accounting cashflow

1. ACCT642
Financial Statement Analysis
Session 8
Analysis of Statement of Cash Flows
Master of Science
in Applied Finance
AY2022-23 Term 1
August 2022

2. Recommended reading materials
2
2022 CFA Program Level 1, Financial Statement Analysis
 Reading 19: Understanding Cash Flow Statements

3.  Why do we need an additional financial statement
 What does SCF show
 How did a company obtain and spend cash during a period
 Why did cash increase/decrease during the period
 What are the purposes of SCF
 Predict future cash flows
 Evaluate management decisions
 Predict ability to pay debts and dividends
3
Statement of cash flows (SCF)

4. Part 1
Classification of Cash Flows and
Non-Cash Activities

5. 5
Example of SCF

6.  “Cash” in SCF includes cash on hand and cash equivalents
• Cash on hand = notes, coins, deposits at banks
• Cash equivalent = Short-term, highly liquid investments
that can be converted easily into cash and are subject to
an insignificant risk of changes in value
Cash and cash flows
6

7. Operating Activities
Investing Activities
Financing Activities
Net Cash Flows
Cash activities related to an entity’s
operations (and whatever else that is
not classified as investing or financing)
Cash activities related to the acquisition
and disposal of long-term assets of a
productive nature and investments
Cash activities related to the changes in
the size and composition of the financial
structure of an entity
Net cash movement for the year (= CFO ±
CFI ± CFF), reconciles beginning and
ending cash & cash equivalent on B/S
Classification of cash flows in SCF
7

8.  What are the cash flows generated or used up in the operations?
 Focus on information from the income statement and changes in
operating assets and operating liabilities
 Most important source of cash flows
8
Inflows – cash receipts from
earning revenues
• Sale of goods or services
• Interest revenue^
• Dividend revenue^
• Other revenues
Outflows – cash payment for
operating expenses
• Salaries and wages
• Payments for inventory/supplies
• Taxes
• Interest paid to lenders
• Other expenses
Note that some expenses and gains/losses do not affect cash (such as depreciation,
amortization, impairment). Those “non-cash” items are discussed later.
Operating activities
^ Depending on classification

9.  What are the cash involved in the company’s investing activities?
 Transactions that increase/decrease long-term assets and other
investments
 Focus on changes in PPE, intangibles, long-term investments, and
other long-term assets
9
Inflows
• Sale of long-term productive
assets
• Sale of long-term investments
• Collection of principal on
loans
• Others
Outflows
• Purchase of long-term
productive assets
• Purchase of long-term
investments
• Purchase of debt investments
• Making loans
Investing activities

10.  How does the company obtain the cash used to finance the
purchases of assets?
 Focus on increases/decreases in long-term liabilities and owner’s
equity
 Include issuing stock, paying dividends, borrowing money and
paying off loans
10
Inflows
• Issuing stock (new or
treasury stock)
• Issuing bonds and notes
• Other forms of borrowing
Outflows
• Cash dividends or withdrawals
by owner
• Purchase of treasury stock
• Repayment of principals on
borrowings
Financing activities

11.  Investing and financing activities that do not affect cash
Examples:
• Acquire PPE by issuing a note payable
• Retire debt by issuing stock
• Convert preferred stock to common stock
 Significant non-cash investing and financing activities must be
disclosed in separate schedule or in a footnote
• Required by IFRS and US GAAP
11
Non-cash investing and financing activities

12. Classification of cash flows: IFRS vs. GAAP
12

13. Classification of cash flows: IFRS vs. GAAP
13

14. A company recorded the following in Year 1:
• Proceeds from issuance of long-term debt €300,000 financing
• Purchase of equipment €200,000 investing
• Loss on sale of equipment €70,000 no cashflow here,
Loss is not a cashflow thus irrelevant
• Proceeds from sale of equipment €120,000 investing
• Equity in earnings of affiliate €10,000 not cash flow, just an income
amount thus irrelevant.
On the Year 1’s statement of cash flows, the company would
report net cash flow from investing activities closest to:
A. (€150,000)
B. (€80,000)
C. €200,000
14
Exercise

15. On 31 December 2018, a company (i) issued a £30,000 180-day
note at 8 percent and used the cash received to pay for
inventory, and (ii) issued £110,000 long-term debt at an 11-
percent annual interest rate and used the cash received to pay
for new equipment.
Which of the following most accurately reflects the combined
effect of both transactions on the company’s statement of cash
flows for the year ended 31 December 2018 under IFRS?
Cash flows from:
A. operations are unchanged.
B. financing increase £110,000.
C. operations decrease £30,000.
15
Exercise Borrow money,
financing activity
Issue debt,
financing act
Financing activity
y

16. Part 2
Format of Statement of Cash Flows

17.  SCF items are computed (derived) mostly based on numbers
reported in the income statement and balance sheet
• Works like converting from accrual basis to cash basis
 Two methods for SCF:
• Direct Method: A method of reporting net cash flows
from operations that shows the major classes of cash
receipts and payments for a time period
• Indirect Method: A method of reporting net cash flows
from operations that involves converting accrual-basis
net income to a cash basis (the “reconciliation” method)
17
Methods of presenting statement of cash flows

18. Direct method
18
Directly shows
the major classes
of cash receipts
and payments

19. Indirect method (operating activities section)
19
The operating activities section provides reconciliations between earnings and net
cash flows from operating activities (CFO)

20. Investing and financing activities
20
Same format
for presenting
net cash flows
from investing
activities (CFI)
and from
financing
activities (CFF)
whether the
direct method
or indirect
method is
used.

21. Example of preparing SCF
21
ACME Corporation
Income Statement for
year ended 31 Dec 2018)
ACME Corporation Comparative
Balance Sheet 31 Dec 2017 and 2018

22. Receipts: P&L Adjustment Adjustment
From customers Sales Revenue + Δ[Unearned Revenue] - Δ[A/R]
Of interest Interest Revenue - Δ[Interest Receivable]
Of dividends Dividend Revenue - Δ[Dividends Receivable]
Payments: P&L Adjustment Adjustment
To suppliers Cost of Goods Sold + Δ[Inventory] - Δ[A/P]
of inventory
For interest Interest expense - Δ[Interest Payable]
For income tax Income tax expense - Δ[Tax Payable]
- Δ[DTL] + Δ[DTA]
For other expenses Operating expenses + Δ[Prepaid Expenses] - Δ[Accrued Liabilities]
 ∆ refers to change, i.e., (Ending – Beginning) of the item (account)
 Sign of “Payments” in this table: + means increasing cash outflow (more payment) and
 means decreasing cash outflow (less payment)
22
Direct method (operating activities)

23. Direct method (operating activities)
23
Cash received from customers Cash paid to suppliers
Cash paid for interest Cash paid for taxes
Cash paid to employees Cash paid for other expenses
Net CFO = Sum of the above items (receipts less payments)

24. Direct method (operating activities)
24
Cash received from customers Cash paid to suppliers
= Sales – ΔAR = 23598 – 55 = 23543 = COGS + ΔINV – ΔAP = 11456 + 707
- 263 = 11900
Cash paid for interest Cash paid for taxes
= Expense – ΔIP = 246 – (–12) = 258 = Expense – ΔTP = 1139 – 5 = 1134
Cash paid to employees Cash paid for other expenses
= Expense – ΔSP = 4123 – 10 = 4113 = Expense + ΔPrepaid – ΔPayable =
3577 – 23 – 22 = 3532
Net CFO = Sum of the above items (receipts less payments)
Some people use T-account approach

25. Direct method (operating activities)
25
Cash flows from operating activities:
Cash received from customers $23,543
Cash paid to suppliers (11,900)
Cash paid to employees (4,113)
Cash paid for interest (258)
Cash paid for taxes (1,134)
Cash paid for other operating expenses (3,532)
Net cash flows from operating activities $ 2,606

26. Indirect method (operating activities)
26
 Under the indirect method, the operating activities section
of SCF provides reconciliations between earnings and CFO
• A simpler process but provides less meaningful
information than the direct method
• Most (if not all) companies use this method in external
reporting because even if they use direct method, they
are still required to do a “reconciliation”.

27. Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
+ Depreciation/amortization/depletion expense
+ Impairment/revaluation loss (i.e., noncash losses)
+ Loss on sale of long-term assets
 Gain on sale of long-term assets
 Increases in current assets other than cash
+ Decreases in current assets other than cash
+ Increases in current liabilities
 Decreases in current liabilities
= Net cash provided by operating activities
Indirect method (operating activities)
Note that the sign of each reconciliation item in this table shows the effect of the
adjustment on CFO. Therefore, + means an addition to derive net CFO and  means a
deduction to derive net CFO. [ Same concept and result as page 22]
These two combined =
∆[related item], where
∆ = Ending – Beginning
These two combined
= +∆[related item]
Non-cash items
(see next slide)
27

28.  Consider the following items that enter into determination of net income
but do not affect operating cash flows:
• Depreciation and amortization expense
• Asset impairment loss
• Gain/Loss on disposal of PPE and intangibles
• Amortization of bond discount/premium *
 Those non-cash items must be adjusted in the reconciliation from NI to CFO
• If the item decreases NI  Add it to derive CFO amount
 Depreciation, amortization, impairment, loss on disposal of asset,
• If the item increases NI  Deduct it to derive CFO amount
 Gain on disposal of asset
28
Non-cash items
* If interest payment is classified as an operating activity:
 Add (Deduct) amortization amount of bond discount (premium)
 Bond discount is amortized as interest expense > interest payment
 Bond premium is amortized as interest expense < interest payment

29. Cash flows from operating activities:
Net income $2,210
Add: Depreciation $1,052
Less: Gain on sale of PPE (205) 847
Adjustments:
Increase in AR (55)
Increase in inventory (707)
Decrease in Prepaid expenses 23
Increase in AP 263
Increase in salary payable 10
Decrease in interest payable (12)
Increase in tax payable 5
Increase in other accrued liabilities 22 (451)
Net cash from operating activities $2,606
29
Indirect method (operating activities)

30. (A) = Cash received from customers = REV – ΔAR
(B) = Cash paid to suppliers = COGS + ΔINV – ΔAP
(C) = Payment for expenses = EXP + Δ[Related Assets] – Δ[Related Liabilities]
NCEL = Non-cash expenses and losses in P&L
NCG = Non-cash gains in P&L
NI = REV – COGS – EXP – NCEL + NCG
CFO = (A) – (B) – (C)
= REV – COGS – EXP – ΔAR – ΔINV + ΔAP – ΔRA + ΔRL
= NI + NCEL – NCG – ΔAR – ΔINV – ΔRA + ΔAP + ΔRL
Reconcile the direct and indirect methods
Adjustments for non-
cash items (because
they affect NI but do
not affect CFO)
Adjustments for changes
in related asset and
liability items
30

31. Cash flows from investing activities:
+ Sales of plant PPE/Intangibles
 Acquisitions of PPE/Intangibles
+ Collection of loans
 Making loans
= Net cash provided by (used for) investing activities
31
Cash flows from investing activities
Note that the amounts in this section are cash receipts/payments, not
the gains/losses resulted from the transactions or events

32. PPE, Net
Beginning
balance
9854
+ Acquisitions
1300
- Depreciation
1052
- CA of assets
sold
?
= Ending
Balance
9545
Sale
proceeds
xxx
= Carrying amount
of assets sold
?
+ Gain
205
- Loss
Notes Receivable
Beginning
balance
+ New loans
made
- Collections = Ending
Balance
Investments
Beginning
balance
+ Purchases - CA of investments
sold
= Ending
Balance
Cash flows from investing activities
Additional info: Total purchases of
new PPE during the year = $1300
= 557
= 762
32

33. Cash from sale of equipment 762
Cash paid for equipment (1300)
CFI (538)
33
Cash flows from investing activities

34. Cash flows from financing activities:
+ Issuance of stock
+ Sale of treasury stock
 Purchase of treasury stock
+ Issuance of notes or bonds payable
 Payment of notes or bonds payable
 Payment of dividends
= Net cash provided by (used for) financing activities
34
Cash flows from financing activities

35. Retained Earnings
Beginning
balance
2876
+ Net income
2210
- Dividends
declared
?
= Ending
Balance
3966
35
Long-Term Debt (Notes payable, Bonds payable)
Beginning
balance
3575
+ Issuance of
new debt
- Payment of debt
?
= Ending
Balance
3075
Share Capital
Beginning
balance
4350
+ Issuance of
new shares
- Purchase of
Treasury shares
?
= Ending
Balance
3750
Cash flows from financing activities

36. Repayment of LTD (500)
Purchase of treasury shares (600)
Payment of dividends (1120)
CFF (2220)
36
Cash flows from financing activities

37. Statement of cash flows for the year ended 31 Dec 2018
….. (Insert the components of CFO)
Net cash from operating activities $2,606
….. (Insert the components of CFI)
Net cash used in investing activities (538)
….. (Insert the components of CFF)
Net cash used in financing activities (2,220)
Net increases (decreases) in cash (152)
Cash at beginning of the year 1,163
Cash at end of the year $1,011
37
Was the company healthy in terms of managing cash flows?
Completing SCF

38. 1. Computing Cash Received from Customers.
Blue Bayou, a fictitious advertising company, reported revenues of $50
million, total expenses of $35 million, and net income of $15 million in the
most recent year. If accounts receivable decreased by $12 million, how
much cash did the company receive from customers?
A. $38 million.
B. $50 million.
C. $62 million.
2. Computing Cash Paid to Suppliers
Orange Beverages Plc., a fictitious manufacturer of tropical drinks, reported
cost of goods sold for the year of $100 million. Total assets increased by $55
million, but inventory declined by $6 million. Total liabilities increased by
$45 million, but accounts payable decreased by $2 million. How much cash
did the company pay to its suppliers during the year?
A. $96 million.
B. $104 million.
C. $108 million.
38
Exercises: CFO components

39. 3. Computing Cash Paid for Other Operating Expenses
Black Ice, a fictitious sportswear manufacturer, reported other operating
expenses of $30 million. Prepaid insurance expense increased by $4
million, and accrued utilities payable decreased by $7 million. Insurance
and utilities are the only two components of other operating expenses.
How much cash did the company pay in other operating expenses?
A. $19 million.
B. $33 million.
C. $41 million.
39
Exercise: CFO components

40. Using the above information from the comparative balance sheets, how
much cash did the company receive from the equipment sale?
A. $12 million.
B. $16 million.
C. $18 million
Computing Cash Received from the Sale of Equipment
Copper, Inc., a fictitious brewery and restaurant chain, reported a gain on
the sale of equipment of $12 million. In addition, the company’s income
statement shows depreciation expense of $8 million and the cash flow
statement shows capital expenditure of $15 million, all of which was for the
purchase of new equipment.
12/31/2019
40
Exercise: CFI components

41. Adjusting Net Income to Compute Operating Cash Flow
Based on the following information for Pinkerly Inc., a fictitious company,
what are the total adjustments that the company would make to net
income in order to derive operating cash flow?
`
A. Add $5 million.
B. Add $21 million.
C. Subtract $9 million.
Exercise: CFO and indirect method
41

42.  Evaluate where the major sources and uses of cash flow are
between operating, investing, and financing activities.
• Is net operating cash flows positive and sufficient to cover
CAPEX?
 Evaluate the primary determinants of operating cash flows.
• Is net operating cash flows higher or lower than net income?
Why?
• How consistent are operating cash flows?
 Evaluate the primary determinants of investing cash flows.
 Evaluate the primary determinants of financing cash flows.
42
Analysis of statement of cash flows

43. Derek Yee, CFA, is preparing to forecast cash flows for Groupe
Danone as an input into his valuation model. Groupe Danone
prepares its financial statements in conformity with IFRS. He has
asked you to evaluate the historical cash flow statement of
Groupe Danone.
1. What are the major sources of cash for Groupe Danone?
2. What are the major uses of cash for Groupe Danone?
3. Is net cash flows from operating activities sufficient to cover
capital expenditures?
4. What is the relationship between net income and net cash
flows from operating activities?
5. What types of financing cash flows does Groupe Danone have?
43
Analysis of statement of cash flows: Example

44. 44

45. 45

46. CFO vs. net income
46

47. Life cycle and cash flows
47

48.  Generally, limited analysis based largely on
 major cash inflows and outflows
 cash flows as a proportion of sales revenues
48
Analysis of common-size statement of cash flows

49. 49

50. 50

51. 51

52. Andrew Potter is examining an abbreviated common-size statement of cash flows
for Apple Inc., a multinational technology company. The common-size SCF was
prepared by dividing each line item by total net sales for the same year.
Analysis of common-size statement of cash flows
52

53. Based on the information in the above:
1. Discuss the significance of (a) depreciation and amortization (b) capital expenditures.
2. Compare Apple’s operating cash flow as a percentage of revenue with Apple’s net
profit margin.
3. Discuss Apple’s use of its positive operating cash flow.
- - -
53

54. Andrew Potter is comparing the cash-flow-generating ability of Microsoft with
that of Apple Inc. He collects information from the companies’ annual reports
and prepares the following table.
Cash Flow from Operating Activities As a Percentage of Total Net Revenue:
Cash Flow from Operating Activities As a Percentage of Average Total Assets:
What is Potter likely to conclude about the relative cashflow generating
ability of these two companies?
54
Comparative analysis of cash flows

55.  FCF is a simple measure indicating the amount of cash
available to the firm for discretionary spending
• At a basic level, it is equal to CFO less net capex
• Net Capex = total capital expenditures – after-tax proceeds from
asset sales
• FCFF = NI + NCC + Int (1-tax) – Capex – Wcex
= CFO + Int (1-tax) – Capex
• FCFE = CFO – Capex + Net borrowing
Free cash flow forAcme Corporation
55
Free cash flows

56. Cash flow ratios
56

57. Cash flow ratios
57

58. CF-Op CF-Inv CF-Fin General Explanation
+ + +
Building up pile of cash. Possibly looking for
acquisition.
+ – –
Operating cash flow being used to buy fixed assets
and pay down debt.
+ + –
Operating cash flow and sale of fixed assets being
used to pay down debt.
+ – +
Operating cash flow and borrowed money being
used to expand.
– + +
Operating cash flow problems covered by sale of
fixed assets, borrowing, and contributions.
– – +
Rapid growth, shortfalls in operating cash flow, and
purchase of fixed assets.
– + –
Sale of fixed assets is financing operating cash flow
shortages.
– – –
Company is using cash reserves to finance cash
flow short-falls and pay creditors.
58
Bruwer and Hamman 2008, Cash-flow tells a story. Feb 2008 USB LEADERS’ LAB
Analysis of statement of cash flows