SolutionCASE 3-1Cash Flow Analysis – Orthodontic Centers of America

1. Actual cash collection for year 1998 to 2000:

2000 1999 1998Total Receivables 3.535.000 87.563.000 66.477.000

net change (84.028.000) 21.086.000 66.477.000

Patient prepayments - - 4.326.000 net change - (4.326.000) 4.326.000

Net Revenue 268.836.000 226.290.000 171.298.000 Less: change in account receivable 84.028.000 (21.086.000) (66.477.000)Plus: change in advances - (4.326.000) 4.326.000

Actual Cash Collections 352.864.000 200.878.000 109.147.000

2. (i) Comparison of cash collection with revenue reported for each year:

2000 1999 1998Cash Collections 352.864.000 200.878.000 109.147.000 Reported Revenue 268.836.000 226.290.000 171.298.000

% Change 31,26% -11,23% -36,28%Difference 84.028.000 (25.412.000) (62.151.000)

(ii) Comparison of cash collection with revenue using pre-Januay 1, 2000 recognition method:

(iii) Comparison of cash collection with revenue using post-Januay 1, 2000 recognition method with adjustment on reported 1998 and 1999 revenue, using pro-forma earnings and assumption 35% tax rate:

2000 1999 1998Cash Collections 352.864.000 200.878.000 109.147.000 Revenue recognition post-Jan1, 2000 method 242.536.000 201.302.308 151.002.769

% Change 45,49% -0,21% -27,72%Difference 110.328.000 (424.308) (41.855.769)

2000 1999 1998Cash Collections 352.864.000 200.878.000 109.147.000 Revenue recognition pre-Jan1, 2000 method 295.136.000 249.081.576 189.915.926

% Change 20% -19% -43%Difference 57.728.000 (48.203.576) (80.768.926)

3. From tax perspective, revenue recognition post-January 1, 2000 method is appropriate as it results in a lower net revenue and thus lowering the tax expense. And a straight line allocation method is better represent the actual revenue recognized at the time the contract is signed.

4. The trends of cash from operations, cash for investing, free cash flows, and cash from financing:Free Cash Flow used here is FCF to Equity

2000 1999 1998Cash Flow from Operating activities 39.644.000 23.347.000 22.109.000 Less: Net Investment in Fixed Capital (20.271.000) (22.520.000) (17.638.000)Less: Debt Repayment (6.530.000) (6.742.000) (7.864.000)Free Cash Flow to Equity 12.843.000 (5.915.000) (3.393.000)

Cash flow from operation is increasing with 34% growth and cash flow used in investing activities also increase due to the acquisition of new affiliated orthodontists and the purchase of property & equipment. However, free cash flow to equity is negative in 1998 and 1999 means that OCA does not have enough operating cash flow over amounts needed for investments and repayment of debt. Further, cash flow derived from financing activities decrease by -21% from 1998 to 2000.

2000 1999 1998 Growth

Cash From Operations 39.644.000 23.347.000 22.109.000 34%Cash for Investing (48.533.000) (43.075.000) (43.159.000) 6%Free Cash flows 12.843.000 (5.915.000) (3.393.000) n/aCash from Financing 7.884.000 23.949.000 12.786.000 -21%

5. The company acquires new affiliated orthodontists through a stock purchase, and entering into a Service Agreement with the orthodontist.

Transactions with Orthodontic Entities

Years Ended December 312000 1999 1998

Notes payable issued $ 1.255.000 $ 3.600.000 $ 8.700.000 Remainder (primarily cash) $ 28.246.000 $ 17.190.000 $ 43.994.000 Share Value (at average cost) $ 4.719.000 $ 910.000 $ 4.206.000 Total Acquisition Costs $ 34.220.000 $ 21.700.000 $ 56.900.000 Common Stock Shares Issued 227.000 80.000 253.000

(a) Since Notes payable issued and Share Value (at average cost) is a Noncash Investing And Financing Activities, the transactions do not affect OCA’s cash from operation, cash for investing, and free cash flow. The transactions are reported separately in Supplemental Disclosure. However, the remainder of the total acquisition cost is allocated to an intangible asset acquired, which represents the costs of obtaining the Service Agreement, so that it affects OCA’s cash for investing activities, but it does not affect free cash flow as it is not investment of fixed capital.

(b) The reporting of the cash flows associated with the acquisition of affiliated practices reported as an intangible asset, because the acquisition ussually in a form of a stock purchase or entering a service agreement. Or it can also be reported as acquisition of businesses but the acquired tangible asset is not part of fixed capital.While, the reporting of cash flows associated with newly developed practices deals with investing in fixed capital which ussually need expenditures for property and equipment. And this investment will affect the amount of free cash flow.

6. The effect of the company’s treatment of the affiliated practice acquisition costs on the analysis of the company’s cash flows is adding the investing activities in intangible assetss acquired that increases cash outflow used in investing activities . An alternative approach to cash flow analysis are: common size analysis which to express each line item as a percentage of net revenue; cash flow ratio with one of the ratio is cash flow from operation devided by cash outflows for investing and financing activities; then free cash flow to the firm.

2000 1999 1998Cash Flow from Operating 39.644.000 23.347.000 22.109.000 Less: Net Capital Expenditures (20.271.000) (22.520.000) (17.638.000)

Free Cash Flow 19.373.000 827.000 4.471.000 GrowthCash From Operations 39.644.000 23.347.000 22.109.000 34%Cash for Investing (acquisition cost adjustment)

(48.533.000) (43.087.000) (44.937.000)4%

Free Cash flows 19.373.000 827.000 4.471.000 108%Cash from Financing 7.884.000 23.949.000 12.786.000 -21%

Investing & Financing Ratio 98% 122% 69%

Using this free cash flow approach results in a higher growth of free cash flow.