Once we have calculated the cash flows from each section, and summed them up to reach Net Change in Cash, we have finally completed an entire statement of Cash Flows. On the next page is an example of the finished product along with an example analysis.
By comparing the cash flow statements of two consecutive years, we can make assumptions about the company’s ongoing success or decline. We can see in Figure 3-3 that Golden Enterprises experienced both declining net income and increasing deficit in cash flows in 2013.
In the operating section, there is a major fluctuation in accounts payable, accrued expenses, and accrued income taxes. These accounts deal with expenses that we have recognized on the balance sheet but have not spent any cash to pay them off. In 2012, net cash spent to pay off accounts payable was approximately
$300,000, while that of 2013 was over $1.2 million. This could be seen as a move by Golden Enterprises to pay down current debts in order to have better liquidity in the future. However, accrued expenses in 2012 decreased throughout the year, causing a $132,524 deduction from cash flows for the year, while this same account increased by over $900,000 in 2013, creating a large inflow of operating cash. This
change counterbalances the activity in accounts payable from a cash flow standpoint. This could be a strategy by management to have a better estimate of costs in order to plan for the future. This could indicate more accrued expenses and less accounts payable. In addition to this activity, Accrued Income Taxes provided
$800,000 less cash inflow in 2013 than it did in 2012. A major cause of this is likely that less income means fewer taxes. Therefore, the company expensed less accrued taxes and thus could not add them back to cash flows.
On the investing section, the Golden Enterprises purchased significantly less property, plant, and equipment, but this is likely due to the fact that they generated less revenues, and they could also be gearing up for the 20% expansion mentioned in the case study that they are planning for 2014, a purchase of $5,000,000. By being a little more conservative with such spending this year, they are allowing themselves to have a better capability of affording this expansion in the following year.
In financing activities, more debt was paid off, more treasury shares were purchased, and more dividends were paid in 2013 than in 2012. Though this seems like a poor management decision—paying out more money when the company made less net income—it can be seen as a decision whose benefits will be reaped long term. By paying off more debt now, there will be less interest expense in future periods. Furthermore, by purchasing treasury stock, there may be opportunity to resell it at a higher price and generate a nice profit from the stock turnover. Also, the paying out of more dividends may be an encouragement to investors that this
company is thinking long-term expansion and simply used this year to prepare for increased profits in the future.
By analyzing such activities within the statement of cash flows, we can deduce the company’s mindset and plans for the future. After building and analyzing this financial statement for Golden Enterprises, it seems that they would be a good company to invest in, as stock prices will likely dip now due to decreased income but will surely increase next year when the big expansion begins.
4. Accounts Receivable—Pearson
Executive Summary
Between 2008 and 2009, Pearson’s sales increased significantly (by over 16%). Due to the nature of their business, all of Pearson’s sales are on account. Therefore, credit policy must be a major concern for the company, to ensure that they are receiving payments in a timely manner. According to an industry standard, normal time to collect a receivable is around 79 days. With this in mind, Pearson needs some major improvement in their collection time, as such abilities have been sub par for consecutive years.
Pearson’s average Days Sales Outstanding (DSO) was over 97 days in 2008.
In the following year, gross receivables increased along with sales, as was to be expected. However, average receivables increased at a slightly lower rate than sales, meaning an increase in AR turnover and a decrease in the average collection period.
Yet while things improved for 2009, their average of 93 days to collect receivables still lagged far behind the norm.
In order to make Pearson better able to compete with those in their industry, management should really work to bring the DSO to a much more reasonable level.
They have a couple options that could potentially help them achieve this. First, they could offer more cash discounts to customers who pay within a given time period,
such as 10 days after the sale. This could incentivize customers to take advantage of the discount, saving themselves money and providing the company with quicker payments. Another method Pearson could use would be to penalize those who don’t pay within the due period. For instance, if an account goes unpaid until its deadline has passed, Pearson could start compounding interest on that account for every period it goes unpaid. Opposite the first method, this would motivate customers to pay their bills on time to avoid greater expenses. This would also provide Pearson with compensation for holding receivables longer than they were due. By implementing some of these small changes, Pearson could likely bring down its DSO to an industry standard level within two to three years.