Harley
Financial Statements
Dr. M. Nusrate Aziz Senior Lecturer and DBA Coordinator
Graduate School of Management Multimedia University E-mail: md.nusrate@mmu.edu.my
Accounting Profit Vs. Cash Flow
• The Midland Company refines and trades gold. It purchased gold at the beginning of the year and paid $900,000. End of the year the company sold it for $1 million. However, money has yet to collect from customer.
Accounting View Income Statement, December 31 Sales - Costs $1,000,000 - $900,000 Financial View Income Statement, December 31 Cash Inflow Cash outflow $0 -$900,000
Profit
$100,000
Balance
-$900,000
• Value creation depends on cash flows. For Midland, value creation depends on whether and when it actually receives $1 million.
Timing of Cash Flow
• Present Value: The value of an investment made by a firm depends on the timing of the cash flows. One dollar today worth usually more than one dollar in the next year. • Suppose, the Midland Company is attempting to choose between two proposals for new products. Both proposals will provide additional cash flows over a four-year period.
Year 1 2 3 4 Total
New Product A $ 0 $ 0 $ 0 $20,000 $20,000
New Product B $ 4,000 $ 4,000 $ 4,000 $ 4,000 $16,000
• Which project would be chosen depends on whether the value of total cash from A outweigh the cash from B or vice versa.
Risk of Cash Flow
• Suppose, the Midlands company is considering expanding operations overseas. Europe is considered to be relatively safe, whereas operating in Japan is seen as risky. After doing a complete financial analysis, company has come up with the following cash flows of the alternative plans under three scenarios:
Pessimistic
Europe Japan $75,000 0
Most Likely
$100,000 $150,000
Optimistic
$125,000 $200,000
• If we ignore the pessimistic scenario, perhaps Japan is the best alternative. When we take pessimistic scenario into account, the choice is unclear (depends whether manager is risk taker
Dr. M. Nusrate Aziz Senior Lecturer and DBA Coordinator
Graduate School of Management Multimedia University E-mail: md.nusrate@mmu.edu.my
Accounting Profit Vs. Cash Flow
• The Midland Company refines and trades gold. It purchased gold at the beginning of the year and paid $900,000. End of the year the company sold it for $1 million. However, money has yet to collect from customer.
Accounting View Income Statement, December 31 Sales - Costs $1,000,000 - $900,000 Financial View Income Statement, December 31 Cash Inflow Cash outflow $0 -$900,000
Profit
$100,000
Balance
-$900,000
• Value creation depends on cash flows. For Midland, value creation depends on whether and when it actually receives $1 million.
Timing of Cash Flow
• Present Value: The value of an investment made by a firm depends on the timing of the cash flows. One dollar today worth usually more than one dollar in the next year. • Suppose, the Midland Company is attempting to choose between two proposals for new products. Both proposals will provide additional cash flows over a four-year period.
Year 1 2 3 4 Total
New Product A $ 0 $ 0 $ 0 $20,000 $20,000
New Product B $ 4,000 $ 4,000 $ 4,000 $ 4,000 $16,000
• Which project would be chosen depends on whether the value of total cash from A outweigh the cash from B or vice versa.
Risk of Cash Flow
• Suppose, the Midlands company is considering expanding operations overseas. Europe is considered to be relatively safe, whereas operating in Japan is seen as risky. After doing a complete financial analysis, company has come up with the following cash flows of the alternative plans under three scenarios:
Pessimistic
Europe Japan $75,000 0
Most Likely
$100,000 $150,000
Optimistic
$125,000 $200,000
• If we ignore the pessimistic scenario, perhaps Japan is the best alternative. When we take pessimistic scenario into account, the choice is unclear (depends whether manager is risk taker