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Free Cash Flow, Ratio Analysis, and Cash Referencing

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1. Explain free cash flow and its importance to a business.
2. Explain the weaknesses of ratio analysis
3. Contrast sources and uses of cash referencing using at least two examples of assets and liabilities (four total). Provide examples of how cash is used or provided depending on whether it is categorized as an asset or liability.

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1. Cash flows into an organization in the form of revenues by selling its products and services and cash flows out of the organization as operating expense. The cash that is left over is taken by the organization to make short term investments in working capital and long-term investments in plant, property and equipment. The cash that is remaining after making investments is used to pay shareholders. This cash flow is called free cash flow as it is free after all the activities with cash have been done and it can be used to pay investors. The FCF is important to company because it is a measure of company's true health. If the cash flow is negative it means the expenses are more than revenues and some remediation is required to reduce the expenses. If a company has free cash flow the management can have added flexibility in decision making. The company in such situation can internally fund a new project or add new product lines without taking loan from bank or raising capital by selling additional stocks. In addition to internal financing, free cash flow allows company to pay dividends. Paying and raising dividends is very important as it is taxed only at 15 percent. ...

Solution Summary

Free cash flows, ratio analysis and cash references are examined.

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Preparation and Analysis of Statement of Cash Flows

Here are the financial statements of Warfield Company.

Compzrative Balance Sheet - December 31:
Assets 2008: Assets 2007:
Cash - $26,000 Cash - $33,000
A/R - 28,000 A/R - 14,000
Merchandise Inventory - 38,000 M/I - 25,000
Property, Plant & Equ - 70,000 P,P & E - 78,000
Less: Accu. Dep - (27,000) Less: Accu. Dep - (24,000)
Total - $135,000 Total - $126,000

Liabilities & Stockholders' Equity
2008: 2007:
A/P - $31,000 A/P - $43,000
Income Taxes Payable - 26,000 I/P - 20,000
Bonds Payable - 20,000 B/P - 10,000
Common Stock - 25,000 C/S - 25,000
Retained Earnings - 33,000 R/E - 28,000
Total - $135,000 Total - $126,000

Income Statement - For year ended December 31, 2008
Sales - $286,000
COGS - 194,000
Gross Profit - 92,000
Selling Expenses - 28,000
Administrative Exp - 9,000
Income from operations - 55,000
Interest Exp - 7,000
Income before income taxes - 48,000
Income tax expense - 7,000
Net Income - $41,000

Addtional data:
1. Dividends of $36,000 were declared and paid.
2. During the year equipment was sold for $10,000 cash. This equipment cost $15,000 originally and had a book value of $10,000 at the time of sale.
3. All depreciation expense, $8,000, is in the selling expense category.
4. All sales and purchases are on account.
5. Additional equipment was purchased for $7,000 cash.

Prepare & Help Please. Thank you
A)Prepare a statement of cash flows using the indirect method.
B)Compute these cash-basis measures:
1) Current cash debt coverage ratio
2) Cash debt coverage ratio
3) Free cash flow

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