Understanding the Statement of Cash Flows

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Understanding the Statement of Cash Flows

• Chapter 4
• UWYO COB ACCT 2000

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Learning Objectives

• The uses of cash flow information
• Understand cash flow statement
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
• Estimate free cash flow and EBITDA

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The uses of cash flows

• Evaluate liquidity
• A company cannot pay employees, creditors and
  others with accrual-based net income.
• Evaluate the ability to generate cash flow from
  operation
• A cash-based measure of profitability
• Assess the quality of earnings
• Persistent and large difference between earnings
  and cash flows is an indication of poor quality
  of earnings
• Predict future cash flows

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Statement of Cash Flows

• Explain the change of the cash accounts via three
  categories
• Net cash flows from operating activities
• Net cash flows from investing activities
• Net cash flows from financing activities
• Cash paid for interest and dividend operating or
  financing?

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An example of Statement of Cash Flows
P5, P2, P16
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Cash Flows from Operating Activities

• Provide information about the ability to generate
  cash flow from operation
• A cash-based measure of profitability
• Methods of presentation
• Direct the cash version of income statement
• Indirect Net income adjusted for certain items

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Cash Flows from Operating Activities Direct
method

• Cash collected from customers
• Cash paid to suppliers
• Cash paid for wages
• Cash paid for SGA costs
• Cash paid for interest

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An example of Cash Flows from Operating
Activities - Direct Method
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Cash Flows from Operating Activities Indirect
method

• Begin with net income
• Make adjustments
• Non-cash items
• Changes in working capital
• Remove non-operating items

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An example of Cash Flows from Operating
Activities - Indirect Method

• P4, P8, P12

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Cash Flows from Investing Activities

• Typically involves non-current assets
• Cash acquisitions of investments and property
• Cash generated upon disposal of investments and
  property

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An example of Cash Flows from Investing Activities
P10
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Cash Flows from Financing Activities

• Long-term liabilities
• Cash obtained from borrowing
• Cash used for the repayment of principal
• Equity
• Cash obtained from stock issuance
• Cash used to repurchase treasury shares
• Cash used for dividend payments

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An example of Cash Flows from Financing Activities
P3, P5, P17
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Statement of Cash FlowsAdditional Disclosures

• Cash paid for interest
• Cash paid for taxes
• Significant non-cash transactions

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An example of Additional Disclosures
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Cash analysis

• Determine free cash flow
• Free cash flow to the firm
• available to both debt and equity holders
• Free cash flow to equity
• available to equity holders only
• Estimate cash flow with EBITDA

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Free Cash Flow (FCF)

• FCF to the firm
• Operating cash flow
• Plus Interest paid (1-tax rate)
• Plus Disposition of fixed capital
• Less Investments in fixed capital
• Free cash flow to the firm
• FCF to equity
• Operating cash flow
• Plus Disposition of fixed capital
• Less Investments in fixed capital
• Plus New Debt Borrowing
• Less Debt Repayment
• Free cash flow to equity
• P13

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Earnings before Interest, Taxes, Depreciation and
Amortization

• An estimate of Cash Flow
• Net income (loss)
• Plus Interest expense
• Plus Tax expense
• Plus Depreciation Amortization expense
• EBITDA
• Caution
• P14 P9

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Summary

• The uses of cash flow information
• Statement of cash flows
• Operating
• Investing
• Financing
• Cash analysis
• Free cash flow
• EBITDA

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Problems and Cases

• Statement of cash flows
• Operating
• General P15 (B), P2 (D), P16 (A)
• Indirect method P4 (B), P8 (OCF140), P12
  (OCF13,050,000)
• Investing
• P10 (-50 million cash from investing activities)
• Financing
• P3 (B), P5 (C), P17 (B)
• Cash analysis
• Free cash flow
• P13 (FCF includes primarily operating and
  investing cash flows),
• EBITDA
• P14 (? Working Capital) P9 (a. not sufficient
  b. ? Working Capital)

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Problems and Cases

• Case 4-1
• Cash flows and earnings can be very different.
• Change of working capital may be attributable to
  the difference (e.g. large increase of account
  receivable)
• Again, pay attention to one-time charges