HANDOUTS ON FUNDAMENTALS OF be extremely valuable in planning

FINANCIAL MANAGEMENT 1 (For intermediate and long-term financing

Classroom Discussion) of the firm. It reveals the firms total
Ms. Carmelita U. de Guzman, CPA,MGM,CESO IV
prospective need for funds, the
Chapter 7: Funds Analysis, Cash
expected timing of these needs, and
Flow Analysis, and Financial
their nature that is, whether the
Planning
increased investment is primarily for
(Reference: Van Horne and John M.
inventories, fixed assets, and so forth.
Wachowicz, Fundamentals of Financial
4. Analyzing the Statement of Cash
Management, 13th edition)
Flows
1. Flow of Funds Statement a a) The statement of cash flows has
summary of a firms changes in replaced the flow of funds statement
financial position from one period to when the firm is required to present a
another; also called a sources and complete set of financial statements.
uses of funds statement or a However, unlike the cash flow
statement of changes in financial statement, the flow of funds
position. This portrays net rather statement does not omit the net
than gross changes between two effects of important noncash
comparable balance sheets at transactions. In addition, the flow of
different dates. funds statement is easy to prepare
2. Sources of Funds: and is often preferred by managers
o Any decrease in an asset item over the more complex cash flow
o Any increase in a claim item statement.
Uses of Funds: b) A major benefit of the statement of
o Any increase in an asset item cash flows (especially under the direct
o Any decrease in a claim item method) is that the user gets a
reasonably detailed picture of a
3. Analyzing the Sources and Uses of
companys operating, investing and
Funds Statement
financing transactions involving cash.
a) The analysis of funds statements
c) This three-part breakdown of cash
gives us insight into the financial
flow aids the user in assessing the
operations of a firm that will be
companys current and potential
especially valuable if we assume the
future strengths and weaknesses.
role of a financial manager examining
Strong internal generation of
past and future expansion plans of the
operating cash, over time, would be
firm and their impact on liquidity.
considered a positive sign.
Imbalances in the uses of funds can
Poor operating cash flow should
be detected and appropriate actions
prompt the analyst to check for
taken.
unhealthy growth in receivables
b) Another use of funds statements is
and/or inventory. Too much reliance
in the evaluation of the firms
on external financing sources to meet
financing. An analysis of the major
recurring needs may be a danger
sources of funds in the past reveals
signal.
what portions of the firms growth
d) When used with other financial
were financed internally and
statements and disclosures, the
externally. In evaluating the firms
statement of cash flows should help
financing, we want to evaluate the
the analyst to assess a firms ability to
ratio of dividends to earnings relative
generate cash for dividends and
to the firms total need for funds.
investment, identify a firms needs for
c) Funds statements are also useful in
external financing, and understand
judging whether the firm has
the differences between net income
expanded at too fast a rate and
and net cash flow from operating
whether the firms financing capability
activities.
is strained. One can determine
5. Cash Budget a forecast of a
whether trade credit from suppliers
firms future cash receipts and
(accounts payable) has increased out
disbursements.
of proportion to increases in current
a) This forecast is particularly useful
assets and to sales.
to the financial manager in
d) As a financial manager, an analysis
determining the probable cash
of a funds statement for the future will
balances of the firm over the near

1
future and in planning prospective
cash needs.
b) In addition to analyzing expected
cash flows, the financial manager
should take into account possible
deviations from the expected
outcome. An analysis of the range of
possible outcomes enables
management to better assess the
efficiency and flexibility of the firm
and to determine the appropriate
margin of safety.
Chapter 13: Cash Flow Analysis
(Reference: Cabrera, Ma. Elenita
Balatbat, Financial Management
(Principles and Applications, vol. 1)
2015 edition)
1) Statement of Cash Flows, defined
a) It is a financial statement that
shows the firms cash flows over a
given period of time. It reports the
amounts of cash that the firm
generated and distributed during a
particular time period.
b) The bottom line on the statement
of cash flows (the difference between
cash sources and uses) equals the
change in cash on the firms
statement of financial position from
the previous years cash account
balance.
c) The statement of cash flows
reconciles income statement items
and noncash statement of financial
position items to show changes in the
cash and marketable securities
account on the statement of financial
position over the particular analysis
period.
2) Usefulness of the Statement of
Cash Flows
a) The primary purpose of a cash flow
statement is to provide relevant
information about a companys cash
receipts and cash payments during an
accounting period that is useful in
evaluating the preceding items.
b) Phil. Accounting Standards (PAS) 7
states that the information in a
statement of cash flows, if used with
information in the other financial
statements, should help users to
assess and evaluate:
b.1) a companys ability to generate
positive future net cash flows
b.2) a companys ability to meet its
obligations and pay dividends
b.3) a companys need for external
financing
b.4) the reasons for differences
between a companys net income and
associated cash receipts and
payments, and
b.5) both the cash and noncash
aspects of a companys financing and
investing transactions during the
accounting period.
c) The following information may also
be obtained from the cash flow
statement:
c.1) the changes in net assets of an
enterprise and its ability to affect the
amounts and timing of cash flows in
order to adopt to changing
circumstances and opportunities.
c.2) the ability of the enterprise to
generate cash and cash equivalents
and enables the users to develop
models to assess and compare the
present value of the future cash flows
of different enterprises, and
c.3) it enhances the comparability of
the reporting of operating
performance by different enterprises
because it eliminates the effects of
using different accounting treatments
for the same transactions and events.
d) The statement of cash flows
likewise provide the means of
measuring a business firms
d.1) Financial Liquidity which
refers to the measures to cash of
assets and liabilities, using the
formula:
Current Cash Debt Coverage
Ratio =
Net Cash Provided by Operating
Activities / Average Current
Liabilities
This indicates whether the company
can pay off its current liabilities from
its operations in a given year. The
higher the current cash debt coverage
ratio, the less likely a company will
have liquidity problems.
d.2) Financial Flexibility which
refers to a companys ability to
respond and adapt to financial
adversity and unexpected needs and
opportunities, by using the formula:
Cash Debt Coverage Ratio =
Net Cash Provided by Operating
Activities / Average Total
Liabilities
This indicates a companys ability to
repay its liabilities from net cash
provided by operating activities,
2
without having to liquidate the assets
employed in its operations. The
higher the ratio, the less likely the
company will experience difficulty in
meeting its obligations as they come
due. It signals whether the company
can pay its debts and survive if
external sources of funds become
limited or too expensive.
A more sophisticated way to
examine a companys financial
flexibility is to develop a free cash
flow analysis by deducting from the
net cash provided by operating
activities, those of capital
expenditures and dividends paid.
Free cash flow refers to the
amount of discretionary cash flow a
company has. It can use this cash
flow to purchase additional
investments, retire its debt, purchase
treasury shares, or simply add to its
liquidity.
If the free cash flow is positive,
the business firm could have
satisfactory financial flexibility.
Companies that have strong financial
flexibility can (a) take advantage of
profitable investment even in tough
terms; and (b) be free from worry
about survival in poor economic
terms.
3) Basic Approach to a Cash Flow
Statement
a) Cash and Cash Equivalents,
defined
Cash includes cash itself and cash
equivalents which consist of short-
term, highly liquid investments such
as treasury bills, SEC registered
commercial papers and money market
funds. Such investments are made
solely for the purpose of generating a
return on funds that are temporarily
idle.
b) Classification of Cash Flow
Activities
b.1) Operating activities - include
delivering or producing goods for sale
and providing services; and the cash
effects of transactions and other
events that enter into the
determination of income.
The amount of cash flows
arising from operating activities is a
key indicator of the extent to which
the operations of the enterprise have
generated sufficient cash flows to
repay loans, maintain the operating
capability of the enterprise, pay
dividends and make new investments
without recourse to external sources
of financing.
Examples:
INFLOWS: sales of goods; revenue
from services; returns on interest
earnings assets (interest); returns on
equity securities (dividends); receipts
from contracts held for dealing and
trading purposes; tax refunds unless
identified with financing and investing
activities
OUTFLOWS: payments for the
following: purchases of inventories;
operating expenses (salaries, rent,
insurance, etc); purchases from
suppliers other than inventory;
lenders; taxes unless identified with
financial and investing activities
b.2) Investing activities - include
acquiring and selling, or otherwise
disposing of (a) securities that are not
cash equivalents and (b) productive
assets that are expected to benefit
the firm for long periods of time; and
lending money and collecting on
loans.
The separate disclosure of cash
flows arising from investing activities
is important because the cash flows
represent the extent to which
expenditures have been made for
resources intended to generate future
income and cash flows.
Examples:
INFLOWS: sales of long-lived assets
such as property, plant and
equipment, intangibles and other
long-term assets; sales of debt or
equity securities of other entities;
collection of loans (principal) to others
(other than advances and loans made
by a financial institution)
OUTFLOWS: acquisitions of long-
lived assets such as property, plant
and equipment, intangibles and other
long-term assets; purchases of debt
or equity securities of other entities;
loans (principal) to others (other than
advances and loans made by a
financial institution)
b.3) Financing activities include
borrowing from creditors and repaying
the principal; and obtaining resources
from owners and providing them with
a return on the investment.
The separate disclosure of cash
flows arising from financing activities
is important because it is useful in
predicting claims in future cash flows
3
by providers of capital to the
enterprise.
Examples:
INFLOWS: proceeds from borrowing
(short-term and long-term); proceeds
from issuing the firms own equity
securities
OUTFLOWS: repayment of debt
principal; repurchase of a firms own
shares; payment of dividends;
acquisition of the enterprises own
shares
4. Calculating Cash Flow from
Operating Activities
a) Direct Method
a.1) In reporting the cash flows from
operating activities, enterprises are
encouraged to report major classes of
gross cash receipts and gross cash
payments and the net cash flow from
operating activities.
a.2) At a minimum, the following
classes of operating cash receipts and
payments should be separately
reported:
o Cash collected from customers,
including lessees, licensees and
the like
o Interest, fees, royalties and
dividends received]
o Other operating cash receipts, if
any
o Cash paid to employees and
other suppliers of goods or
services
o Interest paid
o Income taxes paid
o Other operating payments, if
any
o Contracts held for dealing or
trading purposes

b) Indirect Method
b.1) Enterprises that choose not to
provide the major classes of operating
cash receipts and payments by the
direct method shall determine and
report the same amount of net cash
flow from operating activities
indirectly by adjusting net income to
reconcile it to net cash flow from
operating activities.
b.2) Regardless of whether the direct
or indirect method of reporting net
cash flow from operating activities is
used, the reconciliation of net income
to net cash flow from operating
activities shall be presented.