Reading 26: Understanding Cash Flow Statements. (Cash-flow categories…
Reading 26: Understanding Cash Flow Statements.
Cash from operating activities (CFO)
Cash inflow/outflow from transaction that affect a firm's net income
Cash from investing activities (CFI)
Cash inflow/outflow from acquisition/ disposal of long-term assets and certain investment.
Cash from financing activities (CFF)
Cash inflow/outflows from transactions affecting firm's capital structure.
Reporting non-cash investing and financing activities
Is not reported in the cash flow statement but must be disclosed in the footnote or other supplemental schedual
Different presentation between IFRS and GAAP
Dividends are paid in CFF
Interest paid/ received, Taxes, and dividend received are in CFO
Dividend & interest paid can be reported in CFO or CFF
Interest & dividend can be reported in CFO or CFI
Taxes are reported in CFO, unless they arise from investing or financing transactions.
Direct vs. Indirect method of presenting CFO
each line item of the accrued-based income statement is adjusted to get cash receipts or cash payment.
: it presents clearly the firm's operating cash receipt/payment
Net income is adjusted for non-cash transactions (depreciations, gains/losses from asset sales, etc.) and for change in balance sheet items.
: focus on the difference between net income and operating cash flow.
How Cash Flow Statement connects to Income Statement and Balance Sheet
Operating activities relate to Current Assets.
Financing activities relate to non-current liability and equity
Timing of revenue/expense recognition that differs from cash receipt/payment is reflected in changes in balance sheet accounts.
Preparing the Cash Flow Statement
Begin with net income, and adjust it for gains/ losses related to investing or financing cash flows, non-cash changes to income, and changes in balance sheet operating items.
Sum cash inflow/outflow for operating activities
Cash collection from customers
Sales adjusted for changes in receivables and unearned revenue.
Cash paid for inputs
CoGS adjusted for changes in inventory and account payables.
Cash operating expenses
SG&A adjusted for changes in related accrued liabilities or prepaid expenses.
Cash interest paid
Interest expense adjusted for changes in related accrued liabilities or prepaid expenses.
Cash taxed paid
Income tax expense adjusted for changes in tax payable and changes in deferred tax assets and liabilities.
is calculated by determining the changes in asset accounts that result from investing activities.
Cash flow from selling an asset = book value + any gain from the sale (or minus any loss)
is the sum of net cash flows from creditors (new borrowing - principal repaid) + net cash flows from shareholders (new equity issued - shares repurchased - cash dividend paid)
Convert Indirect to Direct CFO
Adjusting each income statement for changes in associated balance sheet accounts and by eliminating non-cash and non-operating items.
Analyzing Cash Flow Statement
Reported cash flow statement
Determine if a company is generating positive operating cash flow overtime, that is > capital spending needs
Determine if the accounting policies are causing reported earning to diverge from operating cash flow.
Common-size cash flow statement
Show each item as % of revenue; or
show each inflow/outflow as % of total inflow/outflow.
Free Cash Flow formulas
Free Cash Flow to the Firm (FCFF)
= Net income + Non-cash charges + [Interest expense x (1-T)] -fixed capital investment - working capital investment.
= CFO + [Interest expense x (1-T)] -fixed capital investment - working capital investment.
Free Cash Flow to Equity (FCFE)
the cash flow available for distribution to common shareholders after all obligations has been paid
FCFE= CFO - Fixed Capital Investment + net borrowing.