Financial Control

1. MGMT 2023 –
FINANCIAL MANAGEMENT 1
UNIT 3 Cash Flow Analysis

2. Outline
 Statement of Cash Flows
 Net Cash Flow
 Cash Flow Identity
 Free Cash Flow Calculation

3. Statement of Cash Flows
 The Statement of Cashflows
summaries changes in a company’s
cash position. The statement
summarizes activities into 3
categories:
1. Operating Activities
2. Investing Activities
3. Financing Activities

4. Statement of Cash Flows
operating activities,
investing activities, and
financing activities.
This statement reports cash inflows and
outflows based on the firm’s
A summary of a firm’s payments
during a period of time.

5. Statement of Cash Flows
Cash Flow from Operating Activities
Shows impact of transactions not defined
as investing or financing activities.
 These cash flows are generally the cash effects
of transactions that enter into the determination
of net income.

6. Cash Flow From
Operating Activities
Cash Inflows
From sales of goods or services
From interest and dividend income
Cash Outflows
To pay suppliers for inventory
To pay employees for services
To pay lenders (interest)
To pay government for taxes
To pay other suppliers for other operating expenses

7. Cash Flow From
Operating Activities
It would seem more logical to classify interest
and dividend income as an “investing” inflow,
while interest paid certainly looks like a
“financing” outflow.
But, the U.S. Financial Accounting Standards Board --
by a slim 4 to 3 vote -- classified these items as
“operating” flows.

8. Statement of Cash Flows
Cash Flow from Financing Activities
Shows impact of all cash transactions
with shareholders and the borrowing
and repaying transactions with lenders.
Cash Flow from Investing Activities
Shows impact of buying and selling fixed
assets and debt or equity securities of
other entities.

9. Cash Flow From
Investing Activities
Cash Inflows
From sale of fixed assets (property, plant,
equipment)
From sale of debt or equity securities (other
than common equity) of other entities
Cash Outflows
To acquire fixed assets (property, plant,
equipment)
To purchase debt or equity securities (other
than common equity) of other entities

10. Cash Flow From
Financing Activities
Cash Inflows
From borrowing
From the sale of the firm’s own equity
securities
Cash Outflows
To repay amounts borrowed
To repurchase the firm’s own equity
securities
To pay shareholders dividends

11. Net Cash Flow
 Net Cash Flow differs from Accounting
Profits because some of the revenues
and expenses on the income
statement are not paid in cash during
the year.
 The relationship between net cash
flow and net income or accounting
profits can be expressed as:
◦ Net cash Flow=Net Income-Noncash Revenue+ Noncash
Charges

12. Net Cash Flow
 Examples of noncash revenues are:
revenues not collected in cash during
the year.
 Examples of noncash charges are:
depreciation & amortization, deferred
taxes
 Depreciation is the most important and
largest noncash item in most cases
and must be added back to net
income to obtain net cash flow.

13. Statement of Cash Flows
 The company’s cash position as
reported on its balance sheet is
affected by a number of factors
 Similarly, the reported net income may
be used to do a number of things
included: pay dividends, increase
inventories, finance accounts
receivables, invest in fixed assets,
reduce debt, buy back stocks, etc.

14. Statement of Cash Flows
 While the statement of cash flows is
an important statement for use by
creditors and tax collectors.
Managers and stock analysts are
concerned with cash flows: meaning
how much cash came in and what
went out. For corporate decision
making the cash flow analysis is most
important.

15. Cash Flow Identity - defined
 Cash flow to creditors + Cash Flow to
Stockholders represent suppliers of
capital to the firm
Cash Flow from
Assets /Free
Cash Flow
Cash Flow to
creditors
Cash Flow to
Stockholders

16. Cash Flow from Assets/FCF
Cash flow from Assets = Operating Cash Flow
- Adjustments for Capital Spending
-∆Net Working Capital
 FCF involves 3 components
1. Operating Cash Flow
2. Adjustments for Capital Spending
3. Changes to Net Working
Capital(NWC)

17. Step 1: Operating Cash Flow
OCF
 OCF measures the cash generated
from operations. It tells us whether a
firm’s CF from is business operations
are sufficient to cover its everyday
cash flows.
 OCF = EBIT+ Depreciation – Tax

18. Step 2: Capital Spending
 Capital Spending measures changes in
net operating long-term assets (ie plant,
property & Equipment). It is money
spent on fixed assets less money
received from the sale of fixed assets
Capital Spending = Ending PPE* –
Beginning PPE* + Depreciation
*PPE –Property Plant and Equipment

19. Step 3: Change in NWC
 Change in NWC reflects investment in
current assets and changes in current
liabilities which usually changes with
current assets.
 ∆ in NWC = End. NWC – Beg. NWC

20. A note on computing FCF
 There are some variations in exactly
how to compute FCF. Different users
calculate it differently
 It is important to look at what
constitutes working capital. For
example, short term investments and
short term debt should not be
considered as part of CA and CL
respectively.

21. Uses of FCF
1. Pay interest to debt holders
2. Repay debt holders
3. Pay dividends to shareholders
4. Repurchase stock from shareholders
5. Buy marketable securities or other
non operating assets.

22. Example ALM Inc.
 The 2008 balance sheet of ALM, Inc. showed long-term debt
of $4.6 million, $1,740,000 in the common stock account and
$4.2 million in the additional paid-in surplus account. The
2009 balance sheet showed long-term debt of $4.9 million,
$1,815,000 in common stock account and $4.5 million in the
additional paid-in surplus account. The 2009 income
statement showed an interest expense of $870,000 and
dividends of $590,000. You also know that the firm’s net
capital spending for 2009 was $1, 440,000 and the firm’s net
working capital was reduced by $95,000.

◦ What was the firm’s cash flow to creditors during 2009?
◦ What was the firm’s cash flow to stockholders for 2009?
◦ What was the firm’s operating cash flow, OCF for 2009?
◦ What is the value for FCF?

23. Cash flow to Creditors
CFC = Interest – Net new long term debt
= 870,000 – (4,900,000 – 4,600,000)
=570,000
Long Term Debt 4,600,000
$ 4,900,000
$
Interest expense 870,000
$
Dividends 590,000
Common stock $1,740,000 1,815,000
additional-paid in surplus $4,200,000 4,500,000
$5,940,000 $6,315,000
Net capital spending 1,440,000
NWC -95000

24. Cash flow to stockholders
 CFS = Dividends – New Equity
 = 590,000 – (6,315,000 – 5,940,000)
 = 215,000
Long Term Debt 4,600,000
$ 4,900,000
$
Interest expense 870,000
$
Dividends 590,000
Common stock $1,740,000 1,815,000
additional-paid in surplus $4,200,000 4,500,000
$5,940,000 $6,315,000
Net capital spending 1,440,000
NWC -95000

25. Free Cash Flow (FCF)
 FCF = Operating cash flow – Net capital spending
– change in NWC
 FCF = CFC + CFS = 570,000+215,000 = 785,000
Long Term Debt 4,600,000
$ 4,900,000
$
Interest expense 870,000
$
Dividends 590,000
Common stock $1,740,000 1,815,000
additional-paid in surplus $4,200,000 4,500,000
$5,940,000 $6,315,000
Net capital spending 1,440,000
NWC -95000

26. Operating Cash flows
 OCF = EBIT + Depreciation – Tax. (1)
Recall:
 FCF = Operating cash flow – Net capital spending – change in
NWC (2)
◦ Make OCF the subject
◦ OCF = FCF + net cap spending + change in NWC
◦ = 785,000 + 1,440,000 + (-95,000)
◦ =2,130,000
Long Term Debt 4,600,000
$ 4,900,000
$
Interest expense 870,000
$
Dividends 590,000
Common stock $1,740,000 1,815,000
additional-paid in surplus $4,200,000 4,500,000
$5,940,000 $6,315,000
Net capital spending 1,440,000
NWC -95000

27. End of Presentation
Summary Points
 Statement of Cash flows is important
for use by creditors and other external
users
 Conducting of Cash Flow Analysis is
important to Managers and Stock
Analysts
 Free Cash Flow represents cash
available to creditors and stockholders
of the company.