chapter 6 from slides Flashcards
what’s the focus of operating activities for cash flows
to generate cash from selling goods or services at a profit
cash inflows = receipts from customers for sales made or services rendered, receipts of interest and dividends, other receipts that aren’t related to investing or financing, other receipts that aren’t related to investing or financing activities (lawsuit settlements and refunds received from suppliers)
cash outflows = payments to employees or suppliers, payments to purchase inventories, payments of interest to creditors, payments of taxes to government, other payments that aren’t related to investing or financing activities (contributions to charity)
what are investing activities in cash flows
investing activities = acquisition and disposal of PP&E assets and intangible assets, purchase and sale of stock and bonds and other securities, lending and subsequent collection of money
what are financing activities for cash flows
obtains resources from owner, returns resources to owner, borrows resources from creditors, repay amounts borrowed
IFRS vs GAAP requirement for interest/dividends received/paid
IFRS: interest received = operating/investing activity, interest paid = operating/financing activity, dividends received = operating/investing activity, dividends paid = operating/financing activity
GAAP: interest received = operating activity, interest paid = operating activity, dividends received = operating activity, dividends paid = financing activity
what are steps in preparing cashflows in indirect method?
operating activities
1. begin with net income
2. adjust for noncash revenues, expenses, gains and losses - add back: depreciation/amortization and stock based compensation, eliminate gains and losses from sales of investment, PP&E assets or intangible assets as these gains and losses are captured in the investing activity
3. adjust for changes in operating assets and current liabilities
investing activities
1. change in investments, change in PP&E, change in accumulated depreciation, change in patent
financing activities
1. change in common stock (issuance, buybacks) and change in debt (paying debt or getting more)
cash flows - indirect vs direct
direct method = net cash flow from operating activities by showing major categories of operating cash receipts and payments
only operating section of statement of cash flows is different
what are adjustments to convert IS items to operating activity cashflows in the direct methdo
in sales, adjust for AR and deferred revenue
- add decreases in AR, and deduct increases in AR
- add increases in deferred revenue and deduct decreases in deferred revenue
and becomes receipts from customers
in COGS, adjust for inventory and AP
- add increase in inventory and deduct decreases in inventory
- add decreases in AP and deduct increases in AP
becomes payments for merchandise
in operating expenses/interest/income tax expenses adjust with their related prepaid expenses and accrued liability
- add increases in related prepaid expenses and deduct decreases in related prepaid expense
- add decreases in related accrued liability and deduct increases in related accrued liability
becomes payments for expenses
for depreciation/depletion/amortization expense DO NO INCLUDE, please exclude these expenses
also exclude any gains ad losses on investing/financing activities
how does the operating section of direct cash flows look like
cash received from customers
cash paid for merchandise purchase
cash paid to employees
cash paid for insurance
cash paid for income taxes
cash paid for rent/operating expense
net cash provided by operating activities
what are the supplemental disclosures for the direct method of cash flows
separately disclose:
1. reconciliation of net income to the net cash flow from operating activities (indirect method)
2. a schedule of all noncash investing and financing transactions
3. firm’s policy for determining which highly liquid, short-term investments are treated as cash equivalents
provide an analysis of operating cash flows (OCF)
less easily manipulated than operating income or net income
positive signs:
- OCF should be primary source of cash flow for mature company
- OCF should be positive and higher than net income
- COF may be negative to grow for new or growth stage companies
- OCF should be consistently increasing
- OCF should be sufficient to cover CAPEX
what are the primary determinants of investing cash flow
- negative cash flows from investing activities is not necessarily bad if it’s used to support growth
- compare CAPEX with depreciation
- with major capex how does the company fund the CAPEX, through OCF, asset selling or financing?
- how much ICF is for CAPEX, how much is for liquidity investment
- if the company sod significant amount of assets, analyst should investigate the purpose of asset selling
what’s an analysis of financing cash flows
negative cash flows from financing activities =/= bad
- using excess cash flow to reduce financial leverage is a sound strategy it fi lowers the company’s financial leverage to an acceptable level
- distributing excess cash to shareholders through dividends and share repurchases is a way to avoid excess liquidity
important to asses why capital is being raised/repaid - it’s a red flag when a company uses financing cash flow to fund net losses and negative operating cash flows over the long-run
if the company is borrowing each year, consider when repayment may be required
how to conduct the common-size analysis fo the statement of cash flows
- express each line item of cash inflow (outflow) as a percentage of net revenue
- express each line item of cash inflow (outflow) as a percentage of total inflow (outflow)
what are the cashflow patterns for the life-cycle of a company
in introduction stage: the revenue is very little, negative net income,. lots of financing activity, negative operating activity, and negative investing activity
in growth stage: the revenue is positive and increasing, the net income is growing can be low negative or higher positive number, the financing activity is positive and high, the operating activity is negative/positive and low, the investing activity is negative and high.
in the maturity stage; the revenue is positive and at it’s peak, the net income is positive at the peak, the operating activity is positive and high, the investing is turns from negative to positive, the financing decreases from positive to negative.
in the declining stage: the revenue is decreasing but positive, the net income is decreasing going from positive to negative, the operating activity is decreasing but positive, the investing is positive but low, the financing is negative and high for the company to distribute cash to repay debt, buy back stock, pay dividends and realize incoming investing cash flows as assets are gradually sold off
profitability ratios are consistent with expected economic behaviour at each life-cycle stage
cash flow quality: results vs reporting quality
results: whether underlying economic performance is good
- positive OCF, from sustainable sources, adequate to cover Capex, debt repayment and dividends, low volatility
reporting: whether reasonably reflect underlying economic performance
- timing - whether the company selling receivables or delaying paying payables to boost OCF
- classification of cash flow: trading securities vs available for sale, interest capitalization vs expense, operating lease vs finance lease, R&D capitalization vs expense
