Dimension 4 - Cash Flow Flashcards
What are the differences between direct and indirect cash flow?
- Direct cash flow is known as the “top down” approach, while the indirect cash flow is known as the “bottom up” approach.
- Direct cash flow starts with the “top line” on the income statement (Net Sales) whereas the indirect cash flow starts with the “bottom” line on the income statement (Net Income).
- Direct cash flow starts with the income statement (Net Sales) and methodically adjusts the corresponding balance sheet accounts
- Direct cash flow breaks out interest expense. Interest expense in the indirect cash flow is included in the net income figure, so you can’t tell how comfortably the company can pay its interest.
- CPLTD is broken out as a claim against the operating cash flows of a company in the direct method. The indirect method combines CPLTD with other changes in long-term debt to arrive at a “net” number for an increase or decrease in long-term debt. It is not as easy to determine from the indirect method how maturing long-term debt has been financed, either from new long-term debt or from operating cash flow.
- The direct cash flow statement does not include net income. Thus, it is harder to determine the sustainable profitability and, ultimately, the long-term debt-service capacity of your customer.
Cash from Sales
That portion of the present year’s sales collected in the present year, plus any amounts from previous years’ sales collected during the present year.
Cash Production Costs
Cash expended during the present year to produce goods for sale (manufacturer) or to acquire merchandise (wholesaler or retailer). In the case of a manufacturing company, this figure may be adjusted for depreciation as well as for changes in inventory, accounts payable, and other payables.
Gross Cash Profit
= Cash from sales - Cash production costs.
Cash Operating Expenses
Actual cash spent during the present year for selling, general, and administrative expenses. SG&A will be adjusted for depreciation as well as for changes in prepaid and accrued expenses.
Cash after Operations
= Gross cash profit - Cash operating expenses
Net Cash after Operations
= Cash after operations +/- Miscellaneous
items +/-Income taxes paid.
Cash remaining after adjusting cash after operations to reflect net cash outlays (or inflows) arising from changes in income taxes and in miscellaneous assets and liabilities. It is the amount of cash available for servicing interest on bank debt. Investigate large miscellaneous sources and uses of funds.
Net Cash Income
Computed by deducting financing costs (interest, dividends, or withdrawals) from net cash after operations.
Cash after Debt Amortization (CADA)
= Net cash income – Current maturities of long-term.
If, after this deduction, there is still a positive figure, it could mean that a company has been able to generate sufficient cash from its internal operations to meet all its current obligations to its debt holders, including interest and principal payments on your institution’s debt. If the figure is negative, your customer must resort to external sources of financing to meet these obligations and make any capital expenditures.
Financing Requirements or Surplus
Computed by subtracting fixed-asset purchases and expenditures for long-term investments from cash after debt amortization. This measures either the magnitude of external financing needed or the cash generated in excess of all needs of the business.
Calculated Change in Cash
“External financing” refers to the provision of additional cash to a company from new debt or equity. This entry will result in an excess or shortfall of cash after adjusting the financing requirement or surplus by the amount of any external financing.
Actual Change in Cash
This represents the change in the cash account on the balance sheet from the preceding year’s to that of the current year. The change in cash includes changes in other cash equivalent accounts, such as marketable securities classified as current assets.
Cash flow sources important to you are:
- Those that are sustainable and reasonably predictable over the ensuing three to five years.
- Those that increase your margin of protection and indicate your customer’s economic viability.
TYPES OF CASH FLOW
- The most desirable cash flows are those from authentic and repeatable revenues and related noncash expenses. They are the cash flows that improve margins of protection because they are repeatable
- The second most desirable sources are improvements in asset efficiency and the proceeds of additional equity.
- The least desirable sources are flows from additional debt or from the sale of assets. Additional debt, while it may have benefits for your customer, increases leverage,
Three Levels of Cash Flow Analysis
• Analyzing Operating Cash Flows
- Cash flow derived from earnings is dependent on business fundamentals, whereas the cash cycle is driven by swing factors.
- Positive operating cash flow can be attributable to strong profit margins (fundamentals).
- Changes in the swing factors reflect a company’s ability to manage its working capital assets.
- Analyzing Investing Cash Flows
- Analyzing Financing Cash Flows
