04 Cash Flow Flashcards
- Maintaining liquidity is essential to guarantee the survival of any firm. • Most of business failures occur because firms run out of cash.
- The information in the income statement is not enough, since revenues and expenses do not coincide with cash inflows and outflows.
- The firm may be investing in plant and equipment or repaying loans, items that do not generate expenses equal to the amounts paid.
- The Statement of Cash Flows shows how cash is generated and used during every period.
- Cash Flow Statement is Relevant to:
- Management in operating the business:
üDetermine whether short-term financing could cover current liabilities.
üEvaluate the effects of major policy decisions regarding investment and financing needs.
• Investors and Creditors in making investing and lending decisions.
• Assess company’s ability to:
üManage and generate future cash flows
üPay liabilities, dividend and interest
üAnticipate the need for additional financingü预计到对额外融资的需求
- The Cash Flow Statement summarizes all transactions that affect cash!
- Cash flows reconcile 协调 the Profit & Loss by adding and subtracting assets and liabilities that were properly recorded on the P&L or Balance Sheet, but are noncash events, such as: depreciation and accruals.
- Remember, accruals 应计项目 are earned revenues and incurred expenses that have an overall impact on an income statement, but also…
- An expenditure is the disbursement of cash or a commitment to disburse cash. An expense is the recognition of the expenditure and its recording for accounting purposes in the time period that benefited from it.
Accruals affect the balance sheet, which represents non-cash-based assets and liabilities:
- Accounts Payable: purchases to suppliers to be paid at due payment date.
- Accounts Receivable: sales not collected yet.
- Future tax liability: income taxes are paid the year after the financial statement are closed.
- Pre-paid expenses: expenses paid in advance.
- Depreciation/amortization: to prorating a tangible/intangible asset’s cost over that asset’s life, it has “no-cash impact”.
- Dividends: are booked when approved and paid later.
• Reasons why a firm might be making profits, but still be very short of cash:
üProfits may have been reinvested into inventories in anticipation of a sales increase: up INVENTORIES
üAlthough sales have been made, the customers may not yet have paid: up RECEIVABLES
üCash may have been invested in non-current assets. This represents a cash outflow, but the cost is not recognized immediately to the P&L. Only a proportion of the cost is charged as depreciation. up PROPERTY, PLANT & EQUIPMENT
üCash may have been used to pay dividends to the owners. This represents a reduction of retained earnings. down OWNERS’ EQUITY
üCash may have been used to repay loans to banks. This represents a reduction in debt. down LONG-TERM DEBT
- Net Income vs Cash Flows:
- “High net income attracts investors…but does not pay the bills”
- Companies need both: Net income and strong cash flow
- Usually, move together…but not always
- You can’t stop time…neither postpone payment maturity dates
- The positive cash flow indicates that a company’s liquid assets are increasing, so the company can:
- settle debts,
- reinvest in its business,
- return money to shareholders,
- pay expenses
- Negative cash flow indicates that a company’s liquid assets are decreasing.
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Example of preparation of the statement of cash flows:
- We have a summary of the movements in the cash account of A2 company, a merchandising firm, during 2018.
- We group the different cash flows into the three categories: OPERATING,
INVESTING or FINANCING
• This form is known as the DIRECT METHOD and requires the access to the movements in the cash accounts
Example of cash flows (Direct method):
• We start with the movements in the cash account.
We group the different cash flows into the three categories:OPERATING, INVESTING or FINANCING
repayment 偿还
The usual presentation is a simple list of cash collections and payments classified
by their nature (O, I or F).
- Preparing the cash flow statement using the INDIRECT METHOD:
- All companies report investing and financing cash flows as the difference between cash inflows and cash outflows (direct method).
- However, the majority of companies report the operating cash flow as the sum of reported net income plus/minus accrual adjustments (indirect method).
- These accrual adjustments are operating revenues not yet collected or expenses not yet paid.
- Preparing the cash flow statement using the INDIRECT METHOD:
- Starting from basic accounting identity and decomposing it, we obtain the variations in cash:
• Example of the cash flow statement using the INDIRECT METHOD:
üThe first step is to calculate the changes in all the balance sheet accounts and prepare a table.
üFollowing the sign convention dictated by the equation we must reverse the sign of the changes in assets other than cash.
üIn this way, when we add these changes to the changes in liabilities and owners’ equity, we will get the change in cash.
üThe first step is to calculate the changes in all the balance sheet accounts and prepare a table.
Following the sign convention dictated by the equation we must reverse the sign of the changes in assets other than cash
• Example of the cash flow statement using the INDIRECT METHOD:
üSome firms report FREE CASH FLOW, it is cash flow from operations less capital expenditures (FCF = CFO – CAPEX).
üCAPEX is the net cash investments in property, plant and equipment.
üIn a capital intensive industry CAPEX is a strategic decision. It is also analyzed by external users such as banks or investors.
üFCF is the measure of a firm’s ability to generate cash to maintain its operations.
üThe FCF of A2 Company is 24 (= 93 – 69).
Cash Forecast
ü“Cash Forecast” is an internal document for planning future cash requirements.
üIt shows the cash impact of all planning process: Management decisions are taken every day concerning factors such as:
ØLevel of inventories to be held
ØAmount of credit to be given to customers
ØNew equipment to be acquired
ØOthers…
üManagement decisions may be taken to maximize profitability, but if there is insufficient cash resources to finance the plans then:
ØThe plans may need to be modified, or
ØAction might be needed to cover the cash reduction
ØType of action will depend on whether a surplus or deficit is expected and also on how long the situation is expected to last
• (Cash Forecast)
ØAction is needed to cover the cash deficit forecasted for February.
ØIt will be a short-term overdraft from February until May.
ØPossible management decisions are as follows:
- Negotiate a bank account overdraft agreement. It is important to consider the possible timing of cash flows within each month. If all payments in February happen before any collections come in, then the possible overdrawn balance could be 190,000 €
- Perhaps the purchase of the equipment could be delayed until June, when sufficient cash will be available.
- Could the equipment be leased instead of purchased outright?
- Could credit conditions be negotiated with customers?
