Tutorial 3 (Topic 2)Financial Statements Analysis and Cash Flows

Question 1J.B. Chavez Corporation, Balance Sheet at 31/12/2008 and 31/12/2009

Assets 31/12/2008 31/12/2009Liabilities andowners' equity 31/12/2008 31/12/2009

Cash $225 $175 Accounts payable $250 $115

Accounts receivable 450.00 430Notes payable - current (9%) 0 115

Inventory 575.00 625 Current liabilities $250 $230 Current assets $1,250 $1,230 Bonds $600 $600Plant and equipment $2,200 $2,500 Owners' equityLess: Accumulated depreciation (1000) (1200) Common stock $300 $300Net plant and equipment $1,200 $1,300 Paid-in-capital 600 600 Total assets $2,450 $2,530 Retained earnings 700 800

Total owners' equity $1,600 $1,700Total liabilities andowners' equity $2,450 $2,530

J.B. Chavez Corporation, Income Statement for the Years Ending 31/12/2008 and 31/12/20092008 2009

Sales $1,250 $1,450Cost of goods sold 700 875Gross profit $550 $575Operating expenses 30 45Depreciation 220 250 200 245Net operating income $300 $330Interest expense 50 60Net income before taxes $250 $270Taxes (40%) 100 108Net income $150 $162

Industry NormCurrent ratio 5.00Acid-test (quick ) ratio 3.00Inventory turnover 2.20Average collection period 90.00Debt ratio 0.33Times interest earned 7.00Total asset turnover 0.75Fixed asset turnover 1.00Operating profit margin 20%

Operating income return on investment 15%Return on common equity 13.43%

Using J. B. Chavez Corporation’s financial statements:

(a) Compute the following ratios for both 2008 and 2009.

1. (a) 2008 2009 Industrynorm

Current ratio = current assetscurrent liabilities

1250250

=5.0 1230230

=5.348 5.00

Acid test (quick ratio)= current assets−inventory

current liabilities

1250−575250

=2.7 1230−625230

=2.63 3.00

Inventory turnover = C .O.G .S .inventory

700575

=1.217׿ 875625

=1.4׿ 2.20

Average Collection Period= Accounts Receivable

Credit sales×365

4501250

×365=131.4days 4301450

×365=108.24days 90.00

Debt ratio = totaldebttotalassets

8502450

=0.347(34.7 %) 8302530

=0.328(32.8 %) 0.33

Times interest earned ratio = operating incomeinterest expense

30050

=6׿ 33060

=5.5׿ 7.00

Total asset turnover = sales

totalassets

12502450

=0.51׿ 14502530

=0.573׿ 0.75

Fixed assets turnover = sales

¿assets

12501200

=1.042׿ 14501300

=1.115׿ 1.00

Operating profit margin = operating profit

sales×100%

3001250

×100 %=24 % 3301450

×100 %=22.76 % 20%

Operating income return on investment=

operating incometotal assets

×100 %

3002450

×100 %=12.24 % 3302530

×100 %=12.97 % 15%

Return on common equity =net income

commonequity×100 %

1501600

×100%=9.38% 1621700

×100 %=9.53 % 13.43%

(b) How liquid is the firm?

Liquidity ratios which are the current ratio and quick ratio indicate how liquid the firm is. J.B. Chavez Corporation’s current ratio has increased across years from 2008 to 2009 and both years’ current ratio are higher than the industry norm. It shows that the corporation has enough current assets to convert into cash to meet short term obligations. However, the quick ratio has decreased across years from 2008 -2009, and the ratio is lower than the industry norm. This means that the corporation has kept a lot of inventories which are the least liquid current assets and the amount of inventories is getting higher across year.

The inventory turnover is much lower than industry which indicates the company do not have efficient sale as compared to the industry norm and causing the company has to keep more (heavily invest) inventory in hand.

However, since the current ratio is satisfactory, the corporation is considered liquid, but it has greater investment in inventories and receivables.

(c) Is management generating adequate operating profit on the firm’s assets?

Operating income return on investment = Operating profit margin×Total asset turnoverOperatingincome return on investment

Operating profitmargin

Total asset turnover

2008 12.24% 24% 0.512009 12.97% 22.76% 0.57Norm 15% 20% 0.75

The fixed assets turnover has increased across years and higher than the industry norm. It shows that the corporation is reasonably well in utilizing all its fixed assets in making sales. However, total assets turnover is much lower than the industry norm, although it has a slight increase across years. This indicates that the corporation does not utilize fully on its current assets to increase sales volume (it has greater investment in inventories and receivables). Hence, the Operating income return on investment is lower than the industry norm. The corporation does not generate adequate profit on its assets especially on current assets.

We can reasonably conclude that management is not doing an adequate job for generating operating profits on the firm’s assets. However, they did improve between 2008 and 2009. The problem lies not with the operating profit margin, which address the operating costs and expenses relative to sales. Instead, the problem arises from the management not using the firm’s assets efficiently, as indicated by the low asset turnover ratios (problem lies with managing accounts receivables and inventories).

(d) How is the firm financing its assets?

Debt Ratio=Total Time interest earned =

liability/Total asset Operating income/Interest expenses

2008 0.35 62009 0.33(32.81%) 5.5Norm 0.33 7

Mixed results. The firm’s assets are mostly financed by the owner’s equity and financial leverage in the form of bonds.

(I) Balance sheet perspective: Debt ratio decreasing, finance about 1/3 of their assets using debts, little less than 2/3 financed with common equity. Lower financial risks.

(II) Income Statement perspective: TIE below the industry norm, reasons?? (1) the level of EBIT (earnings before interest and taxes) is caused by a lower OIROI; (2) the amount of debt used is same amount with industry; (3) the interest rates no information

Debt ratio decrease from 2008 to 2009 implies that the proportion of total assets financed by firm’s creditors is decreased. When financing with debts decrease, the financial risk decrease. However, time interest earned is lower than industry average. The ratio operating income to cover interest expenses is far below industry average.

However, the company should increase the debt financing (cheapest source as compared to equity financing) until a point where it can cover its interest payment.

(e) Are the common stockholders receiving a good return on their investment?

No in short term. Return on common equity tells how efficiently the capital are being reinvested. The return on common equity has increased from 9% to 10% from year 2008 to 2009, however it is still lower than the industry norm of 13.43%. This shows that the common stockholders are not receiving a good return on their investment as compared to the industry norm. Also if the company could increase the debt financing, the ROE could be higher that makes good return to stockholders.

Yes, this company is good to invest over the long term because the firm is reasonably good in managing fixed assets and debt financing, there are growth opportunities for the firm to increase their revenues. This company has enhanced the return to its owners and with a small decline of financial risk (lower debt ratio).

Question 2The annual sales for Salco Inc., were $4.5 million last year. The firm’s end-of-year balance sheet appeared as follows:

Current Assets $ 500,000 Liabilities $1,000,000

Net Fixed Assets $1,500,000 Owners’ Equity $1,000,000

$2,000,000 $2,000,000

The firm’s income statement for the year was as follows:

Sales $4,500,000

Less: Cost of goods sold ($3,500,000)

Gross profit $1,000,000

Less: Operating expenses ($ 500,000)

Operating income $ 500,000

Less: Interest expense ($ 100,000)

Earnings before taxes $ 400,000

Less: Taxes (50%) ($ 200,000)

Net Income $ 200,000

(a) Calculate Salco’s total asset turnover, operating profit margin and operating income return on investment.

Total asset turnover = Sales/Total Assets

= 4,500,000/2,000,000

= 2.25 times

Operating profit margin = Operating Income(EBIT)/Sales

= 500,000/4,500,000

=0.1111

= 11.11%

Operating income return on investment = EBIT (or Operating Income)/Total Asset

= 500,000/2,000,000

= 0.25

= 25%

(b) Salco plans to renovate one of its plants, which will require an added investment in plant and equipment of $1 million. The firm will maintain its present debt ratio of 0.5 when financing the new investment and expects sales to remain constant, while the operating profit margin will rise to 13 percent. What will be the new operating income return on investment for Salco after the plant renovation?

Total liability/Total asset = 0.5

So, total asset increase $1 million.

Total asset = 3,000,000

New EBIT = 4,500,000 × 0.13

= 585,000

New operating income return on investment = New operating income/Total asset

= 585,000/3,000,000

= 0.195= 19.5%

(c) Given that the plant renovation in part (b) occurs and Salco’s interest expense rises by $50,000 per year, what will be the return earned on the common stockholders’ investment? Compare this rate of return with that earned before the renovation.

Net Income Available to Common is calculated as follows:

Operating Income (0.13 × 4.5m) $ 585,000 Less: Interest ($100,000 + $50,000) (150,000 ) Earnings before Taxes 435,000 Less: Taxes (50%) (217,500 ) Net Income Available to Common $ 217,500

New Common Equity is calculated as follows:

Debt ratio = total liabilitiestotalassets

0.5 = total liabilities

3,000,000Total liabilities = $1,500,000

Equity = Assets – Liability = $3,000,000 – $1,500,000 = $1,500,000

Before renovation:

Return earned on common stockholders’ investment =

$200 ,000$1 ,000 ,000 = 20%

After:Return on equity(ROE)= Net income/Common equity= 217,500/(1,000,000+500,000)=14.5%

The rate of return decreases. In short-term, ROE decreases since COGS and operating expenses (interest) cannot be reduced by new investment. Renovation should not be undertaken.

However, it is not appropriate to base decisions about their acquisition on single year’s ratios. Because investments infixed assets generally produce cash flows over many years, in long term.

Question 9

(a) Current ratio shows the ability of the company to meet its short-term obligations when due. The higher the current ratio, the better it is. Discuss.

Current ratio =

Higher current ratio indicates there is sufficient current assets to pay off currentliabilities.However, if the current ratio are too high, there are undesirable consequences:1) idle cash are tied up unproductively, without investing in potential profitable projects,

which could affect future growth of the firm2) unnecessarily large inventories, resulting in high storage and other carrying costs, and

potential loss in market value of inventories that become obsolete3) a valuable discipline on credit control will be lost, resulting in unwise amount and

length of credit being advanced to customers (potential for bad debts increase)[Lecture note page 42]

(b) Differentiate between ‘overtrading’ and ‘over-capitalization’. Which financial ratios could signal these conditions?

Overtrading - a situation where a firm experiences liquidity problem due to its trading beyond capital resources available to it.- company has limited capital but do a lot of business- low liquidity ratio- high turnover ratio

Over-capitalization - a situation where a firm has excess capital, under-utilized probably due to lack of attractive investment opportunities

- company has a lot of capital but do not have enough sale - high liquidity ratio - low turnover ratio

Question 10Explain five (5) limitations of financial ratio analysis. Give example to illustrate whenever appropriate.

1.Accounting policies/treatments differ among firmsDifferent companies may have different policies for recording the same accounting transaction.For example, depreciation method and stock valuation method.This may affect ratios that use balance sheet items like ‘reserves’ and ‘total assets’ in the formula.

- This may distort cross-sectional ratio analysis between two similar firms.

current assetscurrent liabilities

Examples: depreciation method (straight line, reducing balance, unit of production), stock valuation method (FIFO, LIFO, AVCO), treatment of purchased goodwill, treatment of development cost etc.

- Some firms may have chosen to revalue some of the fixed assets while other firms have not to do so. This affects the ratios that use balance sheet items such as “total assets” in the formula.

2.InflationMost countries financial reporting standards mandated the use of historical cost accounting(original cost). If you try to compare balance sheet information from two different time periods and inflation has played a role, then there may be distortionin your ratios.For example, due to HCA (Historical Cost Accounting), older asset values are more ‘understated’ compared to its current replacement cost and therefore ‘overstate’ ratios such as total asset turnover and OIROI.Ratios comparison may be distorted by inflation.

- Book values of inventories and depreciable assets may differ greatly from their true replacements values. Inflation tends cause older firm with older assets to appear more efficient and profitable than younger firms with newer assets. This is because older assets are more ‘understate’ compared to its current replacement cost and thus ‘overstate’ ratio such as total assets turnover and OIROI.

- Inflation also distorts time-series ration analysis of a firm’s ratios over time.

3.Many firms experienced seasonality in their operations.Balance sheet items and their corresponding ratios vary with time of the year when the statements are prepared. Balance Sheet shows the company’s financial position at one point of time (last day of accounting period), whereas P&L shows the company’s financial performance throughout the accounting period. Using closing figures of balance sheet items in the ratios computation may not be accurate. For example, toy manufacturer that has financial year ended 31st December might have much lower inventory than toy manufacturer that has financial year ended 30th June.

- Cross Sectional analysis between competitors in the same industry that have different financial year-ends might not be accurate if the industry has seasonality sales.

4.Non-financial information must be consideredIn order to have a complete and more accurate picture of the performance and prospects of a company. Examples: general industry and economic data–Is the country’s economy in recession or booming? Which stage of life cycle is the product/ industry in?

5.No two companies are exactly alike when they are operating in different industries.It is not suitable to compare ratio of different industry. For example, companies that carry a lot of inventory, which they can in theory sell quickly for cash, (retailers, for example) similarly require a different approach when interpreting things like the current ratio than when you are looking at a construction company.

Others:1.) Difficult to identify the industry category - Especially if the firm engages in multiple lines of businesses and it is difficult to find

a competitors to compare.

2.) Comparing to industry average means benchmarking to the average firm and not the ‘stars’ and leaders of the industry.

3.) Window dressing and off-balance sheet financing can be done near the year-end to manipulate the closing balance sheet figures and hence distort results of corresponding ratios.

4.) Development of company is not determined by ratios or financial information only. Other non-financial information must be considered.

Question 11(a) Describe the use of DuPont analysis.The DuPont system of analysis is used to dissect the firm’s financial statement and to assess its financial condition. It merges the income statement and balance sheet into two summary measures of profitability.

- The Modified DuPont Formula relates the firm’s ROA to its ROE using the financial leverage multiplier (FLM), which is the ratio of total assets to common stock equity

- Use of the FLM to convert ROA into ROE reflects the impact of financial leverage on the ordinary shareholder’s return.

(b) Is it possible for a company to have an increase in operating income return on investment when its operating profit margin is reducing? Explain.

Yes, it is possible. Operating income return on investment is actually operating profit margin times total assets turnover. A reduction in operating profit margin could still lead to higher OIROI. A firm may want to reduce selling price in order to achieve higher sales volume, especially if that business line is nature very price competitive (company can deliver merchandise or services to customers at much cheaper prices than competitors and still make money). When sales volume increase, given no new investment in fixed assets, total asset turnover ratio will increase. If the effects of sales volume increase is larger than selling price decrease (elastic demand), OIROI could increase.

Question 3The new owners of Bluegrass Natural Foods, Inc., have hired you to help them diagnose and cure problems that the company has had in maintaining adequate liquidity. As a first step, you perform a liquidity analysis. You then do an analysis of the company’s short-term activity ratios. Your calculations and appropriate industry norms are listed.

Ratio BluegrassIndustry

normCurrent ratio 4.5 4.0Quick ratio 2.0 3.1Inventory turnover 6.0 10.4Average collection period 73 days 52 daysAverage payment period 31 days 40 days

(a) What recommendations relative to the amount and the handling of inventory could you make to the new owner?

The inventory turnover is too low for Bluegrass. Besides that, the quick ratio islower than the industry norm. These support the fact that the firm is holding too much inventory, excess inventory.

Recommendation: 1.Provide training to sales staff, improve production line. - Excess of Inventories may occur when the production lines are procrastinated. Furthermore, it can also happen when the workers are not well trained. 2. Introduce stock card system - If the warehouse is in a mess, the warehouse keeper may not notice how much inventories left. 3. Reduce the price and improve the quality of goods. -It may happen when the price of finished goods is too high as well as the quality of the goods is bad.

Higher inventory turnover ratio means the inventories are demanded and sold fast in the time period. The inventory turnover ratio of Bluegrass (6.0) is lower than industry norm (10.4), which means that the inventories of Bluegrass are in low demand and lacking efficiency on selling inventories. Therefore, the inventory turnover ratio should be improved through motivational sales such as promoting sales through advertising.

(b) What recommendations relative to amount and handling of accounts receivable could you make to the new owners?

The average collection period is taking longer than industry norm (too lenient in credit policy/collection from debtors).This indicates that the firm has spent too much time in collecting its debt from its debtors. This may affect the liquidity of the firm.

Recommendation: 1.Tighten credit term and give cash discount. - If a cash discount and tight credit term are given to the customer, they would

pay their debts earlier.The firm can provide discount to those who paid within a period of time, tighten the credit term or prepare aging schedule.

(c) What recommendations relative to amount and handling of accounts payable could you make to the new owners?

The average payment period is shorter than industry norm, might badly hurt the short term cash flows.

Recommendation: Make a proper cash budget of the firm and determine whether the firm is able to make the payment earlier.

The firm is having a good reputation due to the lower average payment period compared to the industry norm. However, the firm can pay its debt later as long as does not exceed the industry norm. This is to prevent cash outflow too frequently. The firm can have internet

audit.

(d) What results, overall, would you hope your recommendations would achieve? Why might your recommendations not be effective?

The recommendations above can help to decrease the holding inventory, urge thecustomer to pay earlier as well as make sure that the firm will not have financialshortage. However, if we tighten the credit term, customers may not be able to pay their debts andwe may lose many customers. Moreover, training, improvement of production line andintroduction of stock card system may increase the costs of finished goods.

Overall, the firm holds too much inventory, too much account receivable and pay too early to the creditor. Thus, liquidity position is not as good as the industry norm.

Question 4Robert Arias recently inherited a stock portfolio from his uncle. Wishing to learn more about the companies that he is now invested in, Robert performs a ratio analysis on each one and decides to compare them to each other. Some of his ratios are listed below.

island Burger Fink Rolandratio electric utility Heaven Software MotorsCurrent ratio 1.1 1.3 6.8 4.5Quick ratio 0.9 0.82 5.2 3.7Debt ratio 0.68 0.46 0 0.35Net profit margin 6.20% 14.30% 28.50% 8.40%

a) What problems might Robert encounter in comparing these companies to one another on the basis of their ratios?The four companies Robert are comparing are in different industries. The high difference in ratio values between these companies are due to different operating characteristics hard to compare.

b) Why might the current and quick ratios for the electric utility and the fast-food stock be so much lower than the same ratios for the other companies?The reason could be that these two companies are highly cash based operated companies which would make their account receivable balance is much lower than the other two companies and result in lower current and quick ratio(running the daily operation based on cash basis).

c) Why might it be all right for the electric utility to carry a large amount of debt, but not the software company?Utilities often have good cash flow (predictable and steady cash flow) and lots of collateral due to the fact that they are usually monopolies or oligopolies and have pricing power. Therefore, utility companies are able to get loans at a lower interest rate and pay off easily with their cash flow. In contrast to software companies have a more uncertain and volatile state of cash flow due to the great amount of competition among other software companies.

d) Why wouldn’t investors invest all of their money in software companies instead of in less profitable companies? Even though software companies have substantial high profits and investment return performance, there is also the great amount of risk associated with the profits. Also, the benefits of reduction of risk associated by diversification are lost when investors only invest in one segment of the industry (don’t put all the eggs in one basket). It would be better to diversify the risk so that losses can be offset by the gain of other different companies.

Question 5Grenoble Enterprises had sales of $50,000 in March and $60,000 in April. Forecast sales for May, June, and July are $70,000, $80,000, and $100,000, respectively. The firm has a cash balance of $5,000 on May 1 and wishes to maintain a minimum cash balance of $5,000. Given the following data, prepare and interpret a cash budget for the months of May, June, and July.(1) The firm makes 20% of sales cash, 60% are collected in the next month, and theremaining 20% are collected in the second month following sale.(2) The firm receives other income of $2,000 per month.(3) The firm’s actual or expected purchases, all made for cash, are $50,000, $70,000,and $80,000 for the months of May through July, respectively.(4) Rent is $3,000 per month.(5) Wages and salaries are 10% of the previous month’s sales.(6) Cash dividends of $3,000 will be paid in June.(7) Payment of principal and interest of $4,000 is due in June.(8) A cash purchase of equipment costing $6,000 is scheduled in July.(9) Taxes of $6,000 are due in June.

March April May June Julysales $50,000 $60,000 $70,000 $80,000 $100,000cash sales (0.20) $10,000 $12,000 $14,000 $16,000 $20,000 Lag 1 month (0.60) $36,000 $42,000 $48,000 Lag 2 months(0.20) 10,000 12,000 14,000other income 2,000 2,000 2,000 Total cash receipts 62,000 72,000 84,000DisbursementsPurchases 50,000 70,000 80,000Rent 3,000 3,000 3,000Wages & salaries 6,000 7,000 8,000Dividends 3,000Principal & interest 4,000Purchase of new equipment 6,000

taxes due 6,000 Total cash disbursements 59,000 93,000 97,000

Total cash receipts 62,000 72,000 84,000Total cash disbursements 59,000 93,000 97,000 Net cash flow 3,000 (21,000) (13,000)Add: Beginning cash 5,000 8,000 (13,000)Ending cash 8,000 (13,000) (26,000)Minimum cash 5,000 5,000 5,000Required total financing 18,000 31,000Excess cash balance(Marketable Securities) 3,000 0 0

The firm should establish a credit line of at least $31,000.Question 6Refer to Problem P3-6 (page 140-141) in Gitman (2009) Principles of Managerial Finance (12th ed.).

Consider the balance sheets and selected data from the income statement of Keith Corporation.

Keith CorporationBalance Sheets

AssetsDecember 31

2009 2008Cash $ 1,500 $ 1,000Marketable securities 1,800 1,200Account receivable 2,000 1,800Inventories 2,900 2,800 Total current assets $ 8,200 $ 6,800Gross fixed assets $ 29,500 $ 28,100Less: Accumulated depreciation 14,700 13,100Net fixed assets $ 14,800 $ 15,000Total assets $ 23,000 $ 21,800Liabilities and Stockholders’ EquityAccounts payable $ 1,600 $ 1,500Notes payable 2,800 2,200Accruals 200 300 Total current liabilities $ 4,600 $ 4,000Long-term debt $ 5,000 $ 5,000Common stock $ 10,000 $ 10,000Retained earnings 3,400 2,800 Total stockholders’ equity $ 13,400 $ 12,800Total liabilities and stockholders’ equity $ 23,000 $ 21,800Income Statement Data (2009)Depreciation expense $1,600Earnings before interest and taxes (EBIT) 2,700Interest expense 367

Net profit after taxes 1,400Tax rate 40%

(3.1) Cash flow from operations = Net profits after taxes + Depreciation and other noncash charges(3.2) Net operating profits after taxes = Earnings before interest and taxes x (1 – Applicable corporate tax rate)(3.3) Operating cash flow = Net operating profits after taxes + Depreciation(3.4) Operating cash flow = [Earnings before interest and taxes x (1 – Applicable corporate tax rate)] + Depreciation(3.5) Free cash flow = Operating cash flow – Net fixed asset investment – Net current asset investment(3.6) Net fixed asset investment = Change in net fixed assets + Depreciation(3.7) Net current asset investment = Change in current assets – Change in (accounts payable + accruals)

a. Calculate the firm’s accounting cash flow from operations for the year ended December 31, 2009, using Equation 3.1.

Cash flow from operations = Net profits after taxes + Depreciation and other noncash charges

= Net profits after taxes + Depreciation expense = $1,400 + $1,600 = $3,000

b. Calculate the firm’s net operating profit after taxes (NOPAT) for the year ended December 31, 2009, using Equation 3.2.

Net operating profits after taxes = Earnings before interest and taxes x (1 – Applicable corporate tax rate)

= $2,700 x (1 – 0.40)= $1,620

c. Calculate the firm’s operating cash flow (OCF) for the year ended December 31, 2009, using Equation 3.3.

Operating cash flow = Net operating profits after taxes + Depreciation + interest tax shield

= $1,620 + $1,600 + $367(0.4)= $3,367

d. Calculate the firm’s free cash flow (FCF) for the year ended December 31, 2009, using Equation 3.5.

Free cash flow = Operating cash flow – Net fixed asset investment – Net current asset investment

= Operating cash flow – (Change in net fixed asset investment + Depreciation) – [Change in current assets – Change in (accounts payable + accruals)]

= 3,367 – [14,800 – 15,000) + 1,600] – [(8,200 – 6,800) – [(1,600 + 200) – (1,500 + 300)]]

= $3,367 – $1,400 – $1,400= $567

NFAI = change in net fixed asset + depreciation = (14800-15000) + 1600 = -200 + 1600 = $1400

Net current asset investment = (current asset 2009 – 2008) – [(account payable + accrual2009)-(account payable + accrual2008)]= (8200-6800) – [(1600+200) – (1500+300)]= 1400 – 0= $1400

e. Interpret, compare, and contrast your cash flow estimates in parts a, c, and d.Keith Corporation has positive cash flow from operating activities. OCF is the cash flow generated from its operation and has a value of $3,367 after adding depreciation expense to NOPAT. FCF is the cash available to investors with a value of $567 after deducting NFAI and NCAI from OCF.

The accounting cash flows are a little less than the operating and FCF. The FCF is meaningful it shows that the cash flows from operations are adequate to cover both operating expenses plus investment in fixed and net operating working capital.

NFAI:Keith Corporation therefore invested a net $1400 in fixed assets during 2009. The depreciation during a year is more than the decrease during that year in net fixed assets, thus a positive NFAI represents a net cash outflow attributable to the fact that the firm sold less assets than it acquired during the year.

NCAI:This means that Keith Corporation made $1400 investment in its current assets net of accounts payable and accrual during 2009.

FCF:During 2009 Keith Corporation generated $567 of free cash flow, which it can use to pay its investors—creditors (payment of interest) and owners (payment of dividends). Thus, the firm generated enough cash flow to cover all of its operating costs and investment and had free cash flow available to pay investors.

Cash flow from operations shows an estimate of cash flow from operations by deducting cash inflow such as depreciation and other noncash charges from net profit

after taxes.Operating cash flow emphasized on cash flow generated by producing and selling the output of goods and services. Unlike cash flow from operation, operating cash flow excluded the interest expense and taxes.Free cash flow emphasized on the amount of cash flow available to investors such as creditors and shareholders, which is different from cash flow from operations and operating cash flow since free cash flow has taken all operating needs and payment for investments in net fixed assets and net current assets into consideration.