Financial Accounting: An Integrated Statements Approach, 2nd Edition

this happen? A review of the statement of cash flows for Disney reveals that during

2004 Disney used cash to support operations. Such changes in the ratio are usually of

little concern. However, large ratios, or large changes in the ratio between years, may

warrant further analysis of the underlying accruals and deferrals, giving rise to the size

or change in the ratio.

Ratio of Cash to Monthly Cash Expenses

As we illustrated for The Walt Disney Company, the cash flow ratio is useful for iden-

tifying when significant changes may have occurred in accrual accounting methods.

Another cash ratio that is especially useful for startup companies is the ratio of cash to

monthly cash expenses.

For companies that are either starting up or in financial distress, cash is critical for

their survival. In their first few years of operations, startup companies often report

losses and negative net cash flows. In these cases, the ratio of cash to monthly cash ex-

penses (negative cash flow for operating activities) is useful for assessing how long a

company can continue to operate without additional financing or without generating

positive cash flows from operations. Likewise, this ratio can be used to assess how long

a business may continue to operate when experiencing financial distress. In comput-

ing cash to monthly cash expenses, the amount of cash on hand can be taken from the

balance sheet, while the monthly cash expenses can be estimated from the operating

activities section of the statement of cash flows.

The ratio of cash to monthly cash expenses is computed by first determining the

monthly cash expenses. The monthly cash expenses are determined as follows:

Monthly Cash Expenses 

Negative Cash Flows from Operations

12

The ratio of cash to monthly cash expenses can then be computed as follows:

Cash and Cash Equivalent as of Year-End

Ratio of Cash to Monthly Cash Expenses 

Monthly Cash Expenses

To illustrate these ratios, we use Gateway Inc., a manufacturer of personal com-

puter products. For the year ending December 31, 2004, Gateway reported the follow-

ing data (in millions):

Negative cash flows from operations $(434.2)

Cash and cash equivalent as of

December 31, 2004 383.0)

Based upon the preceding data, the monthly cash expenses, sometimes referred to as

cash burn, were $36.2 per month ($434.212). Thus, as of December 31, 2004, the cash

to monthly cash expenses ratio was 10.6 ($383.0$36.2). That is, as of December 31,

2004, Gateway would run out of cash in less than 11 months unless it changes its op-

erations, sells investments, or raises additional financing.

328 Chapter 7 Sarbanes-Oxley, Internal Control, and Cash