Q: Is equity in income/loss the same as minority interest income?
A: It’s the same concept approached from the other side of the table. If one company owns less than 50% of a subsidiary company, the parent company will record the minority owner’s share of profit as minority interest on the income statement– an amount that reduces net income available to the parent company. There is generally no cash outflow to the minority owners. Therefore, the reduction to majority owner profit is a non-cash reduction.
The minority owner may use the equity method of accounting to record its minority ownership. If it does so, it will record its share of the subsidiary income as equity in income and increase an investment account by the same amount. But there is, in general, no cash flow to the minority owner from the subsidiary company. Equity in income or equity in loss is a non-cash event, unless accompanied by a cash distribution from the majority to minority owner.
Q: Why wasn't the change in payables included in the calculation?
A: Sequoia Properties does not hold inventory and, therefore, has no cost of goods sold. The balance in that account refers to expenses incurred but not yet paid for services or goods other than inventory. From examining the company’s financial statements, it appears Sequoia Properties used the accounts payable account to report amounts due to contractors, engineers, and other professionals for the cost of developing construction sites. Therefore, we consider payables as a financing source for the preliminary site development costs and exclude it from the computation of accounts (accrued liabilities) payable days. In doing so, we use only a specified amount of accrued expenses, which seem to reflect operating expenses incurred but not yet paid for.
Q: The balance sheet I printed out last week shows accrued expenses as of 12/31/07 of $791,126? You mentioned a figure of $478,008. Is there a corrected financial statement?
A: In Exercise 2, we asked that you use only $478,008 of the 2007 accrued expense balance in computing accounts (accrued liabilities) payable days. We did so because the actual 2007 increase in accrued expenses exceeded the companies operating expenses – excluding non-cash charges and interest expense – for 2007, which is not possible. Therefore, we estimated that some portion of the 2007 accrued expense balance really reflect amounts due to contractors, engineers, and other professionals for services provided in developing construction sites rather than for operating expenses. Only by asking management or the accountant could we determine the proper amount to use, however.
Q: Why is an increase in liabilities a cash inflow? Can you explain this more?
A: It may be easier to think of such an increase as a cash relief, i.e., expenses incurred but not yet paid. For example, if a company records expenses of $100,000 for a year, we consider that a cash outflow of $100,000. But if it accrued the full $100,000 during the year, we would reduce the $100,000 expense by the amount of the cash inflow or cash relief provided by the $100,000 increase in accrued expenses.
Q: How did you get $421,189 for 2007 operating expenses? Can you break this out?
A: Total 2007 operating expenses were $1,703,921 per the income statement. From that amount, we remove all non-cash charges – amortization expense of $117,324 and depreciation expense of $16,258 – as well as interest expense of $1,149,150. The result is an operating expense total of $421,189.
Q: Where did the financing surplus of ($6,210,376) come from?
A: With brackets or a minus sign, the amount should be read as a financing requirement, i.e., the amount of outside cash needed to meet all company expenditures for the year. In this instance, the financing requirement reflects the $55,045 cash surplus at Cash after Debt Repayment less the cash amounts spent on fixed assets, investments, preliminary site development costs, intangibles, and related party cash outflows, i.e., $55,045 – $1,357,034 – $466,967 – $2,406,366 – $719,461 – $1,315,593 = ($6,210,376).
Q: Is the "business profit" just a piece of the UCA cash flow? We shouldn't necessarily use just this as a repayment source, correct? Also, should all three cash flow calculations (Net Income, Business Profit and Cash after Debt Repayment) be discussed in the write up when assessing repayment?
A: Business profit is separate from the UCA cash flow statement, since it does not include any changes in operating asset or liability accounts. If business profit is positive and greater than scheduled long-term debt repayment, it implies there is enough profit in the business to fully service interest-bearing debt. But whether there is enough cash to do so – the acid test, since cash and not profit repays loans – depends on the messages from the UCA cash flow statement. It is the only cash flow statement that properly addresses this issue. Therefore, if Cash after Debt Repayment is positive, you know the company had sufficient cash flow from business operations to fully satisfy its debt service. If Cash after Debt Repayment is negative, regardless of how robust and impressive business income might be, you know the company did not generate sufficient business cash flow to properly service its debt.
You might contrast net income + depreciation with Business Cash Income (or Net Cash Income as it’s frequently called) in a write-up to point out the impact of changes in the balance sheet on a company’s debt service ability. In the final analysis, it’s the results from the UCA cash flow statement that matter, not net income + depreciation or EBITDA as proxies for actual cash flow.
A: It’s the same concept approached from the other side of the table. If one company owns less than 50% of a subsidiary company, the parent company will record the minority owner’s share of profit as minority interest on the income statement– an amount that reduces net income available to the parent company. There is generally no cash outflow to the minority owners. Therefore, the reduction to majority owner profit is a non-cash reduction.
The minority owner may use the equity method of accounting to record its minority ownership. If it does so, it will record its share of the subsidiary income as equity in income and increase an investment account by the same amount. But there is, in general, no cash flow to the minority owner from the subsidiary company. Equity in income or equity in loss is a non-cash event, unless accompanied by a cash distribution from the majority to minority owner.
Q: Why wasn't the change in payables included in the calculation?
A: Sequoia Properties does not hold inventory and, therefore, has no cost of goods sold. The balance in that account refers to expenses incurred but not yet paid for services or goods other than inventory. From examining the company’s financial statements, it appears Sequoia Properties used the accounts payable account to report amounts due to contractors, engineers, and other professionals for the cost of developing construction sites. Therefore, we consider payables as a financing source for the preliminary site development costs and exclude it from the computation of accounts (accrued liabilities) payable days. In doing so, we use only a specified amount of accrued expenses, which seem to reflect operating expenses incurred but not yet paid for.
Q: The balance sheet I printed out last week shows accrued expenses as of 12/31/07 of $791,126? You mentioned a figure of $478,008. Is there a corrected financial statement?
A: In Exercise 2, we asked that you use only $478,008 of the 2007 accrued expense balance in computing accounts (accrued liabilities) payable days. We did so because the actual 2007 increase in accrued expenses exceeded the companies operating expenses – excluding non-cash charges and interest expense – for 2007, which is not possible. Therefore, we estimated that some portion of the 2007 accrued expense balance really reflect amounts due to contractors, engineers, and other professionals for services provided in developing construction sites rather than for operating expenses. Only by asking management or the accountant could we determine the proper amount to use, however.
Q: Why is an increase in liabilities a cash inflow? Can you explain this more?
A: It may be easier to think of such an increase as a cash relief, i.e., expenses incurred but not yet paid. For example, if a company records expenses of $100,000 for a year, we consider that a cash outflow of $100,000. But if it accrued the full $100,000 during the year, we would reduce the $100,000 expense by the amount of the cash inflow or cash relief provided by the $100,000 increase in accrued expenses.
Q: How did you get $421,189 for 2007 operating expenses? Can you break this out?
A: Total 2007 operating expenses were $1,703,921 per the income statement. From that amount, we remove all non-cash charges – amortization expense of $117,324 and depreciation expense of $16,258 – as well as interest expense of $1,149,150. The result is an operating expense total of $421,189.
Q: Where did the financing surplus of ($6,210,376) come from?
A: With brackets or a minus sign, the amount should be read as a financing requirement, i.e., the amount of outside cash needed to meet all company expenditures for the year. In this instance, the financing requirement reflects the $55,045 cash surplus at Cash after Debt Repayment less the cash amounts spent on fixed assets, investments, preliminary site development costs, intangibles, and related party cash outflows, i.e., $55,045 – $1,357,034 – $466,967 – $2,406,366 – $719,461 – $1,315,593 = ($6,210,376).
Q: Is the "business profit" just a piece of the UCA cash flow? We shouldn't necessarily use just this as a repayment source, correct? Also, should all three cash flow calculations (Net Income, Business Profit and Cash after Debt Repayment) be discussed in the write up when assessing repayment?
A: Business profit is separate from the UCA cash flow statement, since it does not include any changes in operating asset or liability accounts. If business profit is positive and greater than scheduled long-term debt repayment, it implies there is enough profit in the business to fully service interest-bearing debt. But whether there is enough cash to do so – the acid test, since cash and not profit repays loans – depends on the messages from the UCA cash flow statement. It is the only cash flow statement that properly addresses this issue. Therefore, if Cash after Debt Repayment is positive, you know the company had sufficient cash flow from business operations to fully satisfy its debt service. If Cash after Debt Repayment is negative, regardless of how robust and impressive business income might be, you know the company did not generate sufficient business cash flow to properly service its debt.
You might contrast net income + depreciation with Business Cash Income (or Net Cash Income as it’s frequently called) in a write-up to point out the impact of changes in the balance sheet on a company’s debt service ability. In the final analysis, it’s the results from the UCA cash flow statement that matter, not net income + depreciation or EBITDA as proxies for actual cash flow.