70 per share 104 part 1 introduction to managerial

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Unformatted text preview: ction to Managerial Finance TABLE 3.5 Baker Corporation Balance Sheets ($000) December 31 Assets 2003 2002 $ 400 $ 300 600 200 Current assets Cash Marketable securities Accounts receivable 400 500 Inventories 600 900 $2,000 $1,900 Total current assets Gross fixed assets (at cost) Land and buildings $1,200 $1,050 Machinery and equipment 850 800 Furniture and fixtures 300 220 Vehicles 100 80 Other (includes certain leases) Total gross fixed assets (at cost) 50 50 $2,500 $2,200 1,300 1,200 Net fixed assets $1,200 $1,000 Total assets $3,200 $2,900 $ 700 $ 500 Less: Accumulated depreciation Liabilities and Stockholders’ Equity Current liabilities Accounts payable Notes payable 600 700 Accruals 100 200 $1,400 $1,400 Total current liabilities Long-term debt Total liabilities $ 600 $ 400 $2,000 $1,800 Stockholders’ equity Preferred stock $ 100 $ 100 Common stock—$1.20 par, 100,000 shares outstanding in 2003 and 2002 120 120 Paid-in capital in excess of par on common stock 380 380 Retained earnings 600 500 $1,200 $1,100 $3,200 $2,900 Total stockholders’ equity Total liabilities and stockholders’ equity ended December 31, 2003, for Baker Corporation is presented in Table 3.6. Note that all cash inflows as well as net profits after taxes and depreciation are treated as positive values. All cash outflows, any losses, and dividends paid are treated as negative values. The items in each category—operating, investment, and financing—are totaled, and the three totals are added to get the “Net increase (decrease) in cash and marketable securities” for the period. As a CHAPTER 3 TABLE 3.6 Cash Flow and Financial Planning 105 Baker Corporation Statement of Cash Flows ($000) for the Year Ended December 31, 2003 Cash Flow from Operating Activities Net profits after taxes Depreciation $180 100 Decrease in accounts receivable 100 Decrease in inventories 300 Increase in accounts payable Decrease in accruals 200 ( 100)a Cash provided by operating activities $780 Cash Flow from Investment Activities Increase in gross fixed assets Changes in business interests ($300) 0 Cash provided by investment activities ( 300) Cash Flow from Financing Activities Decrease in notes payable ($100) Increase in long-term debts 200 Changes in stockholders’ equityb Dividends paid Cash provided by financing activities Net increase in cash and marketable securities 0 ( 80) 20 $500 aAs is customary, parentheses are used to denote a negative number, which in this case is a cash outflow. bRetained earnings are excluded here, because their change is actually reflected in the combination of the “Net profits after taxes” and “Dividends paid” entries. check, this value should reconcile with the actual change in cash and marketable securities for the year, which is obtained from the beginning- and endof-period balance sheets. Interpreting the Statement The statement of cash flows allows the financial manager and other interested parties to analyze the firm’s cash flow. The manager should pay special attention both to the major categories of cash flow and to the individual items of cash inflow and outflow, to assess whether any developments have occurred that are contrary to the company’s financial policies. In addition, the statement can be used to evaluate progress toward projected goals or to isolate inefficiencies. For example, increases in accounts receivable or inventories resulting in major cash outflows may signal credit or inventory problems, respectively. The financial manager also can prepare a statement of cash flows developed from projected financial statements. This approach can be used to determine whether planned actions are desirable in view of the resulting cash flows. An understanding of the basic financial principles presented throughout this text is absolutely essential to the effective interpretation of the statement of cash flows. 106 PART 1 Introduction to Managerial Finance Operating Cash Flow operating cash flow (OCF) The cash flow a firm generates from its normal operations; calculated as EBIT taxes depreciation. A firm’s operating cash flow (OCF) is the cash flow it generates from its normal operations—producing and selling its output of goods or services. A variety of definitions of OCF can be found in the financial literature. Equation 3.1 introduced the simple accounting definition of cash flow from operations. Here we refine this definition to estimate cash flows more accurately. Unlike the earlier definition, this one excludes interest and taxes in order to focus on the true cash flow resulting from operations without regard to financing costs and taxes. Operating cash flow (OCF) is defined in Equation 3.2. OCF EXAMPLE EBIT Taxes Depreciation (3.2) Substituting the values for Baker Corporation from its income statement (Table 3.4) into Equation 3.2, we get OCF $370 $120 $100 $350 Baker Corporation during 2003 generated $350,000 of cash flow from producing and selling its output. Because Baker’s operating cash flow is positive, we can conclude that the firm’s operations are ge...
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