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Importance of Cash Flows in Financial Analysis

Cash flows are crucial for a company's financial stability and growth. Analyzing cash inflows and outflows helps identify profit potential and foresee financial problems. Learn how to analyze cash flows and understand the different activities that impact a company's cash position.

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Importance of Cash Flows in Financial Analysis

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  1. Chapter 12 Statement of Cash Flows

  2. Compare Companies • INCOME Company A Company B • Sales $500 $500 • Expenses 425 425 • Net Income $ 75 $ 75 • CASH • Beginning of Year $25 $25 • End of Year 25 25 • Change in CASH -0- -0-

  3. Cash Activities • Company A B • Cash Rec’d • Customers $450 $350 • Sale of PA 5 60 • Total $455 $410 • Cash Paid • To suppliers $380 $400 • Purch of PA 70 10 • Purch Invest 5 0 • Cash Paid $455 $410 • Change in Cash -0- -0-

  4. Why Are Cash Flows Important? Cash is what pays the bills. You must sell your product and collect cash from your customers in time to: 1. Pay suppliers for merchandise purchases 2. Pay the bank on any loans (debt) 3. Pay employees their wages 4. Pay taxes 5. Purchase new equipment as needed. Analyzing where a company’s cash is coming from & where it is being spent may assist in detecting future profit potential and/or future financial problems.

  5. NET CASH FLOWS Cash Inflows --Cash Outflows = Net Cash Flows

  6. Two parts of Cash Flow Statement • Activities • Operating • Investing • Financing • Cash Balance verification Increase (Decrease) in cash Cash at Beginning of Year Cash at End of Year (Balance Sheet)

  7. Cash Flows from Operating Current accounts: current assets, current liabilities 1. Cash received from customer Cash A/R 2. Cash paid to suppliers A/P Cash

  8. Investing Activities • Invest in Yourself • Purchase of plant assets ( minus cash) Building Cash -- Sale of plant assets ( plus cash) Cash Building

  9. Investing Activities (2) • Investments in Others • Purchase of other company’s stock or bonds • Sale of other company’s stock or bonds • Loaning money to other company (N/R) • Collection of principle payments on loan

  10. Financing 1. Equity ( Your own company) • Issuing shares of stock • Retiring shares of stock • Purchasing shares of treasury stock • Selling shares of treasury stock • PAYING CASH DIVIDENDS ON STOCK

  11. Financing 2 • DEBT Borrowing cash Cash M/P Repaying Principle on a loan M/P Interest Expense Cash

  12. “Foolers” • Interest Paid • Decision to go into debt is Financing activity • Paying interest on the debt is operating or current • Interest Received • Decision to loan money is an investing activity • Receiving interest on loan is operating or current • Dividends Received • Decision to purchase other company’s stock-investing • Receiving dividends is operating or current • Dividends paid - different • Decision to sell stock is Financing activity • Paying dividend to stockholders is also financing activity

  13. Schedule of Non Cash Activities Need to be reported if will affect cash flows in the future. Activities: • Purchasing plant assets by signing a note payable • Purchasing a building through a mortgage loan • Exchanging stock for plant assets • Issuing stock to retire debt • Converting preferred stock to common stock

  14. Operating (O), Investing (I), Financing (F)Source (+), Use (-) 1. Earned a net income O + 2. Paid Cash Dividend F- • Issued stock for cash F+ • Retired Long Term Debt by issuing stock Non Cash 5. Paid A/P O- 6. Purchased inventory with cash O-

  15. Review Sheet. • Homework • Read Chapter 12 or whatever book with cash flow • OR • Watch the narrated power slides on book website • DO 12-1, 12-10 – Activities • DO 12-2 Cash Flow from Operations • DO 12-3 Free Cash Flow • DO 12-8 Statement of Cash Flow • 12-14 -- Analysis

  16. BASIC STRUCTURE OF A STATEMENT OF CASH FLOWS Cash provided (used) by: Operating activities Investing activities Financing Activities Net Incr (decr) in cash and cash equiv Cash and Cash Equiv at beginning of year(last year) Cash and Cash Equiv at end of year

  17. Cash Flow Statement- operating Start with Income on an Accrual Basis, (Net Income) Accrual transactions(No cash in transaction): Dr. A/R Cr. Sales Dr. Advertising X Cr. A/P Then make adjustments (incr or decr) net income to show income on a Cash Basis.

  18. Indirect method • Income from continuing operations (accrual income) • Add: Depreciation, depletion, and amoritization X • Add/decr changes in Current Assets • Add/Decr changes in Current Liabilities • Add back any non cash losses or decr any non cash gains • = Net cash flow from operating activities • This number should always be positive • See Page 555

  19. Changes in Current Assets • Current assets increase ---decrease in cash flow • A/R • Sale I Receive • On Acct I Cash • OPPOSITE • Inventory • Buy I Sale • Inventory I Inventory

  20. Changes in Current Liabilities • Current liabilities increase ---increase in cash flow • A/P • Pay I Purchase • Cash I on acct • SAME

  21. Steps for CFO (Cash flow from Operations) • 1. Write down Net Income from Income Statement • 2. Add in Depreciation and Amortization • 3. Record changes to Current Assets and Current Liabilities • 4. Add in any non cash losses/subtract any non cash gains (sale of plant assets)

  22. Basic Concepts for Investing and Financing Section • Paying back decreases cash flow • Buying decreases cash flow • Selling increases cash flow • Sell stock for cash = issue stock increase cash flow • If you sell more plant assets than you buy your company is contracting • If you buy more than you sell your company is expanding

  23. Investing Basics-Review Problem PPE A.D Beginning Balance 309 194 PPE Sold (12) (5) Subtotal 297 189 Less Ending Balance 430218 Purchased/DeprX 133 29

  24. Financing Basics • RETAINED EARNINGS • Beginning 92 • Plus Net Income 66 • Subtotal 158 • Ending Bal 110 • Dividends 48

  25. Which one would you want to work for??????

  26. Last Section (Cash reconciliation) • Change in cash for the period • Add last year cash (beginning cash) from balance sheet • Should equal cash on balance sheet for current year (Check figure)

  27. Create a Cash Flow for Shubert

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