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Magna Fax, Inc. Income Statement For the Year Ended December 31, 2005 |Sales revenue | |$150,000...

Question:

Magna Fax, Inc. Income Statement For the Year Ended December 31, 2005

Sales revenue $150,000
Cost of goods sold 117,500
Gross Profits $32,500
Selling expense 4,500
General and administrative expense 4,000
Depreciation expense 4,000
Operating profits $ 20,000
Interest expense 2,500
Net profit before taxes $ 17,500 Taxes (40%) 7,000
Net profit after taxes $ 10,500

Magna Fax, Inc. Balance Sheet For the Years Ended December 31, 2004 and 2005

2004 2005
Assets Cash $24,000 $21,000
Accounts receivable 45,000 39,000
Inventory 30,000 27,000
Gross fixed assets $42,000 $40,000
Acc. Depreciation 22,000 18,000
Net fixed assets 20,000 22,000
Total assets $119,000 $109,000
Liabilities and Equity Accounts payable $25,000 $30,000
Notes payable 50,000 40,000
Accruals 1,000 2,000
Long term debts 10,000 8,000
Common stock at par 1,000 1,000
Paid in capital in excess of par 4,000 4,000
Retained earnings 28,000 24,000
Total liabilities and equity $119,000 $109,000

Instructions:

What is Magna Fax?s cash flow from operations?

Make an analysis of the profitability of the company. Backup your analysis with calculations

Operating Cash Flow:

Operating cash flow refers to the generated cash of the company from its normal business operations over a certain period. Operating cash is an important indicator to assess the financial health of the company as whether they generated enough cash to meets its short term obligation.

Answer and Explanation:

Question (a)

Formula on calculating the operating cash flow:

{eq}OCF=Net~income+Noncash~Expense+Changes~in~NWC\\ {/eq}


We need to calculate the Changes in NWC of the firm to calculate its operating cash flow. In this case, the net working capital is the difference between the firm's current assets and liabilities. Meanwhile, the current asset of the firm are cash, accounts receivable and inventory, while the current liabilities are accounts payable, notes payable and accruals. Therefore, we just need to sum the total current asset of the firm on each period, then minus the total current liabilities.

{eq}\begin{align*} 2004~NWC&=(24,000+45,000+30,000)-(25,000+50,000+1,000)\\ &=99,000-76,000\\ &=23,000 \end{align*} {/eq}

The net working capital of the firm in 2004 is $23,000

{eq}\begin{align*} 2005~NWC&=(21,000+39,000+27,000)-(30,000+40,000+2,000)\\ &=87,000-72,000\\ &=15,000 \end{align*} {/eq}

The net working capital of the firm in 2005 is $15,000

Therefore, the changes in net working capital of the firm in 2005 is:

{eq}\begin{align*} Changes~in~NWC&=2005~NWC-2004~NWC\\ &=15,000-23,000\\ &=-8,000 \end{align*} {/eq}


We can now calculate the operating cash flow of the firm using the above formula:

{eq}\begin{align*} OCF&=10,500+4,000-(-8,000)\\ &=22,500 \end{align*} {/eq}

The operating cash flow of the firm is $22,500


Question (b)

We can analyze the profitability of the firm by calculating its return on equity using the dupont method with the following formula

{eq}ROE=Net~profit~margin*Asset~turnover*Financial~Leverage\ {/eq}


{eq}\begin{align*} ROE&=\frac{10,500}{150,000}*\frac{150,000}{109,000}*\frac{109,000}{29,000}\\ &=.07*1.3761*3.7586\\ &=.3621\\ \end{align*} {/eq}

Magna Fax, Inc. display a strong return on equity of 36.21% in 2005. Despite the lower net profit margin of 7.0%, the firm was efficient in generating sales using its assets as seen on its asset turnover ratio of 1.3761x. However, the firm was highly leverage that inflates its return on equity as seen on its financial leverage of 3.7586x. In other words, the firm's higher return on equity was driven by their operating efficiency in generating sales and higher level of debt


Learn more about this topic:

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Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
11K

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