Module 11- Continued Appendix B – Computing/Analyzing Cash Flows

Balance Sheet: Operating – current A/L, Investing – LT Assets, Financing – LT

Working Capital Items (A/R, Inv.) - % of sales liabilities and SE
Nonoperating items – no change/guidance Noncash expenditures – added back(generally stable) – Dep.,
amort., stock based comp., deferred income taxes, L/G on
investments and derivatives
Operating Cash flow:
^indirect method – start w/ NI, add back noncash
CAPEX occurs evenly during year- revenues/expenses and gains/losses (part of investing not
operating)

Investing Cash flows:

-Analyze changes in all noncash asset accounts not used in
Intangible assets – forecasted to decrease by
expected amortization operating – PP&E, land, invest., equip.
Goodwill – forecast no change Financing Cash Flows:
Forecasted RE = Current RE + Forecasted NI – -Analyze changes in L and SE accounts not used in operating
Forecasted Dividends Interpreting SCF – 3 overarching principles:
1.Large and increasing net cash flows from operating
Forecasting treasury stock – notes/MD&A activities are preferred
Forecasting cash (plug)– compute amount of cash 2.Negative cash flows from investing not necessarily bad-
needed to balance the balance sheet
CAPEX may support growth, must exceed depreciation, M&A
Cash = (Total liabilities and equity) – all other asset
justified if leads to immediate CF
balances
3. Negative cash flows from financing not necessarily bad-
Forecasting segment data - prepare separate sales may be used to reduce fin. Lev., avoid excess liquidity. Red
forecasts for the business segments and then sum flag – when financing CF used to finance net loss
the forecasted segment sales
Predictability research – NI better predictor of future NI than
Statement of Cash Flows: operating CF
Use forecasted IS and BS Product lifecycle framework – introduction, growth, maturity,
1. Begins with net income and adds/deducts any decline
noncash expenses or revenues
2. Common method – compute changes in each
line item on forecasted BS and classify as
operating, investing, or financing

abridged Free cash flow = operating cash flow – CAPEX

 Comprehensive Income = NI + OCI
OCI = YoY change in AOCI

Derivative Disclosures-
1.Fair value hedges – hedging fair value of an asset/liability (eg.
Marketable securities)
-Derivative and A/L recorded at FV on BS
-If hedge eMective FV change in A/L is oMset
2.Cash flow hedges – hedge future cash flows
Module 9 – Intercorporate Investments -Only derivative represented at FV on BS
-Changes in FV of deriv. deferred till transaction
Passive investments - <20% of voting stock -unrealized G/L recognized in AOCI
-when purchased -recorded at fair value -When trans. Occurs def G/L shifted to NI
-when sold – recognized gain/loss on sale -Hedges purchased in advance- may not oMset
Equity Carve Outs: 80% of voting stock =80% of 1100

3 methods to determine fair value:

1-quoted market price if public
2-market price for similar securities or use models
3-market multiples/DCF – limited market activity support

Debt securities
àHTM – changes in fair value don’t aaect BS/IS – Market
value = face value
àAFS – recorded at FV, unrealized gains/losses
transferred to AOCI under SE, when sold transferred to
current period NI

Significant Influence -20 -50% of voting shares

Evidence of influence – seat on board, control over
Module 11 – Forecasting
technical knowhow/patents
-Equity method -Inv recorded at purchase cost Order – IS, BS, SCF, Transitory items eliminated
Forecasts must be internally consistent and precise(nth
decimal)

Income Statement:
Begins with estimate of sales growth rate : forecast = sales
* 1+0.0x (guidance - midpoint/average)
COGS – Use historical ratio of COGS/Sales
SG&A – Use historical ratio of SG&A / Sales and check
Equity Method Accounting-analysis implications MD&A
ROE una9ected, NOPM overstated(investee sales not in Interest expense = average debt balance x estimated
NOPM denominator), NOAT impact indeterminate, FLEV interest rate
("#$%.'# )$*+,$-.$/+$) +0 .1')3.#$%.'#.)$*+
understated (absence of investee L) Int. exp = ∗
4
"#$%.'#.56+ $-.$67$
Investments with Control , prev. yr = year b4 forecast
.17+ +80 '$1#7 )$*+ 1%$#19$
Variable interest entity - ability to influence investee’s Income tax expense – Apply estimated tax rate to pretax
decision making, financial results, absorb losses/gains, income, or in guidance exclude changes in transitory
receive residual returns items
- If VIE not met, Voting Interest Test Used – (>50% VS) – sign Interest income – no change
Other nonoperating expenses – use 5 yr avg.
of economic control
Noncontrolling interest – as % of net sales -unchanged
Subsidiary not wholly owned- NCIR (added to SE, sub from Acquisition – all revenues and expenses consolidated
NI) from date of acquisition
Inv. Above book value- Goodwill (from synergies) Divestitures – sales and expenses of discontinued items
Foreign subs. Consolidation- cumulative translation adj. excluded, report any gain/loss, forecast 0
included in AOCI (SE) – translation adj. account only
transferred to NI if foreign subsidiary sold