27. FRA - Understanding Cash Flow Statements Flashcards
LOS 27.a :Compare cash flows from operating, investing and financing activities and classify cash flow items as relating to one of those three categories.
Cash flows from operating activities (CFO) companys day to day activities that create revenue, such as selling inventory/ providing services.
Actvities that consist of cash inflows and outflows resulting from transactions that affect net income.
LOS 27.a :Compare cash flows from operating, investing and financing activities and classify cash flow items as relating to one of those three categories.
Classification of Cash Flows and Non Cash Activities
- Operating >> CFO companys day to day activities that create revenue, such as selling inventory/ providing services.
- Investing >> Include purchasing and selling long term assets and other investment >> PPE, Equity investments.
- Financing >> Include obtaining or repaying capital, such as equity and long term debt.
LOS 27.a :Compare cash flows from operating, investing and financing activities and classify cash flow items as relating to one of those three categories.
Classification of Cash Flows and Non Cash Activities
- Operating >> CFO companys day to day activities that create revenue, such as selling inventory/ providing services.
- Investing >> Include purchasing and selling long term assets and other investment >> PPE, Equity investments.
- Financing >> Include obtaining or repaying capital, such as equity and long term debt.
LOS 27.b: Describe how non-cash investing and financing activities are reported.
- Non cash investing and finance transactions is any transaction that does not involve an inflow or outflow of cash
- Example : common stock in exchange for dividends
- Notes & Supplmentary Schedules: Significant non cash transactions are required to be disclosed in the notes or supplementary schedules.
LOS 27.c: Contrast cash flow statements prepared under IFRS and US GAAP.
IFRS allows more flexibility in the reporting of such items as interest paid or dividends paid or received and in how income tax is classfied.
LOS 27.c: Contrast cash flow statements prepared under IFRS and US GAAP.
LOS 27.d: Distinguish between the direct and indirect methods of presenting cash from operating activities and describe the arguments in favour of each method.
Direct Method >> shows the specific cash inflows and outflows that result in cash flow from operating activities >> cash receipts and payments
Indirect Method >> shows how cash from operations can be achieved by adjustments to net income
LOS 27.d: Distinguish between the direct and indirect methods of presenting cash from operating activities and describe the arguments in favour of each method.
Argument in favour of Indirect method
The main advantage of the direct method is that it presents clearly the firm’s operating cash receipts and payments.
LOS 27.d: Distinguish between the direct and indirect methods of presenting cash from operating activities and describe the arguments in favour of each method.
Argument in favour of direct method
The main advantage of the direct method is that it presents clearly the firm’s operating cash receipts and payments.
LOS 27.e Describe how the cash flow statement is linked to the income statement and balance sheet.
Operating activities typically relate to the firm’s current assets and current liabilities. Investing activities typically relate to noncurrent assets. Financing activities typically relate to noncurrent liabilities and equity.
Timing of revenue or expense recognition that differs from the receipt or payment of cash is reflected in changes in balance sheet accounts.
LOS 27.e Describe how the cash flow statement is linked to the income statement and balance sheet.
A = L + E >> cash is an asset
Balance sheet
- BS => Beginning Cash >>SOCF >> Plus Cash Receipts less Cash Payments => BS Ending Cash
Income Statement
- BS => Beginning Accounts Receivable Plus Revenues minus cash collected from customers ==> Ending Accounts Receivable
LOS 27.f: Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data. CFO
The indirect method of calculating CFO begins with net income and adjusts it for gains or losses related to investing or financing cash flows, noncash charges to income, and changes in balance sheet operating items.
LOS 27.f: Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data. CFO
The direct method of calculating CFO is to sum cash inflows and cash outflows for operating activities.
- Cash collection from customers – sales adjusted for changes in receivables and unearned revenue.
- Cash paid for inputs – COGS adjusted for changes in inventory and accounts payable.
- Cash operating expenses – SG&A adjusted for changes in related accrued liabilities or prepaid expenses.
- Cash taxes paid – income tax expense adjusted for changes in taxes payable and changes in deferred tax assets and liabilities.
LOS 27.f: Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data. CFI
Same for indirect and direct.
CFI is calculated by determining the changes in asset accounts that result from investing activities. The cash flow from selling an asset is its book value plus any gain on the sale (or minus any loss on the sale).
LOS 27.f: Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data. CFF
Same for indirect and direct
CFF is the sume of net cash flows from creditors ( new borrowings minus principal repaid) and net cash flows from shareholders (new equity issued minus share repurchases minus cash dividends paid)
LOS
Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data.
Computing Cash Received from Customers
Revenue adjusted for cash inflow/ outflow based on accounts receivables
LOS
Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data.
Computing Cash Received from Customers
Revenue adjusted for cash inflow/ outflow based on accounts receivables
LOS
Describe the steps in the preparation of the direct and indirect cash flow statements , including how cash flows can be computed using income and balance sheet data.
Computing Cash Paid to Suppliers
- Purchases from Suppliers > COGS adjusted for movement in inventory
- Cash paid to suppliers => purchases from suppliers adjusted for cash inflow/outflow from accounts payable
LOS
Convert cash flows from the indirect and direct method.
- >>>Aggregate all revenues and expenses
- >>>Remove all non cash items from aggregated revenues and break out remaining items into relevant cash flow items
- >>>Convert accrual amoints to cash flow amounts by adjusting for working capital changes
An indirect cash flow statement can be converted to a direct cash flow statement by adjusting each income statement account for changes in associated balance sheet accounts and by eliminating noncash and non-operating items.
LOS
Analyse and interpret both reported and common size cash flow statements.
LOS
Analyse and interpret both reported and common size cash flow statements.
A common size cash flow statement shows each item as a percentage of revenue or shows each cash inflow as a percetange of total inflows and each outflow as a percentage of total outflows.
LOS
Calculate and interpret free cash flow to the firm, free cash flow to equity and coverage cash flow ratios
Free cash flow to the firm (FCFF) is the cash available to all investors, both equity owners and debt holders.
FCFF = net income + noncash charges + [interest expense x (1 – tax rate)] – fixed capital investment – working capital investment.
FCFF = CFO + [interest expense x (1 – tax rate)] – fixed capital investment
LOS
Calculate and interpret free cash flow to the firm, free cash flow to equity and coverage cash flow ratios
Free cash flow to equity (FCFE) is the cash flow that is available for distribution to common shareholders after all obligations have been paid.
FCFE = CFO - fixed capital investement + net borrowing
LOS
Calculate and interpret free cash flow to the firm, free cash flow to equity and performance and coverage cash flow ratios
Cash flow performance ratios, such as cash return on equity or non-assets, and cash coverage ratios, such as debt coverage or cash interest coverage, provide information about the firm’s operating performance and financial strength.
