Expenses and cash payments for the expenses decrease

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expenses and cash payments for the expenses decrease accrued expenses.Page 613National Beverage’s accrued expenses (Exhibit 12.3)decreasedby $259, which indicates that cash paidfor the expenses is more than accrual basis expenses. The decrease (the higher cash paid) mustbesubtractedin Exhibit 12.4. (An increase is added.)Interpreting Cash Flows from Operating ActivitiesThe operating activities section of the cash flow statement focuses attention on the firm’s ability togenerate cash internally through operations and its management of current assets and current liabilities(also calledworking capital). Most analysts believe that this is the most important section of thestatement because, in the long run, operations are the only source of cash. That is, investors will notinvest in a company if they do not believe that cash generated from operations will be available to paythem dividends or expand the company. Similarly, creditors will not lend money if they do not believe thatcash generated from operations will be available to pay back the loan. For example, many dot-comcompanies crashed when investors lost faith in their ability to turn business ideas into cash flows fromoperations.A common rule of thumb followed by financial and credit analysts is to avoid firms with rising netincome but falling cash flow from operations.!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!Rapidly rising inventories orreceivables often predict a slump in profits and the need for external financing.!!!!!!!!!!!!!!!!!!!!!!!!!!In GeneralThe quality of income ratio measures the portion of income that was generated in cash. Allother things equal, a higher quality of income ratio indicates greater ability to finance operating and othercash needs from operating cash inflows.A higher ratio also indicates that it is less likely that thecompany is using aggressive revenue recognition policies to increase net income, and therefore isless likely to experience a decline in earnings in the future. When this ratio does not equal 1.0, analystsmust establish the sources of the difference to determine the significance of the findings. There are fourpotential causes of any difference:1.The corporate life cycle (growth or decline in sales).When sales are increasing, receivables andinventory normally increase faster than accounts payable. This often reduces operating cash flowsbelow income, which, in turn, reduces the ratio. When sales are declining, the opposite occurs, and the
ratio increases.2. Seasonality.Seasonal (from quarter to quarter) variations in sales and purchases of inventory cancause the ratio to deviate from 1.0 during particular quarters.3.Changes in revenue and expense recognition.Aggressive revenue recognition or failure to accrueappropriate expenses will inflate net income and reduce the ratio.4.Changes in management of operating assets and liabilities.Inefficient management will increaseoperating assets and decrease liabilities, reducing operating cash flows and the quality of income ratio.

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Term
Fall
Professor
N/A
Tags
Balance Sheet, Statement of Cash Flows, Generally Accepted Accounting Principles

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