Cash flows or Earnings discussion

Anonymous
timer Asked: Feb 24th, 2019
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Question Description

QUESTIONS

Using the limited information given in this case, address the following issues.

1. What are the primary reason(s) for consistently positive (negative) cashflows for firm A (firm B). What favorable or adverse impact does it have on the firm’s financial condition for this year? For later years?

2. What is your assessment of future viability for firm A and B, respectively?

3. Assume that you are in charge of commercial lending in a bank. Which firm would you prefer to lend the most? The least? Which firm would need external financing the most? The least? State your reasoning.

4. Which would be more useful, earnings or cashflows, to assess the financial performance in a given period, without knowing how a firm would perform in future? Which would be more useful to assess the firm's equity value? State your reasoning.

Company A CONSOLIDATED STATEMENTS OF EARNINGS (Dollars in thousands, except per share data) FISCAL YEAR Year 1 Net revenues 113.098 Cost of goods sold 61.847 Gross profit 51.251 Year 2 175.094 90.915 84.179 Year 3 298.386 160.578 137.808 15.153 9.218 12.372 36.743 14.508 1.243 15.751 4.914 10.837 22.679 13.962 21.533 58.174 26.005 1.522 27.527 8.839 18.688 10.837 18.688 38.465 20.713 37.451 96.629 41.179 2.537 43.716 13.421 30.295 563 30.858 0,25 0,42 0,65 43.586.380 44.858.468 47.684.829 Operating expenses: Marketing and sales General and administrative Research and development Total operating expenses Operation income Interests and other income, net Income before provision for income taxes and minority interest Provision for income taxes Income before minority interest Minority interest in consolidated joint venture Net income Net income per share Number of shares used in computation Page 1 CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended Year 1 Operating activities: Net Income 10.837 Adjustments to reconcile net cash provided by operating activities: Minority interest in consolidated joint venture Depreciation and amortization 1.830 Loss on sale of fixed assets 54 Deferred rent (396) Change in assets and liabilities: Receivables (7.052) Inventories (125) Prepaid royalties (1.351) Other assets (1.055) Account payable 1.914 Accrued liabilities 2.962 Deferred income taxes (530) Net cash provided by operation activities 7.088 Investing activities: Proceeds from sale of furniture and equipment Capital expenditures Net cash used in investing activities Financing activities: Proceeds from sales of shares through employee stock plans and other Tax benefit from stock option exercises S-corporation dividends Proceeds from minority interest investment in consolidated joint venture Net cash provided by financing activities Page 2 Year Ended Year 2 Year Ended Year 3 18.688 30.858 2.002 197 (90) (563) 3.994 216 866 (1.682) (3.309) (1.083) 1.663 6.052 9.782 (2.555) 29.665 (6.581) (3.235) (4.705) (3.777) 19.181 9.876 (3.468) 42.662 12 (2.186) (2.174) 57 (3.915) (3.858) 64 (17.810) (17.746) 1.110 688 (800) 2.911 4.511 (1.501) 5.357 9.060 (362) 998 5.921 3.500 17.555 Translation adjustment Minority interest on translation adjustment Increase in cash and cash equivalents Beginning cash and cash equivalents Ending cash and cash equivalents 290 (254) 6.202 21.377 27.579 31.474 27.579 59.053 (3.557) 62 38.976 59.053 98.029 CONSOLIDATED BALANCE SHEETS Year 2 31-Mar Assets Current assets: Cash and cash equivalents Receivables, less allowances of $18,653 and $11,442 at March 31, 1993 and 1992, respectively Inventories Prepaid Royalties Deferred income taxes Other current assets Total current assets Building, furniture and equipment, net Prepaid royalties Other assets Liabilities and Stockholders' Equity Current Liabilities: Accounts payable Accrued liabilities Total current liabilities (Dollars in thousands) Year 3 31-Mar 59.053 98.029 19.801 9.343 2.847 3.390 705 95.139 26.382 12.578 5.351 6.858 3.583 152.781 5.227 2.165 3.242 105.773 18.899 4.366 5.211 181.257 14.590 23.174 37.764 33.771 33.916 67.687 Minority interest in consolidated joint venture 2.999 Stockholders' equity Preferred stock, $0.01 par value. Authorized 1,000,000 shares at March 31, 1993 and 1992 Common stock, $0.01 par value. Authorized 70,000,000 and 26,000,000 shares at March 31, 1993 and 1992, respectively; issued and outstanding 46,196,623 and 43,964,800 at March 31, 1993 and 1992, respectively Page 3 440 462 Paid-in capital Retained earnings Translation adjustment Total stockholders' equity 28.591 39.223 (245) 68.009 105.773 Page 4 49.770 64.141 (3.802) 110.571 181.257 Company B CONSOLIDATED STATEMENTS OF EARNINGS (In thousands, except per share amounts) 52 Weeks Ended December 29, Year 1 Sales Cost of goods sold and occupancy costs Gross profit 903.306 699.309 203.997 Store operating and selling expenses Pre-opening expenses General and administrative expenses 146.907 8.838 28.530 184.275 19.722 Operating profit Other income(expense) Interest income Interest expense Merger costs Earnings before income taxes and extraordinary credit Income taxes Earnings before extraordinary credit Extraordinary credit Page 5 685 (1.594) 0 18.813 7.329 11.484 1.063 Net earnings 12.547 Earnings per common and common equivalent share Earnings before extraordinary credit Extraordinary credit Net earnings per share $ $ CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) 0,24 0,02 0,26 52 Weeks Ended December 29, Year 1 Cash flows from operating activities Cash received from customers Cash paid for inventories Cash paid for store operating, selling and general and administrative expenses Interest received Interest paid Taxes paid Net cashflow from operating activities Cash flows from investing activities Capital expenditures-net cash used in investing activities Cash flows from financing activities Proceeds from issuance of common stock and other Proceeds from exercise of stock options and warrants Foreign currency translation adjustment Proceeds from long- and short-term borrowing Payments on long- and short-term debt Net cash provided by financing activities Net increase(decrease) in cash and cash equivalent Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Reconciliation of net earnings to net cash used in operating activities Net earnings Adjustments to reconcile net earnings to net cash used in operating activities Depreciation and amortization 900.369 (706.182) (193.413) 685 (1.594) (5.205) (5.340) (47.410) 11.968 892 0 25.004 (7.805) 30.059 (22.691) 33.230 10.539 12.547 9.855 Page 6 Changes in assets and liabilities Increase in receivables Increase in merchandise inventories Increase in prepaid expenses, deferred income taxes and other assets Increase in accounts payable, accrued expenses and deferred credit Total adjustments Net cash used in operating activities (5.035) (96.523) (3.430) 77.246 (17.887) (5.340) CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts) December 28, Assets Current assets Cash and cash equivalents Receivables, net of allowances of $389 in 1992 and $269 in 1991 Merchandise inventories Deferred income taxes Refundable income taxes Prepaid expenses Total current assets Property and equipment, at cost Land and building Furniture, fixtures and equipment Automotive equipment Leasehold improvements Equipment under capital lease Less accumulated depreciation and amortization Other assets Liabilities and stockholders' equity Current liabilities Accounts payable Accrued expenses Income taxes Current maturities of long-term debt Total current liabilities Long-term debt, less current maturities Deferred taxes and other credit 5%, zero coupon, convertible, subordinated notes Page 7 Commitments and contingencies Common stockholders' equity Common stock-authorized 100,000,000 shares of $.01 par value: issued 60,616,816 in 1992 and 58,084,792 in 1991 Additional paid-in capital Foreign currency translation adjustment Retained earnings Less:961,532 shares of treasury stock, at cost Page 8 52 Weeks 52 Weeks Ended Ended December 28,December 26, Year 2 Year 3 1.300.847 1.001.484 299.363 1.732.965 1.334.305 398.660 214.525 7.774 39.007 261.306 38.057 275.016 7.453 53.982 336.451 62.209 151 (2.386) (8.950) 1.303 (1.459) 0 26.872 12.495 14.377 614 62.053 24.261 37.792 1.396 Page 9 14.991 $ $ 0,27 $ 0,01 0,28 $ 39.188 0,62 0,02 0,64 52 Weeks 52 Weeks Ended Ended December 28,December 26, Year 2 Year 3 1.285.534 1.686.468 (1.019.799) (1.335.487) (296.841) 151 (2.386) (8.376) (41.717) (354.146) 1.303 (1.459) (8.090) (11.411) (53.877) (62.542) 132.426 7.257 0 1.989 (16.452) 125.220 29.626 10.539 40.165 0 15.836 98 151.147 (3.101) 163.980 90.027 40.165 130.192 14.991 39.188 15.328 20.792 Page 10 (19.440) (107.079) (26.075) (118.379) (7.288) (16.348) 61.771 (56.708) (41.717) 89.411 (50.599) (11.411) December 28,December 26, Year 2 Year 3 40.165 130.192 35.937 337.873 6.402 0 2.861 423.238 62.012 456.252 9.059 3.385 3.112 664.012 5.842 62.552 6.181 74.395 12.899 161.869 31.670 130.199 5.838 559.275 16.442 82.080 8.179 100.339 12.899 219.939 51.471 168.468 15.893 848.373 197.592 41.084 237.385 66.227 1.732 0 3.012 243.420 6.456 3.956 0 2.948 306.560 3.486 4.800 151.080 Page 11 0 0 581 281.443 606 319.136 0 98 25.169 (1.750) 305.443 559.275 64.357 (1.750) 382.447 848.373 Page 12
Cash flows or Earnings? A firm's stock price is thought to be the present value of future cash flows. Since accounting earnings are not the same as cash flows due to "the accrual process," most finance textbooks emphasize cash flows rather than earnings in firm valuation. The accounting community also realizes the importance of cash flows and requires public companies to produce a separate financial statement called Statement of Cash(flows). Most financial analysts and academicians suggest scrutinizing "cash flow from operations," a measure that is closely related to the accounting income number. As a testimony of the importance of the cash flows, a former chairman of SEC was quoted as saying, “If I had to make a forced choice between having earnings information and having cash flow information, today I would take cash flow information (Forbes).” A noted academician on the other hand observed that, "Asking which one is better, cash flows or earnings, is like asking whether which shoe is more useful, your right or your left?”  Carmen Lake was just hired as equity analyst at Dermonti Brothers. As a part of her training program, she was given financial statements of two firms (denoted A and B) to evaluate the financial conditions. Firm A is a well known computer software manufacturer, B a large discount chain. The first thing Carmen noted was that both companies seemed to be posting strong growth in both sales and earnings. Over the two-year period from 1990 and 1992, Both companies had doubled their revenues and more than doubled their earnings. One thing that bothered Carmen was, however, the operating cash flows. While firm A’s cash flows seemed to grow in line with its earnings, firm B’s cash flows had not caught up with its earnings growth. Rather, B’s operating cash flows nose-dived from -$5.3 million in 1990 to -$41.7 million in 1991. Although the negative cash flow improved to -$11.4 million in 1992, it was a far cry from its reported earnings $39.1 million (see the table given below). Carmen was beset with many questions. First, why is A’s cash flow moving in the same direction with earnings, whereas B’s cash flow is in the opposite direction? Second, how long can firm B survive with consistently negative operating cash flows? Is firm B headed for a financial trouble in the near future? Finally, which indicator, earnings or cash flows, should she rely on, in order to assess the current and past financial performance of firm B? Carmen recalls learning the importance of cash flows (“Cash flow is the king.”) in finance textbooks, as earnings are subject to numerous errors and managerial manipulations. Fiscal Year Earnings per share Operating cash flow per share Company A Year Year Year 3 1 2 0.25 0.42 0.65 0.16 0.66 0.89 Company B Year 1 Year 2 Year 3 0.26 0.28 0.64 (0.11) (0.78) (0.19) QUESTIONS Using the limited information given in this case, address the following issues. 1. What are the primary reason(s) for consistently positive (negative) cashflows for firm A (firm B). What favorable or adverse impact does it have on the firm’s financial condition for this year? For later years? 2. What is your assessment of future viability for firm A and B, respectively? 3. Assume that you are in charge of commercial lending in a bank. Which firm would you prefer to lend the most? The least? Which firm would need external financing the most? The least? State your reasoning. 4. Which would be more useful, earnings or cashflows, to assess the financial performance in a given period, without knowing how a firm would perform in future? Which would be more useful to assess the firm's equity value? State your reasoning.

Tutor Answer

Thomas574
School: Boston College

Attached.

Running Head: ACCOUNTING

1

Accounting
Name
Professor
Institution
Course
Date

ACCOUNTING

2

The primary reason(s) for consistently positive cashflows for firm A and B and their
impacts to the companies
Referring to the data sheet, both companies have positive cashflows. The company’s
earnings per share and operating cash flow per share for the first three years are positive. Company
A recorded earnings per share as 0.25, 0.42 and 0.65 for the years 1,2 and 3 respectively. Similarly,
company B recorded earnings per share as 0.26, 0.28 and 0.64 for the first three years respectively.
Such a growth in cashflows was as a result of the huge profits and revenues generated by the
companies during the three years. By the end of the third year, company A had a total of $42,662
as the net cash generated from operational activities whereas company B had a total of $11411 as
the net cash generated (Rhodes, 2010). Such achievement was achieved since the two companies
had marked ...

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Anonymous
Thanks, good work

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