# 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.

#### 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 is15,000

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