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MGT220H5 Study Guide - Midterm Guide: Debt Service Coverage Ratio, Cash Flow Statement, Cash Cash


Department
Management
Course Code
MGT220H5
Professor
Feng Chen
Study Guide
Midterm

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Zoya Zareen, Dec 09
MGT220 Final Exam Revision Notes
Ch 5 : Financial Position of Cash Flows
Statement of Cash Flows:
To access the firm’s ability to generate cash and cash equivalents
To access the firm’s cash requirements
It shows:
Where the cash came from
What is was used for
What was the change in the cash flow balance
Cash divided into 3 main categories:’
Operating activities – main revenue-producing activities
Cash Inflows:
When operating cash receipts > cash expenditures
Cash Outflows:
When operating cash expenditures > cash receipts
Investing activities – changes in long term assets and investments
Cash Inflows:
Sale of property, plant and equipment
Sale of debt or equity securities of other entities
Collection of loans to other entities
Cash Outflows:
Purchase of property, plant and equipment
Purchase of debt or equity securities of other entities
Loans to other entities
Financing activities – changes in equity and non-operating liabilities
Cash Inflows:
Issuance of equity securities
Issuance of debt (bonds and notes)
Cash Outflows:
Payment of dividends
Redemption of debt
Reacquisition of capital stock
The indirect method:
Reconciles net income to cash flows and affects only the operating activities section of
the cash flow statement
Steps for operating activities (indirect method):
Begin with net income from the income statement
Amortization is a non cash expense that reduces net income -> add
amortization
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Gains and losses from sale of capital assets are reported as part of net income
and the proceeds are reported in the investing activities section -> gains are subtracted
from net income and losses are added to net income
Increases in current assets (other than cash) are subtracted from net income
Decreases in current assets are added to net income
Increases in current liabilities (other than dividends payable) are added to net
income
Decreases in current liabilities are subtracted from net income
Add deferred income tax
Usefulness of the statement of cash flows:
Provides creditors with useful info such as:
Company’s ability to generate net cash from operating activities
Net cash flow trends or patterns from operating activities
Major reasons for positive or negative net cash from operating activities
Whether the cash flows are renewable or sustainable
Measures financial liquidity:
Current Cash Debt Coverage Ratio: Net Cash provided by Operating Activities
Average Current Liabilities
Ratio indicates whether the company can pay off its current liabilities from its
operations.
Ratio near 1:1 is good. However, the higher, the better.
Measures financial flexibility:
Cash Debt Coverage Ratio: Net Cash provided by Operating Activities
Average Total Liabilities
Ratio indicates the company’s ability to repay its liabilities from net cash
provided by operating activities, without having to liquidate the assets employed
in its operations.
The higher, the better.
Free Cash Flow:
Net cash from operations less capital expenditures and dividends
Indicates discretionary cash flow (cash left to invest or expand) to make
additional investments, to retire its debt or to add to its liquidity
Answers questions such as:
oIs the company able to pay its dividends without the
help of external financing?
oIf business operations decline, will the company be able
to maintain its needed capital investment?
oWhat is the free cash flow that can be used for
additional investments, retirement of dent, purchases of treasury stock or
additions to liquidity?
Additional Notes:
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Operating cycle: time it takes for a firm to purchase raw materials, manufacture merchandise,
sell it and receive cash. (8-9 months on average)
Cash trap: Today, firms like to hold more cash due to uncertainty following bad economic
times. Decision-making individuals are more risk-averse.
Principal payments on notes and bonds are a financing activity.
Interest payments on notes and bonds are an operating activity.
Ch 6: Revenue Recognition
Revenue is realized when goods and services are exchanged for cash or claims to cash
(receivables).
Revenue is recognized when:
Performance is achieved (risk and rewards transferred, measurability reasonably assured)
Collectibility is reasonably assured
Revenue is NOT recognized in the following cases:
Buyback agreements - not recognized unless the rights and risks have been passed
on to the buyer
Bill and hold transactions (sold inventory but not delivered yet)
Sale made on a trial and evaluation basis – not recognized unless evaluation
period lapses or customer accepts
Percentage-of-completion:
Used when performance requires many events
Continuous earnings process
Can be used if transaction is measurable
The amount of revenues, cost and gross profit recognized on long-term contracts
depends upon the percentage of work done
Can use input measures – costs incurred or labour hours worked
Can use output measures – storeys of a building completed etc
Cost-to-cost Basis- the percentage of completion method is measured by
comparing costs incurred to date with the most recent estimate of the total costs to
complete the contract.
Steps:
1. Percent complete = costs incurred to date
Most recent estimated total costs
2. Revenue to be recognized to date = percent complete x estimated total revenue
3. Current period revenue = revenue to be recognized to date – revenue recognized
in . . previous periods
4. Gross Profit = current period revenue – current costs
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