Cash Flows and Financial Analysis

Chapter 3

CASH FLOWS AND FINANCIAL ANALYSIS

FOCUS

The first half of the chapter is focused on cash flow in business. The emphasis is on understanding where cash comes from, what it's used for, and how to get that information out of financial statements.

The second half of the chapter deals with financial analysis. A series of ratios are presented along with discussions of the kinds of problems they're designed to illuminate. Practical issues like the interpretation of a long collection period are considered in detail.

PEDAGOGY

Cash Flows: Students often find cash flow confusing, so extra care is taken to develop the ideas carefully starting with examples from personal life. After mastering the basic concepts, we move into business applications.

Ratio Analysis: It's difficult to get students without business experience to appreciate ratio analysis. They calculate ratios readily enough, but have a hard time imagining what a particular comparison or trend implies about operations. For this reason we've spent extra time on the interpretation and implications of ratios.

The comprehensive problem at the end of the chapter (problem 15) is designed to drive the interpretation ideas home. We suggest that you lecture on the material and assign the problem to be gone over in class after students have wrestled with it themselves. The numbers are straightforward,

but you can get a lot of mileage out of having the students role play the analyst and propose possible reasons for the numerical results.

The solution in this manual will give you a lot to work with. The problem and solution are drawn from the author's experience in doing just this kind of analysis in business.

TEACHING OBJECTIVES

Students should gain a thorough understanding of cash flow principles and the mechanics of constructing cash flows from the balance sheet and income statement.

They should also develop an appreciation of financial analysis. Special emphasis should...