Case 1: Cash flow analysis (Signal Cable Company)
1. Why has the stock price fallen despite the fact that the net income has increase?
The stock price for Signal Cable Company has fallen from $7 to $5.50 per share although the income statement stated that the net income has been increased from $12!700." in year 200" to $1"!100 in year 200. #asically! the increase and decrease in stock price is not directly affected by the net income of a company but affected by the supply and demand of the inestors. %s &e can obsere! Signal Cable Company had established t&o additional manufacturing facilities! and that significantly increased its inentory but at the same time! these t&o additional inestments hae increased the debts and liabilities of the company in year 200. 'rom the inestors point of ie&! they belief that high amount of debts and liabilities &ill result in the risk of getting lo&er future net income and thus! their demand for the stock is decreasing and this affect the stock price to decline. 2. How liquid would you say that this company is? Calculate the absolute liquidity of the firm. How does it compare with the previous year’s liquidity position?
(i)uidity is refer to a measure of the e*tent to &hich a person or organi+ation has cash to meet immediate and short,term obligations! or assets that can be )uickly conerted to do this. -hile absolute li)uidity is represented by the cash and near cash items such as cash! bank and marketable securities.
Cash ratio
2! 5000 / 5!000
2" 0!000 / "55!000
cash / current liabilities Current ratio
0.005 1!5!50 / 5!000
0.11" 0!000 / "55!000
curr curren entt asse assetts / curr curren entt 2.0
2.51
liabilities 3uick ratio
41! 41!5! 5!5 50 0 1!"00 1!"00!5 !506 06 /
4current assets inentory6 /
5!000
"55!000
current liabilities
0.1
0.
40!000
50!0006
et &orking capital to total 50!50 / 2!1"!50
5"5!000 / 1.27!000
asset
0."
0.""
/
-C / total asset 8nteral ratio
941!5"7!500 : 0!0006/"5; / 941!""!115 : "2!56/"5; /
94cost of goods sold : 1!5!50
0!000
e*penses6/"5; / total current 2.7"
2".072555
assets %bsolute li)uidity
5"5!000
50!50
-C
'rom the table aboe! &e notices that the absolute li)uidity 4et &orking capital6 has increased in 200 but the relatie li)uidity has decline. #esides! the current ratio also in declining stage but the li)uidity condition of this company still not yet considered as critical because from the interal measures! it estimates that the company still can continue its operation for at least for another 27 days if its cash inflo&s began to dry up. This interal coerage has increased significantly from its leel in 200". Therefore! &e can conclude that although the relatie li)uidity of this company has decline since 200"! but it is not consider as critically lo&. ". How does the market value of the stock compare with its book value? #s the book value accurately reflectin$ the true condition of the company?
Signal=s market alue current stock price > 200!000 shares Signal=s book alue in 200" 94total assets,total liabilities6 shareholders= e)uity;
$1!27!000 4$"55!000 : $200!0006 $2!000 Signal=s book alue per share in 200" $2!000 / 200!000 shares $". Signal=s book alue in 200 94total assets,total liabilities6 shareholders= e)uity; $2!1"!50 4$5!000 : $1!22!206 $72!170 Signal=s book alue per share in 200 $72!170 / 200!000 shares $". 'rom the e)uation aboe! &e can obsere that the stock price is higher than its book alue as Signal Cable Company had en?oyed a run up in profits oer the past fe& years. @o&eer! during the account statement preparation! the result sho&s that there is a drop in price for the current year and this indicate there &ill be an increase in risk due to high debt leel and lo& leel of li)uidity. Therefore! although its sho&s that the book alue per share &hich increases for $0.50 from year 200" 4$".6 to year 200 4$".6! but it is still the market alue that reflects the true condition of the Signal Cable Company.
!. %he board of directors is not clear as to why the cash balance has dropped so much in spite of the increase in sales and the $ross profit mar$in. What should &ay tell the board?
8n order to kno& &hy the cash balance has dropped so much although the sales and gross profit margin are increasing! Aay should do a Statement of Cash 'lo&s for the year 200.
'i$nal Cable Company 2! 'tatement of Cash (lows
Cash at the beginning of year 200
$0!000
)peratin$ activity
et income
1"!000
*lus+
Bepreciation
7!000
8ncrease in accounts payable
0!000
,ess+
8ncrease in accounts receiable
4"0!0006
8ncrease in inentory
450!506
et cash from operating actiity
47!"506
#nvestment activity
'i*ed asset ac)uisition et cash from inestment actiity
470!0006 470!0006
(inancin$ activity
8ncrease in notes payable 8ncrease in long,term debt Biidends paid 8ncrease in common stock et cash from financing actiity et decrease in cash
Cash! end of year
50!000 1!02!20 42!"06 , 1!""!"50 4"5!0006
$5!000
'rom the aboe statement of cash flo&s for the year 200! &e can obsere that Signal Cable Company has heaily inested in inentories! fi*ed assets and accounts payable. @o&eer! these inestments are only partially funded by the increase in payables and retained earnings aailable. Therefore! Signal Cable Company has to borro& from short,term debt and dre& do&n on its cash reseres to fund the balance. 'rom here! &e can conclude that the ac)uisition of assets and
e*pansion of business actiities is the main reason that led to the reduction in cash balance although the sales hae increase.
-. easure the free cash flow of the firm. What does it indicate?
'ree cash flo& refers to the cash that a company is able to generate after laying out the money re)uired to maintain or e*pand its asset base.
'ree cash flo& perating cash flo& net capital spending change in net &orking capital
perating cash flo& earnings before interest and ta*es 4D#8T6 : depreciation ta*es $""!500 : $7!000 , $5!00 $"77!100 et capital spending ending net fi*ed assets beginning net fi*ed assets : depreciation $1!0!000 , $"57!000 : $7!000 $70!000 Change in net &orking capital change in current asset change in current liabilities 4$1!5!50 , $0!0006 4$5!000 , $"55!0006 $15!50 Thus! 'ree cash flo& $"77!100 , $70!000 , $15!50 4$2!"506
'rom the calculation sho&n aboe! Signal Cable Company had a negatie free cash flo& in 200 &hich due to the increase in net capital spending and net &orking capital and this indicates that there is an increase in net ne& borro&ing and e)uity.
et increase in long,term debt $1!22!20 , $200!000 $1!02!20
Biidends and interest paid $2!"0 : $155!000 $17!"0 et amount of additional capital raised $1!02!20 , $17!"0 $2!"50
'orm the checking calculation aboe! its sho&s that Signal Cable Company has raised additional long,term debt to fund the increase in net fi*ed assets and net &orking capital.
/. Calculate the net workin$ capital of the company for each of the two years. What can you conclude about the firm’s net workin$ capital?
et &orking capital 4-C6 current assets current liabilities -C 200" $0!000 , $"55!000 $5"5!000 -C 200 $1!5!50 , $5!000 $50!50
The Signal Cable Company net &orking capital 4-C6 has increases for $15!50 or 7E from year 200" to year 200. This positie increases sho&s that the creditors and inestors of Signal Cable Company are able to generate enough from the operations to pay for the current obligations &ith current assets.
0. 'hould the shareholders be concerned about the drop in cash flow or should they be happy that the earnin$s per share have increased? plain your answer.
The shareholders of Signal Cable Company should be concerned about the drop in cash flo&. 8t is because &hen the cash flo& started to drop! it means that something is going &rong &ith the company. Thus! the company should be a&are of it and plan some moes to reduce the li)uidity risk.