Statement of Cash Flows - An Introduction

CS financing - US GAAP vs IFRS

-US GAAP: interest paid or received, as well as dividends received, are classified as operating activities, while dividends paid are treated as cash flows from financing activities. -IFRS: interest and dividends paid or received may be classified as either operating, investing, or financing activities, provided that they are classified consistently from period to period.

1. Direct Method

-all cash inflows and outflows relating to operating activities are detailed and summarized to give total figures for inclusion in the statement of cash flows. -rarely used: very arduous and time-consuming task

Cash flow from operating activities

-all the cash that the company has generated from its core operations

cash flow from investing activities

-cash spent on, or generated by investments of a long-term nature. -not limited to investments in tangible assets.

accruals principle

-revenue is recognized during the period when it is earned and expenses are recognized when they are incurred, whether or not cash is received or expended. -income statement and balance sheet are prepared on this principle

2. Indirect Method

-starts with the presumption that net income is a close proxy for cash and can be used as a starting point for determining cash from operating activities. -net income number must be adjusted to arrive at the cash the company generated from its operations since it was calculated under the accruals principle. -adjusts net income for the effects of transactions that do not involve a movement of cash, such as accrued expenses, income earned but not yet received, depreciation, and amortization. Therefore, to calculate cash from operating activities, you need to use an income statement and a balance sheet.

The statement of cash flows can be used to assess

-the timing, amount, and predictability of future cash flows and can be used as the basis for budgeting. -an objective tool for analysts who may be interested in valuing the company or to those deciding whether or not to extend credit to the company, either as a supplier or a lender.

Two of the key add-backs in the statements of cash flow are

1. Depreciation: the expensing of an asset over its useful life. The dual effect of depreciation is to reduce the book value of the asset and increase the depreciation expense. Has no cash impact. This deduction is not a cash outflow and must be added back in the statement of cash flows. 2. Provisions: There is no cash impact of this transaction until the company actually pays the amounts owed. The amount is added back to the net income for the period to reflect the fact that the deduction that was made in the income statement was not a cash outflow.

Two key uses of the statement of cash flows

1. Determining company health 2. Company valuation

There are two key methods used to determine cash from operating activities:

1. Direct Method 2. Indirect Method

INDIRECT METHOD: WORKING CAPITAL CHANGES

Any increase in accounts receivable is bad for the company's cash balance and is deducted from net income. Any decrease in accounts receivable means that the company has done well collecting cash from customers and this change would be added back to the net income figure.

The statement of cash flows breaks down cash movements into three key areas:

Cash flows from core business operations (OPERATING ACTIVITIES) Cash flows from investing activities (INVESTING ACTIVITIES) Cash flows from financing activities (FINANCING ACTIVITIES)

1. Determining company health

The ability of a company to: -Fund its needs from internally-generated cash (if outside capital is unavailable) -Continue meeting its debt obligations -Sustain dividend payments -Manage its working capital (for example, rising accounts receivable when sales revenue is static may indicate poor debt collection policies) Key concern: liquidity, the ability of the company to pay its debts as they fall due.

2. Company valuation

The statement of cash flows is a very useful tool to analysts in this regard because the information contained within it is more objective than the information contained in the income statement or balance sheet. The cash has either been received or it hasn't, been spent or not.

The statement of cash flows, UNLIKE the income statement and balance sheet, is prepared on

a cash basis

The statement of cash flows is an important measure oF

a company's liquidity and solvency.

The statement of cash flows

a record of a company's cash inflows and outflows for a given period. shows all the cash that the company has received and all the cash that the company has spent.

cash flow from financing activities

relates to the cash activities that deal with debt and equity.

negative cash flow from investing activities

telling us that the company has been spending cash on investing each year. This is a positive sign in a healthy, growing company.