITIES Change in interest bearing debt Proceeds from issuance of equity (net of repurchases) Dividends Paid Equals: Cash from (used by) Financing Activities Beginning Cash Net Change in cash & equivalents (CFO+CFI+CFF) Ending cash
Lecture 6
Page 6 of 7
Classification of changes in balance sheet accounts (some of these can vary in reality): Operating Investing Financing Assets Marketable securities or investments in securities Accounts Receivable Inventory Other Current Assets Property, Plant & Equipment Accumulated depreciation Other Assets Liabilities and Equity Accounts Payable Notes Payable Current portion of long-term debt
X X X X X X X
X
X X X
Other current liabilities Long-term debt Deferred Taxes (can be asset too) Other non-current liabilities Common Stock Additional Paid in capital Retained Earnings Treasury stock
X X X X X (Net Inc)
X X X X (dividends) X
When you construct a SCF this way, will it match the actual SCF reported by the firm? If not, why not?
Lecture 6
Page 7 of 7
NBA 5060
Lecture 6 – Liquidity and Solvency Analysis
1. Liquidity risk 2. Solvency risk Supplemental note (not discussed in class): 3. Preparing a statement of cash flows from an income statement and two balance sheets
Change in the syllabus: We will discuss the Just for Feet case on Thursday, Feb. 12. The case will be handed out in class on Tuesday, Feb. 10.
Lecture 6
Page 1 of 7
Liquidity Risk Analysis Liquidity risk refers to the ability of a firm to meet its short term obligations.
Analytical Tools:
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Cash + short term investments + AR) / Current liab.
Operating Cash Flow to Current Liabilities = Cash from operations / Current liabilities
Lecture 6
Page 2 of 7
Long-term solvency risk ratios Solvency risk refers to the ability of a firm to service its external debt. Analytical Tools: 1. Debt and Leverage Ratios: includes debt to equity; liabilities to equity; net debt to equity; debt to capital; net debt to capital.
2. Interest Coverage Ratios Income based = (net income + interest exp + tax exp) / interest exp Cash based = (CFO + interest exp + tax exp) / interest exp Note: interest expense and tax expense are used to approximate interest paid and taxes paid in the cash based ratio.
3. Operating cash to capital expenditures = CFO / Capital Expenditures (acquisitions & purchases of PPE)
Lecture 6
Page 3 of 7
Preparing a statement of cash flows from I/S and B/S Why is this important?
Recall the fundamental Accounting Equation: Assets = Liabilities + Equity Thus:
Assetst = Liabilitiest + Equityt Assetst-1 = Liabilitiest-1 + Equityt-1
and
∆Assets = ∆Liabilities + ∆Equity
∆Cash + ∆Current assets + ∆Non-current assets = ∆Liabilities + ∆Non-current liabilities + ∆Equity ∆Cash = - ∆Current assets - ∆Non-current assets + ∆Current liabilities + ∆Non-current liabilities + ∆Equity where ∆Non-current assets = Asset Purchases – Asset Sales +(-) gain(loss) on sale of assets – depreciation expense ∆Equity = Net Income – Dividends paid +/- stock issued (repurchased)
Lecture 6
Page 4 of 7
Rearranging we get: ∆Cash = Net Income + depreciation - (+) gain (loss) on sale of assets ∆Current assets + ∆Current liabilities - Asset Purchases + Asset Sales - ∆Non-current liabilities +/- stock issued (repurchased) Dividends paid In general, because of the fact that assets equal liabilities plus equity, all changes in the balance sheet other than cash have to be accounted for. This will ensure your statement of cash flows balances. Then, the only remaining concern is classifying the changes as operating, investing, or financing.
Lecture 6
Page 5 of 7
A Skeleton Statement of Cash Flows: Sample Company Consolidated Statement of Cash Flows For year ended Jan. 28, 2000 OPERATING ACTIVITIES Net Income Add: Depreciation Amortization Change in Def Taxes (net) Loss (Gain) on Sale of PPE Decrease (increase) in other assets Decrease (increase) in AR Decrease (increase) in Inventory Decrease (increase) other current assets Increase (decrease) in AP Increase (decrease) in accrued expenses Increase (decrease) in other current liab
These are the changes in ‘working capital’ or ‘non-cash working capital’.
Equals: Cash from (used by) Operations INVESTING ACTIVITIES Subtract: Net Purchases of Property, Plant & Equip. Acquisitions net of divestitures Equals: Cash from (used by) Investing FINANCING ACTIVITIES Change in interest bearing debt Proceeds from issuance of equity (net of repurchases) Dividends Paid Equals: Cash from (used by) Financing Activities Beginning Cash Net Change in cash & equivalents (CFO+CFI+CFF) Ending cash
Lecture 6
Page 6 of 7
Classification of changes in balance sheet accounts (some of these can vary in reality): Operating Investing Financing Assets Marketable securities or investments in securities Accounts Receivable Inventory Other Current Assets Property, Plant & Equipment Accumulated depreciation Other Assets Liabilities and Equity Accounts Payable Notes Payable Current portion of long-term debt
X X X X X X X
X
X X X
Other current liabilities Long-term debt Deferred Taxes (can be asset too) Other non-current liabilities Common Stock Additional Paid in capital Retained Earnings Treasury stock
X X X X X (Net Inc)
X X X X (dividends) X
When you construct a SCF this way, will it match the actual SCF reported by the firm? If not, why not?
Lecture 6
Page 7 of 7
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