Limitations of Financial Statements

1
Limitations of Financial Statements

• Examine the limitations of financial statements
  and investigate cash flow management

2
Limitations of Financial Statements

• Subject to earnings manipulation
• Use of estimates and allocation
• Use of historical costs
• Omission of resources and costs
• Delay in providing information

3
Nature of Product Life Cycle (1)

• Introduction
• Lack of Capital
• Poor cash flow
• Learning the business
• Poor financial information and inaccurate
  predictions
• Possibly no profit

• Growth
• High growth in sales and profits
• Highly strained capital
• Potential poor growth management (???)
• Likely cash flow problem to support growth
• High demand for financial information

4
Nature of Product Life Cycle (2)

• Maturity
• Strong Capital
• Positive cash flow
• Experienced management
• Timely and accurate financial information
• Sustaining market shares

• Decline/Renewal
• Declining market shares
• Adequate capital
• Underutilized financial information
• Developing new products

5
Product Life Cycle
Financing CF
0
Investing CF
Op. CF
Intro Growth Maturity Decline
6
Product Life Cycle Effects

• Introduction low profitability, does not
  directly suggest negative operating cash flow
• Growth Stage
• growth rate of sale is not necessarily equal to
  an increase in net incomewhy?
• Growth firms often experience poor cash flow
  management (working capital)sustainable growth
• Maturity Stage less investment opportunity,
  sustaining market share, invest to maintain,
  replace, and renew Property plant and equipment

7
Cash Flow Analysis gt Issues and Concerns

• Interpretation of negative cash flow
• Poor performance?
• Poor working capital management?
• Both?
• Acquisition/disposal of fixed assets
• Disposal upgrading or liquidating?
• Acquisition renewal or expansion
• New Debts
• Debt issued refinancing or expansion
• Overall risk and type of debt
• New Equity issued
• Financing expansion or retiring debt

8
Cash Flow Analysis gt Issues and Concerns gt
Management

• Manage extra cash wisely, cash reserves may be
  costly
• Prepare a monthly cash budget
• Promote cash sales (discounts)
• Keep close track of cash expenditures, daily
  deposits.

9
Cash Flow Analysis gt Management gt Accounts
Receivable

• Take payment in advance whenever possible
• A/R management includes
• Partial payment upfront
• Credit history check
• Late penalty charge
• Increases in sales with liberal credit policy
  must outweigh potential increases in bad debt
• Sell or factor receivables
• Late Paying Customers
• Learn why
• Negotiate to acquire cash
• Collection agency

10
Cash Flow Analysis gt Management gt Inventory

• Be aware of slow-moving inventory
• Maintain low inventory levels
• Just in Time
• Economic Order Quantity
• Reorder point
• Know the market demand, seasons, technology
• Focus on high margin products, minimize loss
  leaders
• Subcontract internally costly processes, payroll
  MUST be paid
• Free lance to minimize benefit costs

11
Cash Flow Analysis gt Management gt PPE

• Lease rather than buy new assets
• Sell and lease backed fixed assets that are
  currently owned
• Rent out unused spaces
• Sell unused/obsolete assets (holding costs money)
• Subcontract facilities in times of excess capacity

12
Leases

• In some cases it is more advantageous to lease an
  asset than to borrow money to purchase it. The
  lessee can conserve cash (no large cash outlay)
• Should the right to use PPE be reported as an
  asset?
• Should obligations (lease contracts) be a
  liability?
• Are all leases the same?
• Operating lease Not required to record an asset
  or a liability off-balance sheet financing
• Capital lease required to record the lease as
  an asset and the future payments as liabilities
• Transfer of ownership at the end of the lease
  term
• Bargain purchase at the end of the lease term
  less than fair value
• Lease term is greater than 75 of the useful life
• Present value of the minimum lease payments is
  90 or more than the fair market value of the PPE

13
Cash Flow Analysis gt Management gt Liabilities

• Dont pay checks and bills before they are due
• Negotiate with suppliers and other creditors for
  discounts, and time before it is necessary
• Refinance long-term debt to take advantage of
  lower interest rates (cost/benefit)
• Avoid government conflicts (pay taxes, medicare,
  sales tax, etc on time)