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3.3. SCF – a more advanced Example 2 (1)

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Core Concepts of Accounting – Numbers and People

Instituto de Física e Tecnologia de Moscou

4.9 (10 classificações) | 1K alunos inscritos

Curso 3 de 5 no Understanding Modern Finance Programa de cursos integrados

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Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

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The Statement of Cash Flows. Analysis and Use of Financial Statements. Financial Accounting and Project Valuation

In Week 3 of the Course we discuss the idea and format of the Statement of Cash Flows and use examples to delve deeper in its role and importance. Special attention is paid to the use of financial accounting inputs – cash flows, net income, and investments – in valuation. Then we briefly discuss the analysis and use of financial statements as a powerful tool in the overall assessment of performance, financial stability, and future development of a company or investment project. Finally, wrapping up the first part of the Course, we draw conclusions about the role of financial accounting in financial valuation in the world of uncertainty.

3.1. The statement of cash flows (SCF) – idea and format10:51

3.2. SCF – Example 114:05

3.3. SCF – a more advanced Example 2 (1)12:25

3.4. SCF – a more advanced Example 2 (2)8:24

3.5. Valuation revisited – cash flows, net income, and FCF7:04

3.6. Comparison of interest treatment in SCF and FCF9:49

3.7. The big question – why use earnings?10:25

3.8. Analysis and use of financial statements – an overview12:39

3.9. Ratio analysis (1) – current position and performance6:05

3.10. Ratio analysis (2) – capital structure5:56

3.11. Ratio analysis (3) – operating performance11:11

3.12. Financial accounting and valuation – conclusions8:55

Ministrado por

Konstantin Kontor
Director and Professor of Finance and Strategy

In the previous episode, we started with the preparation

of statement of cash flows for a very simple example.

Now in what follows we will go ahead and deal with a much more realistic example.

In which we will actually see two comparative balance sheets of a company

and then we will prepare the standard cash flows for this period.

Now, that does require some numbers,

but to save time, I prepared these numbers on the next page of the flip chart.

So this is how it goes.

We see here the two comparative balance sheets.

Because we need two, we put them in this format.

So here you see that this is the 31st of December,

2010 and this 31st of December, 2011.

And here the top part is the assets, and the bottom part is the liabilities and

net worth.

So there are quite a few numbers.

All of these numbers clearly are in our handouts, so this is just for

you to be able to follow through the discussion.

But, see what happens, we see these numbers and

some of the adjustments that we need for a statement of cash flow for

indirect method, we can take from these columns.

So, for example, changes in working capital, changes in account receivables,

inventories, we can easily take from this.

However, the information on this balance sheet is not sufficient.

And in what follows in the next two pages of the flip chart

what I'm going to do I will analyze this additional information and

combine that with what we see in these columns.

So how would that proceed?

I will give examples later, but for now,

the story is that sometimes when you look only at these numbers, if you just,

let's say subtract one from the other, you can easily make a mistake.

Because this additional information may sometimes add something

that we have to properly analyze.

So like I said, what follows will go further and

analyze these pieces of additional information.

So some more information.

What I will do, there will be note 1, note 2, and note 3.

And then, instead of just having these notes, and

then doing some exercises with them, or just extracting some numbers,

I will go ahead and, let's say, note 1, and then we'll come up with some number.

Let's proceed, so 1,

it says that securities were

sold for $39,000.

And so, we have to realize, what is the cost of these securities, their

long term investments and we see that the balance was 68 and then became 20.

So the cost, and that's from the previous page,

is 68 less 20 which $48,000.

Now you can see the cost was this and we sold sold them for just 39.

So the first important thing we find that

there was a loss on sale of securities and

this loss here is $9.000.

So that's our first finding because the losses they are all adjustments to

our operations.

Let's proceed.

The next thing is that we would like to find the depreciation expense for

this year.

Well, so we take property, plant and equipment.

And first of all, there's some additional pieces of information,

that PPE that cost $50K, and depreciated at 80%.

And they were sold, At $8,000,

that's a given.

Now how can we find here?

First of all this is depreciation.

So we can say that the initial balance of depreciation, so deprecation

for 2011, this is what we would like to find.

So the initial balance is 44 + x that is charged here and

now we start to subtract something.

See what happens.

This is the equipment that was sold.

The cost was -50 times 0.8 because this is how it was depreciated and

that is equals to the new balance of 28.

And from this 50 times 0.8 is 40 and

if we solve this equation we can see that depreciation,

is equal to, I'll use a blue marker to be consistent,

depreciation is $24,000.

So that's another finding.

Well, the third piece of information that's given

is that the dividend declared,

Over this year was $10,000,

and paid, 6,000.

Well this allows us to find net income.

How do we do that?

Look we have retained earnings that's a given and

that's 29 because it's 59 less 30 we take that from the balance sheets and

that is equal to net income that is unknown minus dividend declared.

So what do we know from the comparative balance sheet?

This is 29, this is unknown and this is 10.

So we can see that net income is equal to 39K.

That's an important finding, again like I'm saying, we do not have to go directly

to the income statement, we can easily extract that from the balance sheet.

You might say, well this is sort of a torturing exercise, but

sometimes it's important to see all these links.

Because if for example, I would change some number in this balance sheet and

left some of them blank you will be able to

reveal some of these blood numbers using the same logic.

That's not it, there are some more pieces of information.

Now, number 4 is that over this year, land was purchased

and that was purchased for stock issue, so no cash.

Now the question is how we can find the cost of this land?

Well, we have to take a look at the change in common stock,

and the final was 170 + 135.

So this is common stock and this is additional paid in capital.

Now the final balance is 164 here and 100 here.

So we take this sum, we take this sum and we subtract and

that gives us the cost of land of 41K.

That will go to the investment part of the statement of cash flows.

Now come the assets that are amortize, bonds and patent.

Number 5, so we know that bonds, that's a given, were issued

For $81.5K.

Now, if we looked at balance sheet, in the beginning there's zero.

So at the end, we have that bonds, they are 75.

So we can see that the difference, which is 6.5, this is sort of a bond premium.

But the balance of the bond premium, and

bond premium balance again on the balance sheet is just 5.

So we can say that the difference is the bond premium amortization.

So premium amortization is 1.5.

Another piece.

Now the 6th transaction is patent.

They say the patent was acquired

For 10k.

On the balance, we see in the beginning, we see nothing,

and at the end we see 7, so patent amortization,

Is $3,000.

We're almost done, but there's one more very important piece.

We look at the property, plant and equipment and

we would like to see what is the change in these balance that we see.

And we know that land as PPE was purchased for stock, but

there maybe some other purchases and they are for cash.

And in order to do so we have to engage in the following procedure.

So we can say no information on cash

purchases of PPE and that's too bad.

But what we know is we start with

a beginning balance of PPE and

that is $229K.

Then we have purchases and

this purchases are X that is unknown.

This is cash + 41, because this is for

stock, this is none cash.

So these are purchases, but they're also sales.

Of PPE.

What are they?

Remember we sold the piece of equipment at the cost of 50,

that was depreciated at the amount of A.

But here we care only about the cost because accumulated depreciation we

already calculated.

So, the cost here is 50.

And finally, we see that there is

the ending balance, which is 380.

So we put together an equation 229

+ purchases x + 41, less sales and

that should be equal to 380.

And that all, if we solve this equation, gives us that X = $160,000.

These are cash purchases of PPE that will go

into the corresponding part of the statement cash flows.

So we are wrapping up this episode by having prepared

all the information that we will use in the next piece

to come up with the statement of cash flows using the indirect method.

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