Statement of Cashflows

A. Why is SCF important?

1. Measurement of cash:

cash=currency+cash equivalent?

cash equivalent:

? ? a.Short-term?(maturity less than 90 days), readily convertible into cash.

? ? b.Insignificant risk to changes in value

????Such as: money market funds, treasury bill, time deposits.

2.Significance:

when earnings are strong but cash flow is not, it's often a warning sign that there are problem!

3.Purpose of the SCF

How does a company obtain its cash?

Where does a company spend its cash?

What explains the change in the cash balance?

B. How to prepare SCF?

1.Classify Cash Flows:

a.Cash Flow Activities:

Operating Activities:

? ??Major daily activities: purchase, processing and selling of products/ services

????Related to IS, some current assets, some current liabilities

Investing Activities:

? ??Acquire or dispose of long-lived assets/ Investments

? ??Intangible assets, PP&E, long-term assets; short-term investment, loans to others

Financial Activities:

? ??Raise cash from investor or creditor and repay/provide return

? ??Short/long term debt, Capital stock, Treasury stock, Dividend

b.Classification:

classified as Inflow/Outflow; reported under OA/IA/FA

Non-cash Items ? ?unrelated to cash-NOS

? ??depreciation and amortization. issue bonds (equity) for land (PP&E).

Cash Items:

? ? OA:

? ? ? ? Inflow:Sale of goods or services,?Interest revenue,?Dividend revenue

? ? ? ? Outflow:Inventory payments,?Interest payments,?Wages,?Utilities, rent,?Taxes

? ? IA:

? ? ? ? Inflow:Sale of plant assets,?Disposal of investment in other companies,?Collection of principal on loans

? ? ? ? Outflow:Purchase of plant assets, Purchase of investment in other companies, Making of loans to other entities

? ? FA:

? ? ? ? Inflow:?Issuance of own stock, Borrowing, Reissuetreasury stock

? ? ? ? Outflow: Dividend payment,?Repaying principal on borrowing,?Treasury Stock purchase

2.Prepare simple SCF (Direct Method)

information source:

? ? beginning and ending cash balance

? ? transactions involved cash

step:

? ??1. Analyze the impact of each transaction on

cash

? ??2. Categorize and aggregate cash flows for each category (OA, IA, and FA)

? ? 3. Prepare the SCF by listing items in order

3.Analyzing financial Statement to prepare SCF (Indirect Method)

a. Convert NI to CFO

1)Some items in IS do not belong to operating activities

? ??Gain or loss from non-operating activities

? ? -Gain ? ?+loss

2)Some items in IS are never related with cash

? ??Operating revenue/expense never involves cash, such as?Depreciation expense and?Amortization expense

? ??Add depreciation and amortization expense to net income

3)Other items involve cash, but revenue does not equal to cash received, and expense does not equal to cash disbursed

? ??From sales to cash received from customers

? ??From various expenses to cash paid

? ??Double-entry system

Specifically:

#sales vs cash from customers

Analysis:

Dr. Account Receivable

? ? Cr. Sales

Dr. Cash

? ? Cr. Account Receivable

Conclusion:

cash collected=Sales-[A/R(end)-A/R(begin)]

#COGS to cash paid for inventory

Analysis:

Dr. Inventory

? ? Cr. A/Ps

Dr. A/Ps

? ? Cr. Cash

Dr. COGS

? ? Cr. Inventory

Conclusion:

Purchase=COGS+[Inventory(end)-Inventory(begin)]

Cash Paid=Purchase-[A/Ps(end)-A/Ps(begin)]

#expense to cash paid for that expense

Analysis(for those who have their own account-interest & tax):

Dr. XX expense

????Cr. XX payable

Dr. XX payable

? ? Cr. cash

Conclusion:

for interest:

Interest Paid=Interest expense accrued-[Interest Payable(end)-Interest Payable(begin)]

for tax:

Tax Paid=Tax expense Accrued-[Tax Payable(end)-Tax Payable(begin)]

Summary:

????????????????????????????????????Change in account balance during the year

? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? Increase ? ? ? ? ? ? ? ? ? ? ? ? ? ?decrease

current asset ? ? ? ? ? ? ? ? ? ? ?- ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?+

current liability ? ? ? ? ? ? ? ? ? + ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?-

Caution-What should not be included:

Dividends payable????Short-term loans from bank????Notes payable ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? Bonds to be paid with in one year

Notes receivable ? ?Short-term investment

C. How to interpret SCF?

1. Analysis SCF:

? ? ????CFO CFI CFF ? ? ? ? ? ?General Explanation

1 ? ? ? ?+ ? ? ?+ ? ? + ? ?Building up pile of cash. Possibly looking for acquisition

2 ? ? ? + ? ? ? - ? ? ?- ? Operating cash flow being used to buy fixed assets and pay down debt

3 ? ? ? + ? ? ? + ? ? - ? Operating cash flow and sale of fixed assets being used to pay down debt

4 ? ? ? + ? ? ? - ? ? + ??Operating cash flow and borrowed money being used to expand

5 ? ? ? - ? ? ? + ? ? + ??Operating cash flow problems covered by sale of fixed assets, borrowing, and contributions

6 ? ? ? - ? ? ? - ? ? ?+ ??Rapid growth, short-falls in operating cash flow, and purchase of fixed assets

7 ? ? ? - ? ? ? + ? ? ?- ? Sale of fixed assets is financing operating cash flow shortages

8 ? ? ? - ? ? ? - ? ? ? - ??Company is using cash reserves to finance cash flow short-falls and pay creditors

2. Free Cash Flow ? ? ? ?FCF

FCF=net cash provided by operating activities

? purchases of property and equipment

? property and equipment acquired under capital leases.

FCF is one of the key financial indicators of business performance over the long term