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Understanding the Statement of Cash Flows

Understanding the Statement of Cash Flows. Chapter 4 Robinson, Munter, Grant. Learning Objectives. Understand the cash flow statement and how it relates to other financial statements Direct and indirect methods of presenting operating cash flows Investing and financing activities

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Understanding the Statement of Cash Flows

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  1. Understanding the Statement of Cash Flows Chapter 4 Robinson, Munter, Grant

  2. Learning Objectives • Understand the cash flow statement and how it relates to other financial statements • Direct and indirect methods of presenting operating cash flows • Investing and financing activities • Disclosure of noncash transactions • Free cash flow and analysis Chapter 4

  3. Importance of cash flows • Accrual-based accounting requires reporting revenues when earned and expenses when incurred – not when cash is exchanged. • A company cannot pay employees, creditors and others with accrual-based net income. • Valuation models used in financial analysis are often based on projections of future cash flows. Chapter 4

  4. Statement of Cash Flows • Summarizes all activity in the cash accounts of the firm via three categories: • Operating • Indirect • Direct • Investing • Financing Chapter 4

  5. Chapter 4

  6. NokiaCash flow summary (EURm) Chapter 4

  7. Operating activities • Primarily captures • Income statement items • Short-term/operating assets • Short-term/operating liabilities • Methods of presentation • Indirect • Direct Chapter 4

  8. Cash Flows from Operating ActivitiesIndirect method • Reconciles accrual-based net income with cash generated via operations • Begin with accrual-basis net income • Adjust accrual items to reflect cash basis • Noncash items (depreciation and amortization) • Changes in working capital (current assets, current liabilities) • Reclassify nonoperating items • Appear in other sections of the Statement • Gains/losses on sales of fixed assets or debt extinguishment Chapter 4

  9. Adjustments to Net Income • Add back noncash expenses • Depreciation and amortization • Add working capital decreases • Decreases in current assets • Increases in current liabilities • Subtract working capital increases • Increases in current assets • Decreases in current liabilities Chapter 4

  10. Chapter 4

  11. Chapter 4

  12. Cash Flows from Operating ActivitiesDirect method • Recast the income statement to conform to cash-basis listing: • Cash from customers • Cash to suppliers • Cash for wages • Cash for selling, general and administrative costs • Cash for interest… Chapter 4

  13. Calculating Cash from customers + Beginning balance in Accounts Receivable + Revenues • Ending Accounts Receivable = Cash received from customers Beginning A/R + Sales – Payments received = Ending A/R Chapter 4

  14. Calculating Cash paid to suppliers + Cost of (sales) revenue +/- Increase (decrease) in inventory -/+ Increase (decrease) in accounts payable = Cash paid to suppliers The cost of what was sold adjusted for changes in inventory and payments made. Chapter 4

  15. Motorola’s Cash from Operating Activities in Direct Method Format Chapter 4

  16. Nokia’s Cash from Operating Activities in Direct Method Format Chapter 4

  17. Cash Flows from Investing Activities • Typically involves noncurrent capital (long-term) assets • Cash acquisitions of investments, property • Cash generated upon disposal of assets • Noncash acquisitions/disposals are reported as Supplemental Information rather than in the body of the Statement of Cash Flows Chapter 4

  18. Chapter 4

  19. Chapter 4

  20. Cash Flows from Financing Activities • Long-term liabilities • Cash from borrowing • Cash used for repayment of principle • Under IAS cash interest payments may be here • Equity • Cash from stock issuance • Cash used to purchase treasury shares • Cash used for dividend payments Chapter 4

  21. Chapter 4

  22. Chapter 4

  23. Statement of Cash FlowsAdditional Disclosures • Cash paid for interest • Cash paid for taxes • Presented at end of statement (GAAP) or in body of statement (IAS) • May also highlight significant noncash transactions Chapter 4

  24. Chapter 4

  25. Chapter 4

  26. Cash analysis • Determine and examine all sources and uses of cash • Determine free cash flow • Important for valuation (present value of expected future free cash flow) • To the Firm, available to both debt and equity holders • To Equity, available to equity holders only • Estimate cash flow with EBITDA Chapter 4

  27. Free Cash Flow to the Firm Operating cash flow Plus: Interest Paid Times (1-tax rate) Less: Investments in Fixed Capital Free Cash Flow to the Firm Chapter 4

  28. Free Cash Flow to Equity Operating cash flow Less: Investments in Fixed Capital Plus: New Debt Borrowing Less: Debt Repayment Free Cash Flow to Equity Chapter 4

  29. Earnings before Interest, Taxes, Depreciation and Amortization EBITDA Net income (loss) Plus: Interest expense Plus: Tax expense Plus: Depreciation & Amortization expense Free Cash Flow Estimate Chapter 4

  30. Summary • Statement of cash flows • Operating (Indirect, Direct) • Investing • Financing • Interaction with other statements • Free cash flow Chapter 4

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