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How To Prepare a Statement of Cash Flows?

Posted on September 14, 2011 by admin

GAAP allows the use of the direct method and the indirect method to convert accrual revenues and expenses to a cash basis. The FASB suggests using the direct method but the majority of companies use the indirect method. The indirect method starts with income reported on the income statement and adjusts for items that did not affect cash. The direct method reports cash receipts (inflows) and cash disbursements ( outflows) from operating activities in detail.

STEPS FOR THE INDIRECT METHOD

Step 1: Determine the change in cash. Subtract the beginning cash balance for the period being reported from the ending balance on the last balance sheet.

Step 2: Determine cash flows from operating activities. Eliminate all non-cash transactions that did not increase or decrease cash from operating activities. Increases in current assets or decrease in current liabilities indicate use of cash, and decreases in current assets or increases in current liabilities show sources of cash.

Step 3: Determine the cash flows from investing activities. Compare the beginning and ending balances of long-term assets.

Step 4: Determine the cash flows from financing activities. Compare beginning and ending balances for long-term liabilities and stockholders equity. An increase in a stockholder’s equity account is a source of cash and a decrease is a use of cash.

Step 5: Prepare the statement of cash flows.

This Zempower blog focuses on increasing your Financial IQ. Mr. Taniguchi works with businesses to provide merchant cash advance loans within five to seven days based on credit card revenue receipts. He holds the position of Chief Financial Officer with several companies and also does bookkeeping, corporate valuations, financial consulting, and prepares merger & acquisitions packages for other businesses on the side. If you’d like to get updated blogs, please “Like” facebook.com/zempower.

Will The Euro Collapse?

Posted on August 28, 2011 by admin

EFSF (European Financial Stability Fund) includes 27 members of the European Union and was created on May 9, 2010. EFSF works closely with Germany to issue bonds on behalf of the insolvent European nations such as Greece, Spain, and Italy.

On July 11, 2011, the EFSF role expanded regarding the solvency responsibilities. The Greek example shows that the EFSF has bailed out the banks more than they’ve bailed out the country. Greece participated in IMF bailouts and was able to avoid high interest rate penalties; however, this luxury does not extend to Spain or Italy because they yet to receive any bailout money.

“The euro is breaking down,” Mr. Greenspan said last week. “The reason we’re so sluggish is the level of uncertainty.”

Since Germany remains the key player in the EFSF, it risks its own AAA credit rating if it participates in the backing new bond issuances to restructure the high interest Spain and Italy debts. If Germany does not participate in these financial restructurings, these sovereign debts will become insolvent and wreak havoc on the already fragile world markets. It would crash the Euro and cause the next Great Depression.

The financial world is teetering on the edge. For those that think the worse is behind us, think again. The worse is yet to come.

Posted in Economics | Tagged efsf, european financial stability fund, greek bailout, sovereign debt crisis, the coming euro crash, the greek crisis starts the great depression, the next great depression | Leave a comment

Understanding Short-Term Securities and Liabilities

Posted on August 27, 2011 by admin

Trading Securities. Debt and equity securities purchased with excessive cash for the purpose of resale in the near term. As such, they are current assets. They are reported at fair market value using the mark-to-market method. The accountant will make adjustments for unrealized market gains or losses (profit resulting from holding on to an asset versus the cashing out of it) and these are included on the current income statement.

Held-To-Maturity Securities. Debt (and not equity) securities that a company intends to hold till maturity. They are reported at cost less any impairment including amortized costs plus any accrued interest and classified as a non-current asset. Unrealized gains or losses are not recognized.

Available-For-Sale Securities. Debt and equity securities held for an indefinite period of time without the intention of selling before maturity. An accountant will value them using its fair market value, but the unrealized gains and losses are excluded from earnings on the current income statement. They are reported under Unrealized Gain/Loss – Other Comprehensive Income on the balance sheet and classified as a non-current asset unless the company decides to sell them within a year.

Investment in Equity Securities With A Controlling Influence. A controlling influence is defined by Financial Accounting Standard Board (FASB) guidelines as holding between 20 to 50 percent of the financial policies of an investee. An accountant will use the equity method, which records the initial investment at cost and reports a proportional share of the investee’s income on its income statement each period. This shows up on the balance sheet as a non-current asset.

Posted in Accounting | Tagged available-for-sale securities, controlling influence, equity method, held-to-maturity securities, mark-to-market value vs. book value, other comprehensive income, trading securities | Leave a comment

Are We Experiencing A 10-Year Depression?

Posted on August 25, 2011 by admin

The eight year bull market from 1921 to 1929 resulted in a three year bear market from 1929 to 1932, which was a 33% bear market drop. Due to Fed intervention, we’ve seen a thirty three year bull market from 1974 to 2007. History hints at the possibility of a ten to eleven year bear market, or 33% bear market declines when compared to the bull market periods. In the future, the economic scholars may look at monetary intervention as a failed experiment. Could we only delay the inevitable natural market corrections?

The Dow Theory looks for “sell-signals” that indicate the start of a long-term bearish trend. In Dow Theory terms, we experienced a Phase I correction in 2008 and 2009, and historical the Phase II corrections have always been more severe. I started writing this Zempower blog back in January 2011 and the first posts forecasted some major market crashes. The markets took some severe hits in August and amazingly I’ve been surprised that this blog called out the triggers (such as the credit downgrade of the US government and the Greek sovereign debt crisis). The worse is yet to come and the triggers will be a current account deficit correction, challenges to the US dollar as the international currency, and a halting crash to the Chinese economy.

My outlook on real estate has been very dim and would stay out of those markets maybe for another 5 to 7 years. I forecast dropping another 25 to 40% before it rebounds. For those holding long positions in stocks, be extremely careful and vigilant. A lot of people have already sustained major loses and more retirement accounts will continue to lose their value.

Posted in Stock Market | Tagged 10-year depression, current account deficit, dow theory, sell-signals | Leave a comment

How To Depreciate Long-Term Assets?

Posted on July 25, 2011 by admin

Land. Includes purchase price, real estate commissions, closing costs, attorney fees, recording fees, land use due diligence, clearing, grading, filling, landscaping, special assessments (pavement and sewer). Improvements with limited lifespans such as fences and parking would go under Land Improvements and not under Land.

Buildings. Includes purchase price of a finished building, real estate commissions, closing costs, attorney’s fees, recording fees, architectural fees, building permits, other professional fees, excavation costs, and construction costs.

Equipment. Includes net purchase price, sales tax and permits, freight or delivery costs, insurance in transit, normal assembling and installation costs, test runs, interest to finance the purchase of long-term assets. Training costs for learning how to operate the new plant or equipment are not included in acquisition costs.

Depreciable Base. The cost of the asset less its salvage value.

Carrying Value/Net Book Value. The historical cost of the asset less its accumulated depreciation.

Straight-Line Depreciation. Measures depreciation as a function of time rather than as a function of usage and is the most widely used.

Units-of-Output Depreciation Method. Measures depreciation as a function of usage based on units instead of as a function of time.

Declining Balance Method. Assumes that an asset should be depreciated more in the first few years (when it has the most productivity and least amount of repairs and maintenance) than in later years. The double declining balance method utilizes the declining book value of an asset and takes twice the straight-line rate to compute the annual depreciation expense where the ending book value equals the salvage value. The sum-of-the-years’-digits depreciation method accelerates the depreciation using the expected life of the asset and requires a fraction to be computed each year.

The rules for depreciation in tax law are usually completely different than the rules for GAAP financial reporting. Typically, companies use an accelerated depreciation method for tax purposes, but use a straight-line depreciation method for GAAP financial reporting.

Posted in Accounting | Tagged double declining balance method, pp&e, property plant and equipment, straight-line depreciation | Leave a comment

Understanding Basic Cost Accounting

Posted on July 3, 2011 by admin

In accounting terms, the term cost does not equate to the meaning of expense. A cost item requires the expenditure of resources to generate revenue during a specific period of time.

Asset Costs/Unexpired Cost. Expending resources or incurring liabilities to acquire assets. A capitalized cost equals the present value of a uniform series of periodic costs for a long time.

Inventoriable Costs. All costs related to the purchasing or manufacturing of inventory. Product costs specifically define costs incurred by a company to manufacture a product and include raw materials, direct labor, and manufacturing overhead.

Manufacturing Costs. All of the costs inside of the factory are product costs including direct and indirect materials and labor. Period expenses would include non-manufacturing costs such as selling expenses, marketing expenses, administrative expenses, and research and development.

Cost Object. Costs may be moved around (aggregated and re-aggregated) for different purposes and the cost object helps to identify how much something costs for a specific product, operation, activity, specific contract or service. Direct costs are directly traceable to the cost object, whereas indirect costs are not.

Conversion Costs. The costs to convert a raw material put into production into a finished product.

Cost Drivers. The measure of an activity that causes the total variable costs to change. The relevant range defines the relationship between cost and volume.

Differential Costs. A incremental costs or revenues that equals the difference between two alternative choices.

Opportunity Costs. The potential benefit (cost savings or profit) that is foregone by selecting one alternative over another.

Sunk Costs. When comparing alternative choices, these are the costs that have already been incurred and not relevant to the future financial activity. To calculate for sunk costs, an accountant will take the book value of an asset and subtract the accumulated depreciation from the cost of the asset.

Posted in Accounting | Tagged asset costs, capitalized cost, cost drivers, cost objects, differential costs, direct labor, direct vs. indirect costs, inventoriable costs, manufacturing costs, manufacturing overhead, opportunity costs, period expenses, product costs, raw materials, sunk costs, understanding basic cost accounting, unexpired costs | Leave a comment

How To Calculate WACC?

Posted on June 25, 2011 by admin

The weight average cost of capital calculates the return necessary to satisfy the bondholders and stockholders (relates to the risk/return ratios).

Equity Market Capitalization. Use the market value and not the book value for equity portion of the WACC calculation. The build-up approach factors the risk-free rate plus risk premiums for size, liquidity, sector risk, and other risk factors and can be used as an alternative way besides CAPM to calculate the cost of equity. Refer to my blog post on June 14, 2011 to learn how to use CAPM and beta to calculate the cost of equity.

Book Value For Debt. The short-term and long-term debt on the balance sheet should suffice for the value for the cost of debt. Because interest is tax deductible, you must add tax back into the debt portion of the WACC equation. For long-term debts, calculate the yield to maturity on the company’s bonds and for privately held companies use the Moody’s bond rating to estimate the bond yields.

Enterprise Value. Don’t forget that the WACC calcuations use the enterprise value (which includes the market capitalization plus the debts) and not just the market capitalization value.

What It All Means? If a company creates a return on invested capital far exceeding its weight average cost of capital, it means that a company is financially managed well and generating significant value.

Posted in Financial Analysis | Tagged calculating cost of equity using the build-up approach, wacc, weighted average cost of capital calculation | Leave a comment

Will The End Of QE2 Trigger The Next Depression?

Posted on June 23, 2011 by admin

It’s official. The Fed decided not to renew QE2 and its time to bring back the depression forecasts that I’ve been making all year on this blog. In the Fed Chairman’s speech, Bernanke victoriously claimed an end to the deflationary threat but also indicated that unemployment rates would may remain high for several years to come. Goodbye deflation, hello stagflation. Expect higher inflation levels in the future and slow economic growth.

The world today is broke. The gloomy news includes political unrest in the middle east, inflationary pressures in China and high risk levels for Chinese real estate speculation defaults and a wave of non-performing bank loans, the disaster recovery in Japan, a dangerous sovereign debt crisis in Europe, and a budget crisis in America.

WHERE DOES THE MONEY FLOW IN TODAY’S WORLD OF TURMOIL?

When the stock markets faces seven straight weeks of anxiety, we can expect a strong rally soon and investors will start to take a sigh of relief. The financial media will talk about the market upswing but don’t believe the hype. The European Sovereign Debt Crisis may drive the world off the cliff like it did in the late 1920s. In the chart below, the Great Depression was not caused by one huge crash; instead, we see a pattern of crash and rally but a steady bearish trend throughout of lower highs and lower lows.

DISCLAIMER: The author of this blog is not licensed under Series 6, Series 63, Series 7, and/or Series 82 and the contents of this blog should NOT be interpreted as providing financial or security advise as determined by the 1934 Securities Act. These blogs are educational only in purpose. The author is licensed as a Washington State Business and Real Estate Broker (Lag #55692) which includes the licensing rights in Washington to facilitate the brokering and sale of businesses, commercial real estate and residential real estate.

The major market players have been making huge speculations in the last two weeks and the wall street pros are betting on the failure of the global economy through credit default swaps. If Greece defaults and it will, the entire global banking will teeter on the verge of collapse similar to the Mortgage Crisis of 2008. However, this time the US government will neither have the political will nor the $2 trillion dollars for a bailout. In the short-term, the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) crisis devalues the Euro and causes the US dollar to go up. This temporarily keeps the US stock market from crashing, holds off a current account deficit correction with Japan and China, and keeps commodity prices in check. The Fed will be forced to try to contain the Greek defaults through unpopular bailouts, but the efforts will fail and I will explain why.

The US bailouts will continue until the American government gets downgraded from its AAA bond rating status. Since World War II, the US Treasuries have been the financial pillar for a risk-free investment. However, the world has changed and the financially overextended US government may face a bond rating downgrade from its AAA rating as a result of unsustainable deficits. I forecast that the global economy will double-dip into depression when the rating downgrade occurs.

These are tough times in the world.

Posted in Economics | Tagged bullish on gold, is it time to buy gold, the 2012 depression, the coming global depression, the greek crisis starts the global depression, the similarities between the great depression and the 2011 depression | Leave a comment

How To Prepare Financial Statements Without Quickbooks

Posted on June 21, 2011 by admin

The accounting cycle is the process from a when a business transaction occurs all the way to the financial statement preparation process.

Step 1: Identify a business transaction and find the supporting source document such as a receipt or invoice.

Step 2: Determine the amounts to be journalized, whether the accounts should be debited (left side entry) or credited (right side entry), and place into the appropriate journal.

Step 3: Post the journal entries in journal sequence to the appropriate ledger accounts. Accumulated depreciation shows up as an asset offset (deducted from the original cost on the asset side of the balance sheet).

Step 4: Prepare a trial balance (a listing of the current balance of all accounts in the general ledger) and a worksheet at the end of the accounting period. The debits total should equal the credits total. Make adjusting entries to all appropriate accrual and deferred accounts onto the worksheet (where you assemble all of the accounts in one place to make adjustments per the recognition and matching principles) and journalize and post them to the accounts. Prepare and make closing entries to all temporary revenue and expense accounts.

Step 5: Prepare the financial statements.

This Zempower blog focuses on increasing your Financial IQ. Ryland holds the position of chief financial officer for a variety of early growth companies. As a licensed business broker, Ryland also works with investors in buying, selling, and financing $300 k to $10 million dollar businesses and $1 million to $100 million commercial real estate. If you’re interested in selling your company or structuring your company for an acquisition, contact 206.832.9590 for a free business valuation. If you’d like to get updated blogs, please “Like” facebook.com/zempower.

Posted in Accounting | Tagged general ledgers, journalizing vs. posting., old fashion accounting, preparing financial statements without software, trial balance, understanding the accounting cycle | Leave a comment

The Challenges Of Valuing A Small Business

Posted on June 18, 2011 by admin

I perform about four to five small business valuations a week and understand the challenges of this process. Let’s explore this in detail.

Lack of Uniform Accounting. Publicly traded companies are required by SEC law to conform with generally accepted accounting principles (GAAP) and some degree of industry-specific accounting practices. Publicly traded companies also get scrutinized with annual audits. When valuing small businesses, the accounting rules may vary and one has to constantly assess the assumptions being made on the financial statements.

Financial Statements Prepared For Taxes. It’s quite common for small business owners to inflate certain expenses to pay less on their taxes. It’s the American way and most small business owners only pay for a certified public accountant to minimize their tax exposure. The way financials are prepared for taxes may not reflect the true financials and these phantom expenses need to be adjusted on the income statement.

Profit Fluctuations. Because small businesses are not usually managed by financial professionals, it’s common to see a great deal of revenue and profit fluctuations from year to year. The business valuation must smooth out all of the excessive patterns.

Overemphasizing the Profit & Loss (P&L) Statement. Typically, a small business owner will send me their P&L Statements when requesting a valuation and I know from experience that this is the financial document best understood by most small business owners. Becoming financially intelligent means learning how to understand the balance sheet and the statement of cash flows.

Lack of Data. Compared to doing a valuation on a publicly traded company, its much more difficult to get the data needed to do a valuation on a small business. Even when data can be found, it can be very confusing without a lack of uniform accounting standards to make sense of the data. I pay thousands a year in subscriptions for data on small businesses and this is reason enough for a business owner to seek someone experienced to do their small business valuation.

Lack of Stock Returns. When a small business does not have any stock returns (and most small businesses don’t), its much more difficult to calculate risk factors using beta and CAPM.

Owner Wage Adjustments. Small business owners typically overpay or underpay for their own salaries. To value a small business properly, the general and administrative expenses must be adjusted to reflect the market salaries. For a small business owner that underpays themselves, this would increase the expenses, decrease the net profit, and decrease the valuation of the business.

Key Employees. Small businesses may highly depend on key employees and we need to adjust the future revenue projections downward to account for the loss of a key employee. Buyers should protect themselves with earn-out clauses (require the current owner to stay on for 12 months) and/or non-compete clauses.

Liquidity Discounts. A small business should probably be discounted for illiquidity. In contrast to publicly traded companies that remain fairly liquid in open markets, a small business will typically have to go through a business broker that will charge a commission for their services.

Premium for Majority Stake. A majority stake sale means that over 50% equity of a business has been sold and this can add up to 30% in additional value to a newly acquired business.

Balance Sheet Adjustments. Its also common for small business owners to dwindle their cash in anticipation of a sale or to report higher-than-actual account receivables. When an owner plans to sell their business, they will usually reduce spending on capital expenditures and leasehold improvements necessary for future growth and focus on improving the short-term net profits.

Growth Rate Assumptions. The growth rate of a small business highly affects the EV/EBITDA multiples used to value the business. Have the financials been manipulated to improve the growth rates so that a seller can significantly improve their valuation? For example, maybe the seller has borrowed liberally in the last 12 months to improve the business revenues. Can you read the balance sheet with enough proficiency to understand whats going on?

If you ever purchase a small business, you’d want to work with someone with a high financial IQ who also has a willingness to coach you. As Warren Buffet believes, its hardest to manipulate the statement of cash flows. For example, the statement of cash flows will tell you if capital expenditure investments have been lower in the last twelve months compared to historical averages, and this may alert you that the net profits are inflated.

Posted in Business Valuation | Tagged earn-out clauses, financial iq for small business owners, how to value a small business, illiquidity discounts, key employees, non-compete clauses, phantom expenses for taxes, small business valuations, the challenges of valuing a small business | 1 Comment

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