Final

CASH FLOW ADEQUACY RATIO

A.       Definition of Financial Statement Analysis

Financial statement analysis is an evaluative method of determining the past, current and projected performance of a company. Several techniques are commonly used as part of financial statement analysis including horizontal analysis, which compares two or more years of financial data in both dollar and percentage form; vertical analysis, where each category of accounts on the balance sheet is shown as a percentage of the total account; and ratio analysis, which calculates statistical relationships between data.

Financial statement analysis is not an end in itself but is performed for the purpose of providing information that is useful in making lending and investing decisions. An understanding of analytical methods associated with financial statement analysis is extremely using when interpreting and analyzing financial reports.

The objectives of financial reporting are designed to meet the needs of investors and creditors for decision making purpose. The primary focus of financial reporting is information about earnings and its components. Information useful in evaluating the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans is basic to many investment decisions. These and other concerns are the basic objectives of financial reporting.

The qualitative characteristics or accounting information are those qualities that enhance its usefulness for decision making accounting information useful for decision making. Predictive value, feedback value, and timeliness are the three components of relevance. Representational faithfulness and verifiability are the components of reliability. The qualitative characteristics of useful accounting information are pervasive and provide a basis for choosing among accounting and reporting alternatives.

B.       Scope of Financial Statement Analysis

1.      Liquidity analysis is used to determine a company’s ability to meet its short-term debt obligations.

2.      Solvency analysis is analysis used to measure a company's ability to meet long-term obligations. The solvency analysis measures the size of a company's after tax income, excluding non-cash depreciation expenses, as compared to the firm's total debt obligations. It provides a measurement of how likely a company will be to continue meeting its debt obligations.

3.      Profitability analysis is an analysis of costs and revenue to determine whether or not a venture will make a profit, and, if so, how much. This is important information in deciding on whether to make an investment. The length of time required to repay the initial investment can be a critical factor.

4.      Cash flow analysis is an examination of a company's cash inflows and outflows during a specific period. The analysis begins with a starting balance and generates an ending balance after accounting for all cash receipts and paid expenses during the period. The cash flow analysis is often used for financial reporting purposes. See also cash flow projection, cash flow forecast.

5.      Bankruptcy analysis is Bankruptcy can be explained as a legal proceeding which involves a business or individual being unable to repay his outstanding debts. Bankruptcy proffers another chance to an individual or business to start afresh by absolving the debts which can just not be paid while offering a chance for the creditors to get some amount of repayment based on the availability of assets.

6.      Risk analysis refers to the uncertainty of forecasted future cash flows streams, variance of portfolio/stock returns, statistical analysis to determine the probability of a project's success or failure, and possible future economic states. Risk analysts often work in tandem with forecasting professionals to minimize future negative effects.

7.      Investment analysis is an  examination and assessment of economic and market trends, earnings prospects, earnings ratios, and various other indicators and factors to determine suitable investment strategies

C.       Cash Flow Adequacy Ratio

Cash Flow Adequacy Ratio (CFAR) measures how well the company can cover the annual payments of all the long-term annual debt with the cash flow from its operating activities. This performance ratio can be calculated different ways, as the average value of the maturities might include the current year, plus several of Long Term Debt.

Formula of Cash flow adequacy ratio:

Cash flow from operations Long-term debt paid + Purchase of assets + Dividends paid

Importance of Cash Flow Adequacy:

This performance ratio should usually have a value of 1.0, which would mean the company is able to at least cover its long-term annual debt using its Cash Flow from Operations. Occasionally a company may have more Long Term Debt, as they may make take on debt to handle emergencies or to fund expansions of its operations, but if the company is continually borrowing more over time than it can reasonably handle with its inflow of cash, then this might point to rough times ahead for the company

D.       Calculated CFAR of PT United Tractors

Calculated CFAR of PT United Tractor’s financial statement:

CFAR  = (5.101.022 / (1.784.529 + 3.148.232 + 1.165.300))

= 5.101.022 / 6.098.061

= 0.8365

E.       Conclusion          

1.      Financial statement analysis is an evaluative method of determining the past, current and projected performance of a company.

2.      Importance of Cash Flow Adequacy Ratio is this performance ratio should usually have a value of 1.0, which would mean the company is able to at least cover its long-term annual debt using its Cash Flow from Operations.

3.      Based on calculated CFAR of PT United Tractor’s financial statement is 0.8365 or less than 1 which it’s mean PT United Tractor have potential problem about cover their yearly long term debt payment with their cash flow.