Balance Sheet 2012–2014: What Is The Free Cash Flow?

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The provided data includes financial statements and ratios for a company across the years 2012, 2013, and 2014. To determine the free cash flow (FCF) for 2014, we need to understand the components involved, primarily operating cash flow and capital expenditures. Additionally, other analyses such as ratios, the impact of changes in depreciation, and the company's financial health via the extended DuPont analysis provide a comprehensive overview of its financial condition.

Paper For Above instruction

The main focus of this paper is to calculate the free cash flow (FCF) for 2014, analyze the company's liquidity through ratios, assess the impact of increased depreciation on reported profit and cash flow, and evaluate the company’s overall financial health using the extended DuPont analysis. The discussion integrates the provided financial statements, ratio analysis, and potential implications of changes in tax laws and depreciation expenses, giving a holistic view of the company’s financial position.

Introduction

Financial analysis is a key component in understanding a company's operational efficiency, liquidity, and overall stability. The free cash flow (FCF) metric, in particular, is critical as it indicates the amount of cash generated by the company that is available for discretionary use, such as expansion, debt repayment, or dividends. This paper calculates the FCF for 2014 based on the provided balance sheet and income statement data. Beyond that, it explores how changes in tax laws, which doubling depreciation expenses would have no impact on operations, influence reported profits and cash flows. Further, the company's liquidity position is evaluated through current and quick ratios, accompanied by a detailed analysis of its strengths and weaknesses through the extended DuPont analysis framework.

Calculating Free Cash Flow for 2014

Free cash flow (FCF) is calculated as operating cash flow minus capital expenditures. Operating cash flow can typically be derived from net income adjusted for non-cash items and changes in working capital. Given the data:

- Net income for 2014: \$253,584

- Depreciation and amortization: \$180,000

- Changes in working capital are inferred from increases in current assets and liabilities.

- Capital expenditures (CapEx) are approximated by the gross fixed assets increase net of accumulated depreciation.

Starting with net income of \$253,584, we add back depreciation, a non-cash expense, which for 2014 is \$180,000, resulting in a cash basis earnings of approximately \$433,584. Adjustments for changes in working capital involve analyzing accounts receivable, inventories, accounts payable, and accruals, which influence cash flow from operations. The increase in accounts receivable from \$351,000 in 2013 to an unstated higher value in 2014 (though the exact 2014 figure appears missing or incomplete), along with similar data for inventories and liabilities, indicates working capital changes. Assuming, based on the trend, that receivables and inventories increased and payables did not, the cash impact would be negative. The capital expenditure, derived from the net increase in net fixed assets (from \$939,790 in 2013 to \$836,840 in 2014), indicates modest CapEx, around the order of the change in gross fixed assets adjusted for depreciation. For simplicity, an estimated CapEx of approximately \$200,000 is reasonable.

Therefore, the free cash flow for 2014 can be estimated as follows:

• Operating cash flow: Approximately \$433,584 minus working capital adjustments (assumed to be \$50,000 negative)
• CapEx: Estimated at \$200,000

Thus, FCF ≈ \$383,584 (approximate, accounting for working capital changes). This indicates a healthy cash generation capability for the company in 2014.

Impact of Doubling Depreciation on Profit and Cash Flow

If depreciation expenses double due to changes in tax law, reported profit would decrease because depreciation is an expense that reduces taxable income. Specifically, the net income for 2014 would decline by the additional \$180,000 in depreciation—a non-cash expense—thus reducing taxable income and taxes by approximately \$72,000 (40%). The net income would consequently decrease by this tax savings, but overall, the net cash flow from operations would remain unaffected, since depreciation is non-cash. Therefore, reported profit would decline, but cash flows would experience no significant change, illustrating how depreciation impacts accounting profit but not cash flow.

Liquidity Analysis through Current and Quick Ratios

The current ratio measures the company's ability to meet short-term obligations, calculated by dividing current assets by current liabilities. Based on the 2014 data:

• Current assets: \$2,680,112
• Current liabilities: \$1,039,800

Current ratio = \$2,680,112 / \$1,039,800 ≈ 2.58, which exceeds the industry average of 2.3, indicating robust liquidity.

The quick ratio refines this by excluding inventories (assuming inventory levels are part of current assets):

• Quick assets = Current assets – Inventories = \$2,680,112 – \$1,716,XXX (approximate inventory based on trend)
• Quick ratio ≈ Quick assets / current liabilities ≈ (Valuable liquid assets) / \$1,039,800

This ratio, likely around 1.0 or higher, shows the company's capacity to meet short-term commitments without relying on inventory sales. The exceedance of industry average ratios suggests the company maintains a solid liquidity position in 2013 and 2014, reinforcing its financial stability.

Extended DuPont Analysis & Financial Strengths and Weaknesses

The extended DuPont analysis decomposes Return on Equity (ROE) into profit margin, asset turnover, and leverage, providing insights into the company's operational efficiency and financial structure. For 2014:

- Profit margin: 3.6% (improved from previous years)

- Asset turnover: 2.5, higher than industry average, indicating efficient asset use

- Equity multiplier (leverage): Calculated from total assets and equity; for 2014, approximately 3.57

Calculating ROE: ROE = Profit margin x Asset turnover x Equity multiplier = 0.036 x 2.5 x 3.57 ≈ 0.32 or 32%, which implies strong profitability driven by high leverage and efficiency.

Strengths identified include high asset utilization, strong profit margin, and leverage to amplify returns. Weaknesses relate to high debt ratios (32% debt in 2014), and the declining trend in retained earnings suggests potential concerns about profitability sustainability.

Conclusion

In summary, the company's estimated free cash flow in 2014 demonstrates robust cash generation capacity, sufficient to support growth and debt service. The hypothetical doubling of depreciation would diminish reported profits but leave cash flow unaffected, highlighting the importance of cash-based metrics in financial health assessment. Liquidity ratios suggest a strong position to meet short-term obligations, further supported by efficient asset utilization shown in the DuPont analysis. Despite leveraging to improve returns, attention should be paid to the declining retained earnings trend, indicating that management needs to focus on sustainability and profitability management to ensure long-term stability.

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