Dalton Media, a fictional newspaper and magazine publisher, earns $75 million in year 3 (FY3). Its cash balance grows by $1 million. Profit and more cash sound reassuring. Is that enough to call its finances stronger?
Choose before reading on: accept that conclusion, ask for a specific follow-up, or pause judgment. Give one reason.
Allow 5–8 minutes to read the case, or up to 15 to work through the optional routine with the packet ready. Investigating the missing evidence takes longer.
Minutes 0–2: check what you have
The packet contains Dalton's reported FY2 and FY3 figures: full-year results and year-end balances. Money and shares are in millions; EPS is in dollars. Ratios and percentage changes below are calculated and rounded.
Locate profit, cash and operating cash flow (OCF) across the three statements. A bank balance tells you what is there, not how it got there.
Missing: receivables aging (invoices grouped by age), detailed debt repayment dates and loan conditions.
For a real US public company, start with the notes and management discussion in its SEC filing. They explain material changes and liquidity; a detailed aging breakdown may need a separate request.
Minutes 2–5: locate the profit change
Read the income statement and write one sentence explaining why profit fell faster than sales. Then compare your answer.
Annual results · USD millions; shares in millions, EPS in dollars.
| Selected row | FY2 | FY3 |
|---|---|---|
| Revenue | 940 | 883.6 |
| Gross profit | 451.2 | 397.62 |
| Operating income / EBIT | 174 | 150 |
| Interest expense | 45 | 50 |
| Net income | 96.75 | 75 |
| EPS (basic/diluted) | 3.225 | 2.50 |
| Weighted-average shares | 30 | 30 |
| EBITDA | 229 | 200 |
A strong answer: “Dalton brings in less and keeps less of each dollar.” Revenue falls 6%. Gross margin falls from 48% to 45%; operating margin falls from 18.5% to 17.0%. Interest expense also rises by $5 million.
Net income and EPS both fall 22.5%. Basic and diluted weighted-average shares stay at 30 million: the decline in profit reaches each share unchanged.
Minutes 5–8: explain the extra cash
Annual cash flows · USD millions. D&A is depreciation and amortization; capex and owner payments are shown as amounts spent.
| Selected row | FY2 | FY3 |
|---|---|---|
| D&A addback | 55 | 50 |
| Working-capital effect | −15 | −20 |
| Operating cash flow | 136.75 | 105 |
| Capex (all maintenance) | 75 | 65 |
| Owner cash payments | 54 | 54 |
The cash-flow reconciliation adds back D&A and subtracts cash tied up in working capital: $75 + $50 − $20 = $105 million of OCF. There are no other adjustments here.
Free cash flow is $105 − $65 = $40 million, down from $61.75 million. We subtract all cash capex. Dalton's $65 million maintains presses and distribution systems; substituting depreciation would miss $15 million spent.
Earnings conversion falls from about 64% ($61.75 ÷ $96.75) in FY2 to 53% ($40 ÷ $75) in FY3. Less of each dollar of profit remains after capital spending.
The missing inflow is $15 million. The financing row confirms net borrowing of zero in FY2 and $15 million in FY3. No other investing or financing flows remain. The cash change is $40 + $15 − $54 = $1 million, taking $143.75 million to $144.75 million.
More cash in the bank can come from borrowing. Dalton generated less cash after capex and borrowed to cover the gap. You can stop here and finish later; keep this finding in your investing journal if you use one.
Minutes 8–11: test the apparent buffer
Read the balance sheet: year-end balances in USD millions, with unrestricted cash.
| Selected row | FY2 | FY3 |
|---|---|---|
| Cash | 143.75 | 144.75 |
| Receivables | 135 | 160 |
| Current assets | 338.75 | 359.75 |
| Current liabilities | 280 | 280 |
| Current debt (included) | 100 | 100 |
| Interest-bearing debt | 950 | 965 |
| Equity | 308.75 | 329.75 |
The liquidity ratios rise, while the debt checks show a heavier burden on earnings. All ratios are in times, using year-end balances and full-year earnings and interest.
| Check | FY2 | FY3 |
|---|---|---|
| Current ratio | 1.21 | 1.28 |
| Quick ratio | 1.00 | 1.09 |
| Net debt / EBITDA | 3.52 | 4.10 |
| EBIT / interest expense | 3.87 | 3.00 |
Dalton's quick assets are cash plus receivables: ($144.75 + $160) ÷ $280 = 1.09 in FY3.
Receivables rise 18.5% while sales fall. The buffer on paper grows because more money sits in unpaid invoices. A better ratio can hide a longer wait for cash.
Each gap blocks a different conclusion:
- Aging and payment terms: how much of the $160 million is overdue, and how reliable that buffer is.
- Debt schedule and loan conditions: when repayments fall due and how close Dalton is to any covenant limits. The $100 million current debt is part of $280 million in current liabilities; cash has other bills to cover.
Minutes 11–14: check the explanation
EBITDA checks out: $150 million operating income + $50 million D&A = $200 million. This is the denominator used in the debt comparison above. No management-adjusted result is supplied.
Stock-based compensation and repurchases are both zero in these years. Actual year-end shares also stay at 30 million. A changing share count does not explain the weaker per-share result.
Apply the accounting red flags habit: offer one explanation for rising receivables and evidence that could contradict it before reading on.
Late-year sales on credit could leave more recent invoices outstanding despite lower annual sales. An aging breakdown showing a larger overdue share under unchanged payment terms would challenge that explanation.
A plausible story earns a test, not a free pass.
Minute 14–15: choose your follow-up
Make your final choice and give a reason before reading the model answer. The review can establish one finding while leaving another open.
The model answer fits in three sentences:
Profit falls 22.5%, FCF drops to $40 million, and $15 million of borrowing explains the extra $1 million in cash.
Collection reliability and repayment timing remain unknown.
Request aging with payment terms and the debt schedule with loan conditions before calling the buffer comfortable.
Use the lesson links when a step needs a refresher. Price versus value is an optional next skill: financial health alone cannot establish an attractive price. Your diversified-fund plan can remain your complete investing route.
In short
- Match source, period, units and definitions before judging a result.
- More cash in the bank can come from borrowing while the business weakens.
- A quick ratio still depends on customers paying their bills.
- Name the missing evidence and the conclusion it prevents.
- A specific follow-up or justified pause completes a first-pass review.