CASH FLOW STATEMENT On the statement, cash flows are segregated based on source: Operating activities: involve the

cash effects of transactions that enter into the determination of net income. Investing activities: concern with buying (and selling) property, plants, and equipment (PPE); acquiring and disposing of securities of other entities; Financing activities: include issuance and reacquisition of a firm's debt and capital stock, and dividend payments. • Operating cash flows information indicates the business' ability to generate sufficient cash from its continuing operations • Investing cash flows information indicates how the business plans to expand Information about financing cash flows illustrates how the business plans to finance its expansion/reward shareholders.

Cash Flows - 1

: Net Income Non Cash Expenses: e.000 $50. Changes in operating (working capital) e. (as we shall see).Cash from operations: The statement of cash flows typically arrives at cash from operations by adding to (or subtracting from) net income two types of adjustments: 1. Cash Flows .000 15.000 $35. the direct method is more useful.g. For analytical purposes.2 . “Non-cash” expenses’ 2.000 5. Depreciation Change in operating accounts: Decrease in inventory Cash from operations $30.g.000 The format illustrated above follows the indirect method of presentation.

800 19X2 $60 520 770 $1.350 550 $1.900 $75 615 20 $710 350 310 400 130 $1. 1990 CFA adapted] The following financial statements are from the 19X2 Annual Report of the Niagara Company: Income Statement for Year Ended December 31.300 500 $1. transactional analysis. 19X1 O P E R A T I O N S I N VESTMENT Sales $1.000 Cost of goods sold (650) Depreciation expense (100) Sales and general expense (100) Interest expense (50) Income tax expense (40) Net income $60 Balance Sheets at December 31. 19X2. 19X2 Prepare a statement of cash flows for the year ended December 31.5.[Cash flow. 19X1 and 19X2 19X2 Δ Sales COGS Sales & General A/R Inventory A/P Interest Tax Expense Depreciation PP&E Purchase Int Payable Def Tax 19X1 Assets Cash Accounts receivable Inventory Current assets Fixed assets (net) Total assets Liabilities and equity Notes payable to banks Accounts payable Interest payable Current liabilities Long-term debt Deferred income tax Capital stock Retained earnings Total liabilities & equity $50 500 750 $1. Use the direct method.800 $100 590 10 $700 300 300 400 100 $1.900 Fixed Assets Notes Payable F I N A N C ING Debt Payment Stock Issue Dividend Net Income LTD Capital Stock Ret Earnings Cash Flows .3 .

4 .Niagara Company Sales $1.000 Cost of goods sold (650) Depreciation expense (100) SGA (100) Interest expense (50) Income tax expense (40) INDIRECT METHOD Cash from Operations Net Income 60 Non Cash Items Depreciation 100 Deferred taxes 10 Δ in operating accounts A/R (20) Inventory (20) Interest payable 10 A/P 25 165 Cash for Investment Capital Expenditures Cash for Financing ST Debt repayment LT Debt borrowing Dividends Change in Cash (150) (25) 50 (30) ( 5) 10 DIRECT METHOD Cash from Operations Cash collections Cash for inputs Cash SGA Cash for Interest Cash for Taxes 980 (645) (100) ( 40) ( 30) 165 Cash for Investment Capital Expenditures Cash for Financing ST Debt repayment LT Debt borrowing Dividends Change in Cash (150) (25) 50 (30) ( 5) 10 Cash Flows .

Cash Flows .Changes Included in Cash Flow from Operating Activities (CFO) Balance Sheet Account Accounts receivable Inventories Prepaid expenses Accounts payable Advances from customers Rent payable Interest payable Income tax payable Deferred income taxes Cash Flow Description Cash received from customers Cash paid for inputs (materials) Cash expenses Cash paid for inputs/expenses Cash received from customers Cash expenses Interest paid Income taxes paid Income taxes paid Changes Included in Cash Flow from Investing Activities (CFI) Balance Sheet Account Property. When a liability increases. the firm must have paid cash in exchange. and equipment Investment in affiliates Cash Flow Description Capital expenditures Proceeds from property sales Cash paid for acquisitions and investments Changes Included in Cash Flow from Financing Activities (CFF) Balance Sheet Account Notes payable Short-term debt Long-term debt Bonds payable Common stock Retained earnings Cash Flow Description Increase or decrease in debt Increase or decrease in debt Increase or decrease in debt Increase or decrease in debt Equity financing or repurchase Dividends paid The relationship between balance sheet changes and cash flows can be summarized as follows: • Increases (decreases) in assets represent net cash outflows (inflows). the firm must have received cash in exchange. 5 . If an asset increases. plant.P. • Increases (decreases) in liabilities represent net cash inflows (outflows).

000 30.000 10.000 10.000 (4.000 20.000 2.Converting Indirect Method Cash Flows to Direct Method: (Creating CFO from FFO) Cash Flows = Income Statement +/Balance Sheet Changes From Customer Sales ∆ A/R ∆ Advances To Suppliers COGS ∆ A/P ∆ Inventory For Expenses SG&A ∆ Accrued expense ∆ Prepaid Expense The Income Statement and the Cash Flow from Operations portion of the Statement of Cash Flows of the XYZ Company follow: Sales COGS Depreciation Wages Rent Interest Taxes 90.000 3.000) (3.000 Prepare the Cash Flow from Operations using the Direct Method: Cash Flows .000 3.000 5.P.000 Net Income Add: Depreciation ∆ in A/R ∆ in A/P Less: ∆ in Inventory ∆ in Rent Payable ∆ in Tax Payable 30.000 60.000) 36.000 10.000 12.000) (2. 6 .

• Cash from operations does not include cash outlays for replacing old equipment (required to ensure uninterrupted operating activities). Interest paid 5. • Identical firms that make different accounting choices may report different cash from operations.P. Interest and dividends received 4. Noncash transactions Drawbacks of cash from operations (analyst point of view). Examples: 1. depreciation is added back into income in arriving at cash from operations. investing. 2. Cash Flows . Although total cash flow is not subject to manipulation CFO (and CFF and CFI) is affected by reporting methods that alter the classification of cash flows among operating. Capitalizing expenditures-firms report higher cash from operations than expensing-firms. 7 .Cash Flow Classification Issues While the classification of cash flows into the three main categories is important. and financing categories 1. Leasing firms report lower cash from operations than purchasing firms as lease rentals reduce cash from operations whereas payments for purchasing reduce cash from investing activities. we must recognize that classification guidelines can be arbitrary. Differences due to some accounting methods 3. Cash flows involving Property Plant and Equipment 2. • Cash from operations does not include charges for the use of long-lived assets.

200 1 May be called Inventory: Work in Process at Contract Price and may be reported at times net of advances Cash Flows .000 2.800 1.Example: Assumptions: Project -3 year life Cash disbursements measure progress.500 3 1.200 Year Cash Inventory Current Assets Advances (CL) Retained Earnings Liability & Equity 1 100 900 2 500 1. Year Cash Receipts Disbursements Δ cash Δ cash cumul 1 1. 8 .000 0 2.000 1.000 1.200 600 1.200 1.000 1.200 1.000 300 700 1.000 1.000 CFO 100 400 BALANCE SHEET Completed Contract 3 3.000 2.000) 700 Total 3.200 INCOME & CASH FLOW Completed Contract Year 1 2 0 0 Revenues Expenses 0 0 0 0 Income Δ Inventory (900) (600) ΔAdvances 1.000 1.P.000 1.200 Percentage of Completion Percentage of Completion Year Revenues Expenses Income Δ A/R 1 1.800 1.200 500 500 0 600 1.200 CFO 1.800 1.000 1.200 0 1.000 1.800 Year Cash Accounts Receivable1 Current Assets Advances (CL) Retained Earnings Liability & Equity 1 100 2 500 3 1.000 1.500 (2.000 900 100 100 2 1.000 600 400 0 400 3 500 300 200 500 700 Total 3.200 600 1.000 600 400 500 3 1.200 0 1.200 Total 3.200 1.500 900 600 (500) 100 2 1.000 0 1.000 1.

P.000 500 1.000 4.000 500 0 1.500 Year Cash UFI Assets Retained Earnings Liability & Equity 1 500 0 2 2.500 Income 500 Add Deprec 2.500 Total 6.000 0 2.500 Cash Flows .500 2.500 1.500 4.000 4.500 3.Example: Assumptions: Project -3 year life Up front item (UFI) cost of $1.000 0 2. 9 .000 1.500) CFI 500 Δ Cash 2 2.000 CFO (1.000 3 2.000 2.500 500 2.500 Capitalize / Amortize Year Cash UFI Assets Retained Earnings Liability & Equity 1 500 2 2.000 4.500 4.000 500 1.500 6.500) 4.500 4.500 0 500 500 500 2.500 1.500 may be capitalized or expensed immediately.500 500 500 2 2.500 2.500 Capitalize / Amortize Year 1 2.500 500 500 2 2.500 4.000 Total 6.500 0 3 4.500 3 4.500 4.000 1.000 (1.500 4.500 3.500 3.500 INCOME & CASH FLOW Expense Year Revenues Expenses Income CFO BALANCE SHEET Expense 1 2. Year Cash / Income Pre "Up front item" Δ cash Δ cash cumul 1 2.500 4.000 0 2.000 3 2.000 2.000 1.000 2.000 Total 6.500 1.000 0 2.000 1.500 1.000 0 2.000 1.000 4.500 500 2.500 3 2.000 Revenues 500 Expenses 1.000 0 2.

which are classified as operating cash flows. analysts typically use free cash flows as an alternative measure for cash from operations defined as: CFO less net cash outlays for the replacement of operating capacity. This has the advantage of reporting identical cash from operations by two firms with different capital structure but otherwise identical. This has the advantages of reporting operating cash flows that reflect only operating activities of the firm's core business • Interest payments.FREE CASH FLOWS To overcome these problems. which are classified as operating cash flows. the free cash flow may overstate or understate true cash from operations. Thus. 10 . This may overstate (understate) the net investment in replacing equipment because some of the investment reported under cash used by investing activities may represent expansion (downsizing).P. should be reclassified (using the after-tax numbers) as investing cash flows. • Significant Noncash transactions Cash Flows . Although the definition implies that only net investment in replacing old equipment is subtracted from cash from operations. should be reclassified (using the after-tax numbers) as cash used by financing activities. in practice total investment appearing in the cash used by investing activity section of the statement of cash flows is used. Free cash flows still shares two drawbacks of cash from operations • Interest and dividends received.

The Effect of Accounting Policies • The cash flow statement allows the analyst to distinguish between the actual events that have occurred and the accounting assumptions that have been used to report these events. The (Validity) of the Going Concern Assumption • the statement of cash flows serves as a “check” on the assumptions inherent in the income statement. Consider the interrelationship between cash flow components over time Cash Flows . Review individual cash flow items for analytic significance 2. 3. 11 . Analysis of Cash Flow Trends The data contained in the statement of cash flows can be used to 1. Examine the trend of different cash flow components over time and their relationship to related income statement items.P.Alternatively CFO provides information as to Liquidity • The cash flow statement provides information about the firm's liquidity and its ability to finance its growth from internally generated funds.

12 .Cash Flows .P.

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