Fin 601 - Finance Exam

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The Cash flow statement is presented by three major categories:

- Operating activities, or operations, which refer to cash generated by company’s ordinary operation.

- It includes all activities which explicitly don’t describe other two categories.

- Investing activities covers cash spent on capital equipment and other investments (outgoing), and cash realized from the sale of such investments (incoming).

- Financing activities refer to cash used to reduce debt, buy back stock, or pay dividends.

As a conclusion, we can say that Cash Flow statement tells where the Organization’s cash came from and where it went. It shows the relationship between net profit and the change in cash recorded from one Balance Sheet to the next.

Table 1. The Cash Flow Statement (Sample)

Description

Amount

Net Income

Operating Activities

a

Accounts receivable

Inventory

Prepaid expense

Accounts payable

Accrued expense

Income tax payable

Depreciation expense

Total changes in operating assets and liabilities

b

Cash flow from operations

a-b

Investing activities

Sale of property, plant, and equipment

Capital expenditures

Cash flow from investing activities

c

Financing activities

Short term debt decrease

Long-term borrowing

Capital stock

Cash dividends to shareholders

Cash flow from financing activities

d

Variation in cash during year (Increase / Decrease)

(a-b)-c-d

Q. 2-a:

Investment Ratios measure investor response to owing and organization’s stock. Also, Investment Ratios measure the Cost of issuing Stock. Investment Ratios are concerned with the Return on Investment (ROI). Additionally, Investment Ratios are concerned with the relationship between the Return and the Value of the investment in the Organization.

The Accounting Ratios that focus on Investment Potential include:

- Price / Earnings Ratio (PER);

- Price – to – Book Ratio (PBR);

- Price / Earnings to Growth Ratio (PEG);

- Dividend Yield (DY).

Q.2-b:

Organization’s Investment Potential can be found out by calculating Investment Ratios.

- Price / Earnings Ratio, which can be calculated by using below formula:

P/E Ratio = Current Share Price / Earnings per Share.

This specific Ratio will compare company’s financial performances with peers, within same industry sector and at overall market. High P/E ratio usually indicated positive future performance and investors are willing to pay more for this company's shares, but if ratio is lower, on the other hand, is usually an indication of poor current and future performance. This could prove to be a poor investment. In general, a higher ratio means that investors anticipate higher performance and growth in the future. It also means that companies with losses have poor PE ratios. (My accounting course (2017) Price Earnings P/E Ratio. Available at: http://www.myaccountingcourse.com/financial-ratios/price-earnings-ratio (Accessed: 22 August 2017))

- Price-to-Book Ratio, which can be calculated by following formula:

Price-to-Book Ratio = Stock Price / Book Value of Equity.

This Ratio represents the value of an Organization if it is Broken up and Sold. It usually includes anything that can be sold such as:

- Equipment;

- Buildings and Lands;

- Stock Holding and Bonds.

By calculating this Ratio Investors may determine whether a company is overpriced or underpriced. Price-to-Book Ratio above 1 indicates that the investors are willing to pay more for the company than its net assets are worth. This could indicate that the company has healthy future profit projections and the investors are willing to pay a premium for that possibility.

If the market book ratio is less than 1, on the other hand, the company’s stock price is selling for less than their assets are worth. This company is undervalued for some reason. Investors could theoretically buy all the outstanding shares of the company, liquidate the assets, and earn a profit because the assets are worth more than the cumulative stock price. Although, this strategy probably wouldn’t work.

This valuation method is only one that investors use to see if an investment is overpriced. Additionally, we should remember that this method doesn’t take dividends into consideration. Investors are almost always willing to pay more for shares that will regularly and reliability issue a dividend. There are many other factors like this that this basic calculation doesn’t consider. The real purpose of it is to give investors a rough idea as to whether the sale price is close to what it should be. (My accounting course (2017) Price to Book Ratio. Available at: http://www.myaccountingcourse.com/financial-ratios/price-to-book-ratio (Accessed: 22 August 2017))