The question is:
Compute the recent two years’ cash flow on total assets ratios for this company.
This is the info given:
Operating cash flow for current year (in millions): $1,762
1 year prior - $1,740
2 years prior - $1,981
Total Assets for current year - $13,570
1 year prior - $11,864
2 years prior - $10,294
I know that the cash flow ratio for total assets is Operating cash flows/average total assets.
My question is do I use the operating cash flows for current year and the total assets for current year and 1 year prior or current year and 1 and 2 years prior?
= 1,762/[(13,570+11,864+10,294)/3]
= 1,762/11,909.33
=14.8%
Or
= 1,762/[(13,570+11,864)/2]
= 1,762/12,717
=13.9%
And, does the cash flow on total assets ratio reflect on the quality of earnings?
To compute the recent two years’ cash flow on total assets ratios for the company, you need to use the average total assets for those two years. In this case, you would use the current year's total assets and the total assets from the two prior years.
The correct calculation would be:
Cash flow on total assets ratio (in percentage) = Operating cash flow / Average total assets
= $1,762 / [($13,570 + $11,864 + $10,294)/3]
= $1,762 / $11,909.33
≈ 14.8%
The ratio is approximately 14.8%.
Regarding your question about the quality of earnings, the cash flow on total assets ratio does reflect on the quality of earnings. A higher ratio suggests that a company is generating more cash flows from its total assets, indicating better efficiency and stronger earnings quality. Conversely, a lower ratio may suggest that the company's cash flows generated from its total assets are relatively weak, and further investigation may be required to understand the impact on earnings quality.
Selected transactions for D. Reyes, an interior decorator in her first month of business, are as follows.
Jan.
2
Invested $10,000 cash in business.
3
Purchased used car for $4,000 cash for use in business.
9
Purchased supplies on account for $500.
11
Billed customers $1,800 for services performed.
16
Paid $200 cash for advertising.
20
Received $700 cash from customers billed on January 11.
23
Paid creditor $300 cash on balance owed.
28
Withdrew $1,000 cash for personal use of owner