Reference no: EM132439744

Financial Reporting and Analysis

Please respond the below statement

200 words and reference:

Question No. 1

Firms must manage various performance metrics associated with their day to day operations in order to properly evaluate performance on an ongoing basis. On a yearly basis, managers and accountants should compare performance metrics to prior periods. This will allow them to determine how the firm's operations and performance has changed throughout the periods. Moreover, two major metrics that firms should pay close attention to include the current ratio and operating cash flow.

The current ratio is the measure of current assets divided by current liabilities. Current assets include the following: cash and cash equivalents, accounts receivables, inventory, short term investments, and any prepaid investments. Generally current assets are defined as cash and other assets that are expected to be converted to cash within a year. Conversely, current liabilities include the following: accounts payable, taxes payable, interest payable, accrued expenses and customer deposits. Like current assets, current liabilities are amounts that will be come due to credits within one year. With this, the purpose of managing current ratio is to measure how liquid a firm is. A firm's liquidity is chiefly important when it comes to considering how easily the firm can pay obligations to creditors in the short term.

Additionally, cash flow from operating activities is another performance metric that managers and accountants should pay close attention to. Cash flow from operating activities is generally calculated by starting with net income. Both noncash expenses and changes in working capital are added back to net income to arrive at cash flow from operating activities. The reason that noncash expenses are added back is because they do not have a cash effect, but they do decrease net income. Changes in working capital also relate to the current ratio (as described above), because working capital is calculates as current assets less current liabilities.

With this, there are a number of reasons for why a firm may experience an increasing current ratio but a decreasing operating cash flow to current liabilities ratio. First, increasing current assets would drive current ratio higher. If current assets increase more than current liabilities over a period, then this would result in an increasing current ratio and a decreasing operating cash flow to current liabilities ratio. Also, a reason why a firm may experience an increasing current ratio and decreasing operating cash flow to current liabilities ratio could be because operating cash flow may be decreasing. Operating cash flow may be decreasing because noncash expenses are lower in the current period than they had been in previous years. Operating cash flow may also decrease if a firm is struggling to generate revenue through sales, or if their operating expenses have increased as a result of a change in their operations.

Please respond the below statement

200 words and reference:

Question No. 2

The current ratio formula is one of the simplest ways used by companies to communicate to their investors on the ability to meet short term obligations. Meeting these obligations is not only a key element in conveying information on timely payments to debts and other liabilities but also shows profitable operations that most investors are interested in. As described in the textbook, the current ratio is calculated by dividing the total current assets by the total current liabilities. The current asset values represent assets that are reasonably expected to convert into cash within a year and current liabilities are those obligations due within a year. The analysis of the current ratio helps with the interpretation of the firm's ability to fulfill its obligations, where the analysis of a higher number suggests good results.

Operating cash flow measures the amount of cash produced or used during normal operations. Positive cash flow shows the firm's ability to grow in operations and negative cash flows may suggest or require other methods of raising capital to sustain operations through investing or financing activities. Operating cash flow to current liabilities ratio is obtained by dividing cash flows from operations by the current liabilities used in the operation of the business.

The general analysis of the increased current ratio implies that the numerator, current assets is greater than the denominator, current liabilities. In the case of this week's discussion topic, a firm may be experiencing an increased current ratio but a decreasing operating cash flow to the current liabilities' ratio due to various reasons. For one, both ratios use different elements of the numerator when calculating the final result. In the case of the current ratio, the numerator only comprises of current assets, while in the case of operating cash flow to the current liabilities' ratio, other elements are used in the numerator. If the company expanded its operations, for example, they may have to use up more of their cash reserves to pay for the new inventory, property, plant, and equipment, casing the cash flows from operations to be smaller. This is true when cash is used to pay for the new expenses incurred with the expansion of new business operations. Additionally, the operations may not generate cash or cash equivalents immediately upon inception, lowering the amount of cash generated from operations. While current assets continue to grow in the numerator for current ratio calculation, operating cash flow decreases, hence the difference in results. The differences in time between the examples given where there is an increase in assets to help facilitate added production, the speed at which money and other cash equivalents are realized may create a variation in results for the two computations. As the firm's ability to meet short term obligations continues to increase and suggesting profitability, operations cash flow to current ratio may go the opposite way regardless of the firm's new level of risk in operations and production.

Attachment:- Financial Reporting and Analysis.rar