EFM03-08(4) Flashcards
Explain why cash flow is different from net income.
- Timing:
- depreciates allocates one-time cash outlay for purchase of an asset over many years
- sales revenue: recognized when product or service is delivered even though customer pays later.
- COGS: recognized when product or service delivered, even though the materials were paid for much earlier.
What are the three parts of the cash flow statement? Be able to assign a particular cash flow to the appropriate part.
- Operating Activities
- Investing activities
- Financing Activities
Know whether a particular activity represents a cash inflow or a cash outflow.
Operating:
Inflows: cash sales, collections from customers, customer downpayments, interest income
Outflows: payments for materials, direct labor, fixed costs, interest payments, tax payments
Investing:
Inflows: after-tax proceeds from disposal of fixed assets.
outflows: purchase or cost to develop fixed assets.
Financing:
Inflows: borrowing, increase in capital lease obligations, equity contributions.
outflows: debt principal payments, decrease in capital lease obligations, dividends and distributions to equity.
Define Net Working Capital and know when a change in NWC is a cash inflow or a cash outflow
NWC = current assets other than cash - current liabilities other than interest bearing short term debt.
Increase in NWC is cash outflow, decrease is inflow.
Direct Method
Know the simple equation linking net income to cash flow from operating activity.
cash flow from operating activity =
net income
+depreciation
-Change in net working capital
How does the statement of cash flows for one year tie to the cash flow statement for the next year?
Ending Cash and cash equivalents of previous year is the beginning cash and cash equivalent of the current year.
How does the cash flow statement tie to the balance sheet?
Tells you about the purchase of PPE as well as the source of income through operations and raised capital through leases and borrowing.
Recognize the questions that investors’ and Creditors’ expect the cash flow statement to answer.
- Is the firm generating cash from operations or by selling assets, borrowing, or diluting equity?
- Why are operating cash flows different from net income?
- Is there evidence of long-term negative cash flows that will lead to bankruptcy?
- Why does the firm need more cash now?
Why is a growing firm likely to have positive profits and negative cash flows?
-Have a lot of sales, but haven’t collected the money from sales, also are using more inventory
What are the three most common reasons for cash flow problems?
- Difficulty in collecting receivables: credit terms, credit policies, up-front deposits, timely and accurate billing
- Seasonality of Sales: diversify, modified payment plan from vendors
- Unexpected variation in sales: more accurate forecasts, worst case scenario forecast(in addition to most-likely case
What are the three most common ways of coping with cash flow problems?
- use personal money
- borrow
- adjust scheduled purchases
What are the two types of cycles that affect cash flows?
Transaction cycles: based on operations. manufacturer may have to pay suppliers and employees before getting paid by customers.
Seasonal cycles: based on time of year. Flower store may have more cash around holidays but less at other times.
Be able to calculate cash per dollar of sales.
Operating cash flow / Sales
Operating cash flow divided by sales.
What is the “cash conversion cycle.” What does a negative “cash conversion cycle” mean?
It’s the length of time cash is tied up in the production and sale of a product.
The time between incurring a cash outlay for the purchase of raw materials or inventory and the receipt of the cash from the customer.
Be able to compute the number of days in a firm’s cash conversion cycle.
Days in cash conversion cycle =
of days in inventory
+ Days in accounts receivable
-Days in accounts payable
