Cash Flow Analysis, Gross Profit Analysis, Basic Earnings Per Share and Diluted Earnings Per Share

8/12/2019 Cash Flow Analysis, Gross Profit Analysis, Basic Earnings Per Share and Diluted Earnings Per Share

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Cash Flow Analysis


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Learning Objectives

Describe the nature and purpose of the Statement of Cash flows.

Define Cash and Cash Equivalents

Distinguish among operating, investing, and financing activities.

Describe the content and the form of Statement of Cash flows.

Compute and explain the differences between the direct andindirect method of determining the net cash flows provided byoperating activities

Prepare the statement of cash flows using both the visual inspectionmethod and worksheet method.


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Information obtained fromCash Flow Statement

The changes in net assets of an enterprise and its ability to affect theamounts and timing of cash flows in order to adopt to changincircumstances and opportunities

The ability of the enterprise to generate cash and cash equivalents andenables the users to develop models to assess and compare the presentvalue of the future cash flows of different enterprise

It enhances the comparability of the reporting of the operatinperformance by different enterprise because it eliminates the effects ofusing different accounting treatments for the same transactions andevents.


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Cash and Cash Equivalents

Cash comprises cash on hand and demand deposits

Cash equivalents is short term and highly liquid investment that arereadily convertible into cash and acquired three months or lessbefore the date of maturity


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Classification of cash flow activities

OPERATING ACTIVITIES

Measuring the cash inflows and outflows caused by core businessoperations, the operations component of cash flow reflects howmuch cash is generated from a company's products or services.Generally, changes made in cash, accounts receivable, inventoryand accounts payable are reflected in cash from operations.


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Operations

Cash flows from operating activities are related to your principal lineof business and include the following:

Cash inflows

Cash receipts from sales or for the performance of services

Returns on interest earnings assets (interest)Returns on equity securities (dividends)

Receipts from contracts held for dealing and trading purposes

Tax refunds unless identified with financing and investing activities


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Operations

Cash Outflows

Payments to suppliers and contractors

Payment for operating expenses (salaries, rent, insurance, etc.)

Payment for purchases from suppliers other than inventory(supplies)

Payment for lenders (interest)Tax payments


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Investing

Changes in equipment, assets or investments relate to cash frominvesting. Usually cash changes from investing are a "cash out" itembecause cash is used to buy new equipment, buildings or short-termassets such as marketable securities. However, when a companydivests of an asset, the transaction is considered "cash in" fcalculating cash from investing.


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Investing

Cash inflowsProceeds from the sale of property, plant and equipment

Proceeds from the sale or redemption of investments

Collection of loans (principal) to others (other than advances and loansmade by a financial institution)

Cash outflowsPurchases of property, plant and equipment

Purchases of stock or other securities (other than cash equivalents)

Loans (principal) to others (other than advances and loans made by afinancial institution)


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Non-cash transactions

Provides that investing and financing transactions that do not requireuse of cash and cash equivalents shall be excluded from statement ofcash flows.

a. Acquisition of asset either by assuming directly related liability by means of finance lease

b. Acquisition of asset by means of issuing share capital or bondpayable

c. Conversion of debt to equity

d. Conversion of preference share to ordinary share


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Selected transactions of the Davis Company are listed below.

1. Common stock is sold for cash above par value.

2. Bonds payable are issued for cash at a discount.

3. Interest on a short-term note receivable is collected.4. Merchandise is sold to customers for cash.

5. Cash is paid to purchase inventory.

6. Equipment is purchased by signing a 3-year, 10% notepayable.

7. Cash dividends on common stock are declared and paid.

8. One hundred shares of XYZ common stock are purchased forcash.

9. Land is sold for cash at book value.

10. Bonds payable are converted into common stock.

Instructions


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CONTENT AND FORM OF T

STATEMENT OF CASH FLO


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A statement of cash flows for a period shall reportthe following:

A. Net cash provided or used by:Operating Activities

Investing Activities

Financing Activities

B. Net effect of those inflows and outflows on Cashand Cash Equivalents

NOTE: Noncash investing and financing transactions shall bedisclosed in the Notes to Financial Statements.


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REPORTING REQUIREM


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Reporting Requirement #1

Report cash flows from operating activitiesusing either:

Direct Method

Indirect Method


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Direct Method

In reporting the cash flows from operating activitiesenterprises are encouraged to report major classes of grossreceipts and gross cash payments and the net cash flowfrom operating activities.


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Under the direct method you would then report the following in the cashflows from operating activities section of the cash flow statement:

Cash Inflows from Operating Activities

Cash receipts from customersInterest and dividends collected

Other operating receipts

Cash Outflows for Operating ActivitiesCash payments to suppliers

Cash paid for operating expensesInterest paid

Other operating payments

Taxes paid

Equals net cash provided by (used in) operating activities


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Cash receipts from customers:

Net sales per the income statement

Plus decrease in accounts receivable

Minus increase in accounts receivable

Plus increase in deferred revenue

Minus decrease in deferred revenue

Equals cash receipts from customers


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Interest and Dividends CollectedInterest revenue and dividend income per income statement

Plus decrease in interest receivableMinus increase in interest receivable

Plus amortization of premium on investment in bonds

or

Minus amortization of discount on investment in bonds

Equals interest and dividends collected


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Other operating receiptsOther revenues per income statement

Plus increase in unearned revenuesMinus decrease in unearned revenues

Minus gains on disposal of assets and liabilities

Minus investment income (equity method)

Equals cash inflows from other operating receipts


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Cash payments to suppliers:

Cost of goods sold

Plus increase inventoryMinus decrease inventory

Plus decrease in accounts payable

Minus increase in accounts payable

Equals cash payments for inventory


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Cash paid for operating expenses:

Operating expenses per income statement

Minus depreciation expenses, depletion andamortization

Plus increase in prepaid expenses

Minus decrease in prepaid expenses

Plus decrease in accrued expensesMinus increase in accrued expenses

Equals cash paid for operating expenses


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Interest paid:Interest expense per the income statement

Plus decrease in interest payableMinus increase in interest payable

Plus amortization of premium on bonds payable

or

Minus amortization of discount on bonds payableEquals interest paid


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Other operating payments:

Other expenses per income statement

Minus losses on disposal of assets and liabilitiesMinus investment loss (equity method)

Equals other operating payments


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Tax Expense:Tax expense per the income statement

Plus decrease in taxes payableMinus increase in taxes payable

Plus decrease in deferred tax liability

or

Minus increase in deferred tax liabilityEquals taxes paid


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Indirect Method

In preparing the cash flows from operatingactivities section under the indirect method, youstart with net income per the income statement,reverse out entries to income and expenseaccounts that do not involve a cash movement,and show the change in net working capital.


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Net income after taxes

PLUS

A decrease in current assets would be shown as a positive figure, because other current assets wereconverted into cash.

An increase in current liabilities (excluding short-term debt which would be reported in the financingactivities section) would be shown as a positive figure since more liabilities mean that less cash wasspent.

Depreciation, depletion and amortization expense

Amortization of discount on bonds payable

Amortization of premium on investment in bondsIncreased in deferred income taxes

Loss (net) on disposal of assets or liabilities

Investment loss under the equity method

Interest expense

Income taxes


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MINUSAn increase in current assets (excluding cash and cash equivalents)

would be shown as a negative figure because cash was spent orconverted into other current assets, thereby reducing the cash balance.

A decrease in current liabilities would be shown as a negative figure,because cash was spent in order to reduce liabilities.

Amortization of premium on bond payable

Amortization of discount on investment in bonds

Decrease in deferred income taxes

Gain (net) on disposal of assets or liabilities

Investment income under the equity method


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Report separately major classes of receiptsand payments arising from investing andfinancing activities


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Cash flows arising from the following operating,investing or financing activities may be reported on a

net basis:Cash receipts and payments on behalf of customers when thecash flows reflect the activities of the customer rather than those

of the entityCash receipts and payments for items in which the turnover isquick, the amounts are large and the maturities are short


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Cash flows arising from each of the followingactivities of a financial institution may be reported on

a net basis:Cash receipts and payments for the acceptance and repaymentof deposits with a fixed maturity date

Placement of deposits with and withdrawal of deposits from otherfinancial institutions

Cash advances and loans made to customers and the repaymentof those advances and loans


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Cash flows arising from transactions in aforeign currency that should be recordedin an entitys functional currency


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Cash flows arising from taxes on incomeshall be separately disclosed and shall beclassified as cash flows from operatingactivities.


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PROCEDURES IN PEPARIN

STATEMENT OF CASH FL


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2 Common Procedures

VISUAL INSPECTION METHOD

WORKSHEET METHOD


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Steps in Visual Inspection Method

Step 1. Prepare the heading of the SCFStep 2. Determine the net chance in cash that occurredduring the period

Step 3. Determine the companys NI to be listfirst item in CF from operating activities section


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Step 4. Determine the changes and of each BS accountStep 5. If no cash flow occurred, determine whether the increase ordecrease in each balance is due to non cash IS item.

Step 6. Complete the various sections of SCF.


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WORKSHEET METHOD

Commonly used in practice because analysis of even the mostcomplex set of Financial Statements may be documented in arelatively concise working paper.


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Steps in Worksheet Method

Step 4. Make a final worksheet entry to record the netchange in cash.

Step 5. Prepare SCF and accompanying schedule.

f


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Example of Worksheet Method

l f k h h d


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Example of Worksheet Method


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METHOD USED TO ANALY

STATEMENT OF CASH FLO

STEPS USED TO ANALYZE


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STEPS USED TO ANALYZESTATEMENT OF CASH FLOW

Scan the big pictureCheck the power of the Cash Flow engine

Determine the Positive and Negative outcome

Integration

St 1 S th bi i t


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Step 1: Scan the big picture

Place your company in context in terms of its age, industry and size.Flip through the annual report and other accounting records todetermine how management believes the year progressed.

Look at Net Income. Does it show income or losses over the pasfew years?

Step 2: Check the power of the


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Step 2: Check the power of theCash Flow engine

Check if CF from operating activities is greater than zero. Checkwhether it is growing or shrinking.

Examine the operating working capital accounts. Inventoriesreceivables, and accounts payable usually grow in expandingcompanies.

Step 3: Determine the Positive and


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Step 3: Determine the Positive andNegative outcome

Check CF from Investing activities, whether the company generating cash in its investing activities.

Check the entire package to determine the good or bad outcomesof CF in Financing Activities.

Step 4: Integration


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Step 4: Integration

Putting the piece altogether.


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The advantages of cash flow


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The advantages of cash flowaccounting

Survival in business depends on the ability to cashCash flow is more comprehensive than profitdependent on accounting conventions and conceptCreditors are more interested in an entitysrepay them than in its profitability

The advantages of cash flow


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The advantages of cash flowaccounting :

Cash flow reporting provides a better means of comparing theresults of different companies than traditional profit reporting

Cash flow reporting satisfies the needs of all users better

Cash flow forecasts are easier to prepare, as well as more useful theprofit forecasts

Chapter 7


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Chapter 7

Gross Profit VariationAnalysis and

Earnings Per ShareDetermination

Objective of gross profit variation


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Objective of gross profit variationanalysis

Explain the objective of Gross Profit variation Analysis

State and Explain the factors affecting the change in gross profit

Describe and apply the techniques in G/P Variation Analysis

Analyze the change in Gross Profit of a company

Single product line

Multiple product line

state the procedures in the computation of basic and diluted earnings pershare

Compute the BPS and DPS in accordance with PAS 33 Earnings Per Share

What affects Gross Profit


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What affects Gross Profitdetermination?

VolumeSelling priCost

Sales mix

Volume Factor


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Change insales volumand its affeon sales, cosales and grprofit

Volume Factor

Selling Price Factor


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Se g ce acto

Change in uselling priceits effect onsales and gr

profit

Cost Factor


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Change in cost and effect on cosales and

profit

Techniques in analyzingG P fit V i ti


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Gross Profit Variation A firm that manufactures or buy

and sell only one product;

A firm that manufactures or buys

and sell two or more products withunequal gross margin

Sell only One Product


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y

Formula:Volume/Quantity factor:

Sales this year at last years price xx

Less: Sales Last year xx

Increase (Decrease) in Sales xx

Multiply by: G/P Margin Last Year x%

Increase(Decrease) in G/P xx



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y

Formula:Price factor:

Sales this Year xx

Less: Sales this Year at last years Price xx




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y

Cost factor:Formula:

Cost of Sales this Year xx

Less: cost of Sales this Year at last years Cost xx



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Sell Multiple Products


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Cost factor:

Formula:

Cost of Sales this Year xx

Less: Cost of Sales of different products

this Year at last years Cost xx




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Formula:

Volume/Quantity factor:

Sales this year(units) xx

Less: Sales Last year(units) xx

Increase (Decrease) in Total Quantity xx

Multiply by: Average G/P Margin

Last Year x%




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Sales mix factor

Formula

Average G/P per unit at last Years Price xx

Less: Average G/P per Unit last Year xx

Increase(Decrease) in ave. G/P per unit xx

Multiplies By: Total Quantity Sold This Year xx

Increase(Decrease) in Gross Profit xx

Sample Problem:


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2013 2012

Sales 15,000 10,000

Cost of sales 10,000 6,000

Gross profit 5,000 4,000

Additional information:

Units sold 500 400

Selling price 30 25Cost per unit 20 15

Gross profit rate 50% 40%

S l P bl


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2013 2012

Sales 15,000 10,000

Cost of sales 10,000 6,000

Gross profit 5,000 4,000

Questions:

Selling price increase by 25%

Quantity increase by 10%

Cost per unit increased by 10%

Sample Problem:


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Earnings Per ShareDetermination

Earnings Per Share Determination


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Basic Earnings Per Share

Diluted Earnings Per Share

Earnings Per Share


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PAS 33 prescribes the principles for the determination andpresentation of EPS for enterprises whose ordinary shpotential ordinary share are publicly traded and byenterprises that are in the process of issuing ordinary share orpotential ordinary shares in public securities market or anyenterprise which discloses earnings per share.

Earnings Per Share (Presentation)


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Face of the Incomestatement

Continuing Operation Discontinued Operation

Either on the Face of the incomeStatement or notes to FS

EPS (Presentation)


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Notes to FS

Consolidated FS

Face of the SeparateIncome Statement

Separate FS

Uses of Earnings Per Share


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Determinant of Market PriceMeasure of Performance



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The Basic Equation :

Net Income(Loss) attributable to OSWeighted-Average

Common Shares OutstandingThe Complications :

Issuance or reacquisition of common stock Stock dividends or stock splits

Guidelines to be observed in applyingth f l


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the formula

For the purpose of calculating basic earningsper share, the net income or loss for the periodattributable to ordinary shareholders should bethe net income or loss for the period after

deducting preferred dividends.

Guidelines to be observed in applyingthe formula


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the formula

The amount of preferred dividends that isdeducted from the net income for the period

Noncumulative preference share

Cumulative preference share

Basic Earnings Per Share(Illustration 1)


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Preference share capital, P100 par, 10% cumulativeP1,000,000

Ordinary Share capital, P100 par, 50000 sharesP5,000,000

Income From Continuing Operation P1,500,000

Income From Discontinued Operation P 500,000

Compute for BEPS.

Computation of BEPS


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Income From Continuing Operation P1,500,00Preference dividends for current year P 100,00Income to ordinary share P1,400,00

BEPS

Income From Continuing Operation P28Income from Discontinued Operation P10Net income P38


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Shares Outstanding January 1: 10,000New Shares Issued May 1: 5,000

Shares Repurchased November 1: 2,000

Weighted-Average Number of Shares

Jan. 1 to May 1 10,000 x 4/12 = 3,333

May 1 to Nov. 1 15,000 x 6/12 = 7,500

Nov. 1 to Dec. 31 13,000 x 2/12 = 2,167

Dec. 31 Weighted-average shares 13,000



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the formulaThe weighted average number of ordinaryshares outstanding during the period and for allperiods presented should be adjusted forevents, other that the conversion of potentialordinary shares, that have changed the numberof ordinary shares outstanding, without a

corresponding change in resources.

Illustration 4 comparative incomestatement


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statementNet income 2011 7,200,0

Net income 2012 6,000,0Ordinary shares Outstanding on Jan.1,2011 200,000

On Oct 1, 2012 entity implemented bonus issue in the ratioof two ordinary shares for each original ordinary share.

Compute for BEPS.

Computation


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Ordinary share Outs.-Jan.1,2011 200,000Bonus Issue on October1, 2012 400,000Total ordinary shares Outs. 600,000

BEPS2011(7,200,000/600,000) 122012(6,000,000/600,000) 10



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the formula

Stock dividend and Share Split

Stock Dividends and Stock Splitsh d


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Shares outstanding January 1.. 2,600

Shares issued for exercise

of options on February 1. 400Shares issued for 10% stock

dividend on May 1.. 300

Shares sold for cash on September 1.. 1,200

Shares repurchased on November 1 400Shares issued for 3-for-1 stock split

on December 15 8,200

Stock Dividends and Stock Splits


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1/1 to 2/1 2,6002/1 Option 4002/1 to 5/1 3,000

No. of Stock Stock Portion of WeightedDate Shares Dividend Split Year Average



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1/1 to 2/1 2,600 x 1.10 2/1 Option 4002/1 to 5/1 3,000 x 1.105/1 Dividend 3005/1 to 9/1 3,300



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1/1 to 2/1 2,600 x 1.102/1 Option 4002/1 to 5/1 3,000 x 1.105/1 Dividend 3005/1 to 9/1 3,3009/1 Sale 1,200

9/1 to 11/1 4,500



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9/1 to 11/1 4,50011/1 Purchase (400)11/1 to 12/1 4,100



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9/1 to 11/1 4,50011/1 Purchase (400)11/1 to 12/1 4,10012/1 Split 8,20012/1 to 12/31 12,300


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Stock Dividends andStock Splits

All stock splits and stock dividends must


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All stock splits and stock dividends mustbe incorporated into the computation of

weighted average shares outstanding.

This must done for all periodspresented in the financialstatements.

Current EPS figures may have tochanged in the future as a result ostock splits or dividends.



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Rights Issue

Fair value per share immediately priorto the exercise of rights

Theoretical ex-rights fair value per share

Illustration 5 Compute for BEPSNet Income


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2011 P1,375,000

2012 P1,762,000

Ordinary Outs. prior to rights issue 50,0

Rights issue during 2011-one new ordinary share for each 5outs. Or a total of 10,0

Date of exercise April 1, 2012MV of share Right-on P110

Exercise or subscription price P50

Theoretical Market value of share Ex-right


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MV of Ordinary shares outstanding(50,000xP110) 5,500,00

Proceeds from Exercise of rights(10,000xP50) 500,0

Total

Theoretical Market value of share Ex-right

(6,000,000/60,000)

Computation for Adjustment Factor


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Adjustment factor: 1.10Fair value per share immediatelyprior to the exercise of rights

______________________________________________Theoretical ex-rights fair value per share

110100


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Computation for Basic Loss per share


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Net loss (5,

Preference Share capital,100 par, 10% cumulative,20,000 shares convertible into 40,000 ordinaryshares P2,

Ordinary Share capital, 100 par, 100,000 shares

P10,0Compute for Basic loss per share.

Computation


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Net Loss (5,

Preference dividend(2Mx10%) (200000

Total Loss to OS (5,2

Ordinary share outstanding 100,0

Basic Loss Per Share

Diluted Earnings Per Share


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Net income attributable to OS as adjustedWeighted average number of OS and PD

Three Major Types of Potential OrdinaryShares


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Convertible Bond Payable

Convertible Preference ShareShare option and Warrant


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Simple and Complex Capital Structures


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Considers onlycommon shares issuedandoutstanding.

Basic

Simple and Complex Capital Structures


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Considers onlycommon shares issuedand

outstanding.

Basic

Reflects the maximumpotential dilution frompossible stock converthat would have

decreased EPS.

Diluted

Capital Structures

Simple Capital Structure- Complex Capital Structu


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p pThe corporation has only

common and nonconvertiblepreferred stock and has noconvertible securities, stockoptions, warrants, or other

rights outstanding.

p pcorporation has one or

instruments outstandincould result in issuancadditional common shFor example, a firm wpotential for per share

Diluted Earnings per Share- Options,Warrants, and Rights

Dilution occurs if inclusion of a potentially dilutive securityd h b i EPS i h b i l h


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reduces the basic EPS or increases the basic loss per share.

Proceeds from conversion are assumed to be used forpurchase of treasury stock at current market price.Treasury stock is assumed to be reissued to option or warrantholders.Any additional shares issued, over treasury stock, are addedto weighted - average shares outstanding. Exercise is assumed to occur on the first day of the yearunless issue date is later.



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1. Adjustments may include on an after-tax basis the ff:

a. Dividends on dilutive potential ordinary share.b. Interest recognized in the period for the dilutive

potential

c. Any other changes in income or expenses thatwould result from the conversion of dilutive potentiaOS.

Illustration


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An entity had the following securities outstanding on January 1,2011:10% convertible bonds payable, each P1000 bond convertibleinto 10 OS 4,Ordinary share capital, P100 par, 250,000 shares authorized,100,000 shares issued 1Net Income 5,Income Tax Rate

Compute for BEPS and DEPS.


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Diluted Earnings Per share


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Net Income 5,000,000

Interest expense 400,000Income tax (120,000) 280,000Adjusted net income 5,280,000OS actually outstanding100,000

Assumed Issued OS 40,000 140,000DEPS 3



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Dilutive potential ordinary shares should deemed

to have been converted into ordinary shares atthe beginning of the period, if later, the date ofissue of the potential ordinary shares.



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For the purpose of computing diluted earnings

per share, an enterprise should assume theexercise of dilutive options and other dilutivepotential common shares of the enterprise.

Options and Share warrants

Illustration


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Net Income 5,000

Ordinary share capital,100 par, 100,000 shares10,0

Employee share option:Option shares 30,0Fair value of each share option 20Option price 13Average market price 2

Computation


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BEPS(5M/100,000shares) 50

DEPS:Net income 5,000,000Option shares 30,000Total option price 150Proceeds from assumed exercise 4,500,000

Average market price 250Assumed treasury shares 18,000

Computation


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Ordinary Share 100,000

Incremental OS:Option shares 30,000

Assumed TS (18,000) 12,000

Total ordinary shares 112,000

DEPS(5M/112,000) 44.64


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Multiple Potential Ordinary Share(illustration)

An entity provide the following data for the current year.

Income from continuing operation 5,000,000


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Loss from discontinued operation (1,000,000)

Ordinary share Actually outstanding 500,000

Option shares 50,000

Option Price(including FV of stock option of P10) 60

Average market Price 75

Preference share capital, P100 par 5,000,000

Bond payable 5,000,000Income Tax rate 30%

The preference share capital is 5% cumulative and convertible into 25,000 ordinaryshares

The bond payable has nominal rate of 10% and convertible into 40,000 OS.

BEPS

f


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Preference dividends (250,000)Income to OS 4,750,000OS actually outstanding 500,000BEPS 9

BEPS for discontinued operation (2.00)

DEPS

INCOME ORDINARY SHARE

Basic EPS 4,750,000 500,000 9.50


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Options 0 10,000

Diluted EPS 4,750,000 510,000 9.31Convertible bond 350,000 40,000

Diluted EPS 5,100,000 550,000 9.27

Convertible PS 250,000 25,000

Diluted EPS 5,350,000 575,000 9.30


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THANK YOU!

Documents

Cash Flow Analysis, Gross Profit Analysis, Basic Earnings Per Share and Diluted Earnings Per Share