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2. The Statement of Cash Flows. Provides information about cash inflows and outflows during an accounting period. Shows how cash makes its way from the Income Statement to the Balance Sheet.. 3. The Statement of Cash Flows Con't.. Required by SFAS
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1. 1 FINANCIAL STATEMENT ANALYSIS Lecture 4
2. 2 The Statement of Cash Flows
Provides information about cash inflows and outflows during an accounting period.
Shows how cash makes its way from the Income Statement to the Balance Sheet.
3. 3 The Statement of Cash Flows Con’t. Required by SFAS #95 - Statement of Cash Flows
Replaced the Statement of Changes in Financial Position in 1988
Is created from existing Balance Sheet and Income Statement data
4. 4 The Statement of Cash Flows Con’t. “A positive net income on the income statement is ultimately insignificant unless a company can translate its earnings into cash.
The best source in financial statement data for learning about the generation of cash from operations is the statement of cash flows”
5. 5 Income Flows vs. Cash Flows Cash flows do not equal income flows
Why not?
Accrual accounting used for net income
(i.e. revenue reported but no cash received)
Noncash expenses
(i.e. depreciation)
6. 6 Cash Flows from Operations Indirect method
2 types of adjustments:
Non-“working capital” accounts (Type 1)
Adjustments for changes in working capital accounts (Type 2)
What is working capital?
Current assets minus current liabilities
7. 7 Cash Flows from Operations Non-“working capital” accounts
depreciation
deferred income taxes
stock option expense
gain/loss on disposition of PP&E
Important – Here, the flow is already reported on the income statement so balance sheet comparisons are not applicable.
Working capital accounts
accounts receivable, inventories, etc.
accounts payable, current liabilities, etc.
8. 8 Net Income relative toCash Flows from Operations Type 1 adjustments
usually increase cash flows over net income
Type 2 adjustments’ effects depend on:
Firm’s stage in life cycle
Length of firm’s operating cycle
9. 9 Product Life Cycle Introduction/Early Growth:
Revenues are low
Net income may be negative (losses)
Negative CF from operating activities
Negative CF from investing activities
External financing (Positive CF from financing)
10. 10 Product Life Cycle Growth:
Increasing revenues
Net income becomes positive
Increasing cash flows from operations
Continuing negative cash flows from investing activities
Decreasing positive cash flows from financing activities Changes in non-current accounts will be changes from investing activities.Changes in non-current accounts will be changes from investing activities.
11. 11 Product Life Cycle Maturity:
Peak revenues
Net income also peaks
Positive cash flows from operations
Cash flows from investing activities may begin to increase
Cash flows from financing activities may become negative (repayment of debt, stock repurchases, etc.)
12. 12 Product Life Cycle Decline:
Revenues decrease
Net income decreases (may become negative)
Cash flows from operations decreases
Cash flows from investing activities positive (as firm divests)
Cash flows from financing activities negative
13. 13 The Statement of Cash Flows Con’t. It also helps identify cash needs to fund growing revenue and related growing accounts receivable concerns.
Many companies get in trouble during rapid growth phases when they find they can’t pay their operational bills because cash is coming in too slowly.
14. 14 Objectives of the Lecture
To explain how the statement of cash flows is prepared
To interpret the information presented in the statement
15. 15 Preparing a Statement of Cash Flows
Begins with a return to the balance sheet
Prepared by calculating changes in all of the balance sheet accounts
16. 16 Preparing a Statement of Cash Flows - Continued The easiest way to understand how to prepare a Statement of Cash Flows is to assume that the change in each item is directly related to cash and nothing else.
For instance:
Balance Sheet item
2002 2003
Inventory $1 mil. $2 mil. ?
Cash $6 mil. $5 mil. ?
$1 million in cash was used to increase inventory = Cash Outflow.
17. 17 Preparing a Statement of Cash Flows - Continued
Balance Sheet item
2002 2003
Inventory $2 mil. $1 mil. ?
Cash $6 mil. $7 mil. ?
$1 million in cash was generated from inventory sales = Cash Inflow.
18. 18 Preparing a Statement of Cash Flows - Continued
Balance Sheet item
2002 2003
Accounts Payable $3 mil. $1 mil. ?
Cash $6 mil. $4 mil. ?
$2 million in cash was used to pay a bill = Cash Outflow
19. 19 Preparing a Statement of Cash Flows - Continued
Summary
2002 2003 Cash Flow
Inventory 1 $1mil. $2 mil. $(1 mil.)
Inventory 2 $2mil. $1 mil. $ 1 mil.
Accounts Payable 1 $3mil. $1 mil. $ (2 mil.)
Cash Flow from Ops. $ (2 mil.)
Very, very simple Cash Flow statement!
20. 20 Preparing a Statement of Cash Flows Continued Cash
Operating activities
Investing activities
Financing activities
21. 21 IN GENERAL:
Changes in current assets and current liabilities affect Operating Activities
Changes in Fixed Assets and other noncurrent assets affect Investing Activities
Changes in Long-term liabilities and Stockholders’ Equity accounts (except net income) affect Financing Activities
22. 22 Preparing a Statement of Cash Flows Notable Exceptions:
Marketable securities—these are considered to be Investing Activities, regardless of short-term nature
Notes payable—if payable to banks, are considered financing activities, even if very short-term
Current portion of long-term debt—financing
23. 23 Preparing a Statement of Cash Flows Continued Cash & Cash equivalents:
24. 24 Preparing a Statement of Cash Flows Continued Short-term investments:
25. 25 Preparing a Statement of Cash Flows Continued Delivering or producing goods for sale and providing services
The cash effects of transactions and other events that enter into the determination of income
26. 26 Preparing a Statement of Cash Flows Continued Cash flows resulting from sales of goods
Purchase of inventories,
Payment of operating expenses
27. 27 Preparing a Statement of Cash Flows Continued Acquiring/disposing of securities that are not cash equivalents
Acquiring/disposing of productive assets
Lending money/collecting on loans
28. 28 Preparing a Statement of Cash Flows Continued Borrowing from creditors/repaying the principal
Obtaining resources from owners
Providing owners with a return on investment
29. 29 Preparing a Statement of Cash Flows Continued
30. 30
*Data from SEC website, www.sec.gov
31. 31 Preparing a Statement of Cash Flows Continued Look at changes in balance sheet accounts from beginning to end of accounting period
32. 32 Preparing a Statement of Cash Flows Continued Transfer the account changes to the appropriate area of a statement of cash flows
33. 33 Preparing a Statement of Cash Flows Continued
34. 34 Calculating Cash Flow from Operating Activities Direct Method
Indirect Method
35. 35 Direct vs. Indirect Method Direct Method – Start with Revenue and works down to actual cash flow
Indirect Method – Start with Income and works back to cash flow
Very Very important Note - Remember, it is a statement of Cash “FLOWS”. The entry for balance sheet items is based on the change between periods, the equivalent of a “flow”. The entry for Operating/Income/Earnings statement items is the actual number (these numbers already are a “Flow”).
36. 36 Calculating Cash Flow from Operating Activities Continued Shows cash collections from customers, interest and dividends collected, other operating cash receipts, cash paid to suppliers and employees, interest paid, taxes paid and other operating cash payments
37. 37 Calculating Cash Flow from Operating Activities Continued Starts with net income and adjusts for deferrals; accruals; noncash items, such as depreciation and amortization; and nonoperating items, such as gains and losses on asset sales
38. 38 Calculating Cash Flow from Operating Activities Continued 593 firms out of 600 (99%) used the indirect method in 2003 according to Accounting Trends and Techniques
39. 39 Calculating Cash Flow from Operating Activities Continued
40. 40 Calculating Cash Flow from Operating Activities Continued
41. 41 Calculating Cash Flow from Operating Activities Continued
42. 42 Calculating Cash Flow from Operating Activities Continued
43. 43 Analyzing the Statement of Cash Flows Is an important analytical tool for creditors, investors and other users of financial statement data
44. 44 Analyzing the Statement of Cash Flows Con’t. Firm’s ability to generate cash flows in the future
Firm’s capacity to meet cash obligations
Firm’s future external financing needs
45. 45 Analyzing the Statement of Cash Flows Con’t. Firm’s success in productively managing investing activities
Firm’s effectiveness in implementing financing and investing strategies
46. 46 Cash Flow from Operations Pay dividends or invest in new equipment
Service debt
47. 47 Cash Flow from Operations Continued It is also possible for a firm to be profitable and go bankrupt
48. 48 Cash Flow from Operations Continued How?
The problem is cash
49. 49 Cash Flow from Operations Continued The ongoing operation of any business depends upon its success in generating cash from operations
50. 50 Statement of Cash Flows
Cash flow from operating activities
Cash inflows
Cash outflows
51. 51 Statement of Cash Flows Continued The success or failure of the firm in generating cash from operations
The underlying causes of the positive or negative operating cash flow
52. 52 Statement of Cash Flows Continued
The magnitude of positive or negative operating cash flow
Fluctuations in cash flow from operations over time
53. 53 Summary Analysis of the Statement of Cash Flows Provides an approach to analyzing a statement of cash flows that can be used for any firm that provides comparative cash flow data
54. 54 Analysis of the Statement of Cash Flows (cont.)
55. 55 Summary Analysis of the Statement of Cash Flows Con’t. The information underlines the importance of internal cash generation—from operations—and the implications for investing and financing activities when this does and does not occur
56. 56 Analysis of Cash Inflows Capital expenditures and expansion
Repayments of debt
Payments of dividends
57. 57 Analysis of Cash Inflows Con’t. When analyzing the cash outflows, the analyst should consider the necessity of the outflow and how the outflow was financed
58. 58 Summary Cash Flow Table.