From the e-Activity, evaluate the logic of reflecting key person life insurance in the operating activities of the cash flow statement and determine if this presentation is misleading to users of the financial statements.
Key person insurance are premiums paid either monthly or quarterly by a firm to an insurance company. They are to cater for the losses that a firm will experience once it has lost a key person. These are losses experienced in terms of operation as the firm will not be able to meet the expectations as before the loss of the individual. This is not money that is received by the family of the key person in case they happen to die but it is the money that the firm receives as compensation of a key person and is to be used to acquire another one. This can be in the form of training another individual to have the skills and capabilities that the other one had, it can also be used to lure in another employee from another firm as an incentive so that the position is not left vacant.
This can be misleading to users of financial statement, because this is funds that will be earned once a person has left the firm which is an occurrence that is more likely to happen more often than not (Gitman, 2010). It can be stated as insurance premiums but it is a form of investment that the company is keeping somewhere and will gain from it in the long run. When there is loss of a key person in the firm and he is easily replaced, the money is taken as an increase in the profits and reinvested again. This can be very misleading when analyzing the cash inflows.
In this case the firm is the main benefactor of the insurance plan and not the person. This is more so when the loss of a key person is caused by death. The firm argues that it insures the loss that it will experience once the key person has died or has become otherwise incapacitated and cannot deliver. The main argument is that the company is the one that pays the premiums and therefore should be the only beneficiary of the policy. The compensation is used to implement strategies that will help save the firm funds before replacement of the person, this is understandable because the company should cushion itself against losses from the death of an individual. The main corrections that should be made are to ensure that there are no misunderstandings is that should be clearly outlined that it is a form of investment for the firm and that it does not come from the individual personal income but it is paid by the firm, this will avoid misleading on the cash inflow and cash outflow (Siegel, 2008).
“Free Cash Flow” Please respond to the following:
Cash flow statement on free cash flow is meant to ensure that there is a good enough inventory cash ratio to help operate in the business. The operating activities involve the cash outcomes of transaction that will be used in the long run to determine the net income and net profits of the company. When calculating the cash flows from operations you start with the net profit and add on cash inflows and subtract cash outflows that have no effect on the profit. This will give the exact cash or liquidity position of the company.
Depreciation is one of the factors that are added to the cash flows, if it is nit added there could be a potential erroneous figure of the cash flows this means that the company will be working under assumption of money that it does not have or it lacks (Siegel, 2008). This can lead to use of company funds that are the incomes and profits to be given out and at times the company can fall into bankrupts because it is unable to invest back into the company.
Cash flow is acquired by subtracting the operational costs from the capital expenditures of a company. It is usually used as measure of how well off a company is. It represents the amount of money that is available in a company for the daily transaction purposes (Gitman, 2010). If the company is spending daily more than it makes in the same day, then it means that the expenses are more than the earnings then it cannot be termed as a healthy company. This is because in the long run it will make negative profits.
Let us take an example of a manufacture company that deals in the manufacture of ceramic cups and plates. On a daily basis it has to produce 500pieces per day. It costs them on average $5 to make one piece. It also costs them an extra $300 to pack and deliver the goods to the distributors. The inputs are brought daily, this means that on average the company should have
(500×5) + 300 = $2800 every day.
On average it sells 350 pieces at $10 per day, this means that per day it makes $3500, this is a viable business. Suppose there is a recession and the sale per day reduces to 200 pieces, then it would not be a healthy company unless it decreases the number of pieces it produces.
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