Statement of Cashflows
A. Why is SCF important?
1. Measurement of cash:
cash=currency+cash equivalent
cash equivalent:
a.Short-term (maturity less than 90 days), readily convertible into cash.
b.Insignificant risk to changes in value
Such as: money market funds, treasury bill, time deposits.
2.Significance:
when earnings are strong but cash flow is not, it's often a warning sign that there are problem!
3.Purpose of the SCF
How does a company obtain its cash?
Where does a company spend its cash?
What explains the change in the cash balance?
B. How to prepare SCF?
1.Classify Cash Flows:
a.Cash Flow Activities:
Operating Activities:
Major daily activities: purchase, processing and selling of products/ services
Related to IS, some current assets, some current liabilities
Investing Activities:
Acquire or dispose of long-lived assets/ Investments
Intangible assets, PP&E, long-term assets; short-term investment, loans to others
Financial Activities:
Raise cash from investor or creditor and repay/provide return
Short/long term debt, Capital stock, Treasury stock, Dividend
b.Classification:
classified as Inflow/Outflow; reported under OA/IA/FA
Non-cash Items unrelated to cash-NOS
depreciation and amortization. issue bonds (equity) for land (PP&E).
Cash Items:
OA:
Inflow:Sale of goods or services, Interest revenue, Dividend revenue
Outflow:Inventory payments, Interest payments, Wages, Utilities, rent, Taxes
IA:
Inflow:Sale of plant assets, Disposal of investment in other companies, Collection of principal on loans
Outflow:Purchase of plant assets, Purchase of investment in other companies, Making of loans to other entities
FA:
Inflow: Issuance of own stock, Borrowing, Reissuetreasury stock
Outflow: Dividend payment, Repaying principal on borrowing, Treasury Stock purchase
2.Prepare simple SCF (Direct Method)
information source:
beginning and ending cash balance
transactions involved cash
step:
1. Analyze the impact of each transaction on
cash
2. Categorize and aggregate cash flows for each category (OA, IA, and FA)
3. Prepare the SCF by listing items in order
3.Analyzing financial Statement to prepare SCF (Indirect Method)
a. Convert NI to CFO
1)Some items in IS do not belong to operating activities
Gain or loss from non-operating activities
-Gain +loss
2)Some items in IS are never related with cash
Operating revenue/expense never involves cash, such as Depreciation expense and Amortization expense
Add depreciation and amortization expense to net income
3)Other items involve cash, but revenue does not equal to cash received, and expense does not equal to cash disbursed
From sales to cash received from customers
From various expenses to cash paid
Double-entry system
Specifically:
#sales vs cash from customers
Analysis:
Dr. Account Receivable
Cr. Sales
Dr. Cash
Cr. Account Receivable
Conclusion:
cash collected=Sales-[A/R(end)-A/R(begin)]
#COGS to cash paid for inventory
Analysis:
Dr. Inventory
Cr. A/Ps
Dr. A/Ps
Cr. Cash
Dr. COGS
Cr. Inventory
Conclusion:
Purchase=COGS+[Inventory(end)-Inventory(begin)]
Cash Paid=Purchase-[A/Ps(end)-A/Ps(begin)]
#expense to cash paid for that expense
Analysis(for those who have their own account-interest & tax):
Dr. XX expense
Cr. XX payable
Dr. XX payable
Cr. cash
Conclusion:
for interest:
Interest Paid=Interest expense accrued-[Interest Payable(end)-Interest Payable(begin)]
for tax:
Tax Paid=Tax expense Accrued-[Tax Payable(end)-Tax Payable(begin)]
Summary:
Change in account balance during the year
Increase decrease
current asset - +
current liability + -
Caution-What should not be included:
Dividends payable Short-term loans from bank Notes payable Bonds to be paid with in one year
Notes receivable Short-term investment
C. How to interpret SCF?
1. Analysis SCF:
CFO CFI CFF General Explanation
1 + + + Building up pile of cash. Possibly looking for acquisition
2 + - - Operating cash flow being used to buy fixed assets and pay down debt
3 + + - Operating cash flow and sale of fixed assets being used to pay down debt
4 + - + Operating cash flow and borrowed money being used to expand
5 - + + Operating cash flow problems covered by sale of fixed assets, borrowing, and contributions
6 - - + Rapid growth, short-falls in operating cash flow, and purchase of fixed assets
7 - + - Sale of fixed assets is financing operating cash flow shortages
8 - - - Company is using cash reserves to finance cash flow short-falls and pay creditors
2. Free Cash Flow FCF
FCF=net cash provided by operating activities
− purchases of property and equipment
− property and equipment acquired under capital leases.
FCF is one of the key financial indicators of business performance over the long term
