Session 11.docx

# How can a firm have negative earnings but positive

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How can a firm have negative earnings but positive cash flow from operations? What does this mean about firm performance? 9

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Riffe – ACCT 6201 –Session 11 –Fall 2018 +ive accrual Losses Depreciation and adjustments If a firm has positive cash flow from operations and net income, the ratio Cash Flow ¿ Operations ¿ Net Income is a measure of how effectively a firm is at converting net income to cash flow. It will be close to one for many firms. A higher number means (relative to other firms or across time) the firm is more effective in turning profits into cash. A lower number could mean any of the following: There are not as many noncash expenses to add back to net income to calculate CFO Accrual adjustments are less positive or more negative and are decreasing CFO relative to net income (which can happen when a firm is growing so they have large negative accrual adjustments) Firm has become more aggressive in measuring net income relative to cash flows. Calculate the ratio for TI for the two most recent years: For 2017 5363/3682 = 1.46, For 2016 4614/3595= 1.28 Trend is increasing means we are better to generate cash rather than net income. If it is a +ive trend then as per earning quality articles, it is a good trend as trend is increasing slowly not very aggressively. So, you have more confidence in earning and its reporting. Use the direct method template to calculate cash collected from customers, cash paid to suppliers for the most recent year. TI doesn’t list a separate line item for depreciation. Accordingly, cost of goods sold includes depreciation expense. This noncash expense must be added back to take it out of cost of goods sold for the cash paid to supplier’s calculation. Assume 70% of depreciation expense relates to cost of goods sold (cost of revenue) for manufacturing equipment. Since expenses are shown as negatives, 70% of depreciation expense must be added back as a positive adjustment to remove it. 0.7* 539 = 377.3 Depreciation expense included in COGS. While rest 30% in R&D, SG&A Use the accrual adjustments from the cash flow statement rather than calculating them from change in balance sheet accounts because it is more accurate. Keep the sign the same as listed on the cash flow statement. For example, AR went up so the accrual adjustment on the cash flow statement is negative and it is used in the table. ∆Cash Assets = On the Direct Cash Flow Statement (Cash Rec’d + and Cash Paid -) - ∆Noncash Assets Accrual Adjustments Related to Assets + ∆Liabilities Accrual Adjustments Related to Liabilities + ∆Stockholders Equity On the income statement (Show Rev + and Expense -) Explanation Cash Collected for AR -7 + Sales Revenue 14961 10
Riffe – ACCT 6201 –Session 11 –Fall 2018 Customers 14961-7= 14954 - Cash Paid for Purchases of Inventory -5085.7 is cash paid for inventory +337.3 Depreciation expense -167 for inventory AP +51 - Cost of Goods Sold -5347 For firms using the indirect method, why would it be helpful for investors to also calculate Cash Collected from Customers and Cash Paid to Suppliers? To see that how CFO relates to Net income they had EBITDA is calculated as earnings before interest, taxes, depreciation and amortization are subtracted.

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• Fall '09
• Robbins

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