Cfin4 - Chapter 2

CFIN4 - CHAPTER 2

INTEGRATIVE PROBLEM SOLUTION

a. Begin by reviewing briefly what balance sheets and income statements are. Then give an overview of the statement of cash flows. Explain that some data (net income, depreciation, and dividends) come from the income statement, while the other items reflect differences between balance sheet accounts and thus show changes in those accounts between the two dates.

The cash flow statement highlights some important aspects of Computron’s financial condition. First, note that the firm’s net operating cash flow is -$73,780, so its operations are draining cash despite the positive net income reported on the income statement. Second, because of its negative cash flow from operations, Computron had to borrow a total of $126,180 in long- and short-term debt to cover its operating cash outlays, to pay for fixed asset additions, and to pay dividends. Even after all this borrowing, Computron’s cash account still fell by $5,600 during 2010.

b. Financial ratios are used to get an idea about how well the company is being operated, and where it needs improving. The ratio categories, and their purposes, are as follows:

1. Liquidity: Can the company make required payments in the short run (defined as the next year)?

2. Asset management: Are the investments in assets about right in view of sales levels?

3. Debt management (financing mix): Does the company have about the right amount of debt, or is it over leveraged?

4. Profitability: Are costs under good control as reflected in the profit margin, ROE, and ROE?

5. Market values: Do investors like what they see as reflected in the P/E and M/B ratios?

c. Computron has $540,200 in obligations that must be satisfied within the coming year. Will it have trouble meeting its required payments? A full liquidity analysis requires a cash budget, but these two ratios provide quick, easy-to-use measures of liquidity:

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