FSA: Understanding the Cash Flow Statements

Question 1

CFS: Basics =

Answer 1

provides info in addition to the IS (which is based on accrual rather than cash accounting)

Items on the CFS come from 1) IS items 2) changes in balance sheet accounts

FOR AN ANALYST: provides info on the firm’s liquidity, solvency, financial flexibility.

Whether:

• regular operations generate enough cash to sustain the business
• enough cash is generated to pay off existing debt as it matures
• the firm will need additional financing
• unexpected obligations can be met
• the firm has the ability to take advantage of new business opportunites as they arise.

Question 2

CFO =

Answer 2

inflows and outlows of cash from transaction that affect net income

typically relate to CURRENT ASSETS AND LIABILITIES

Question 3

CFI =

Answer 3

inflows and outflows from acquisition or disposal of lont term assets and certain investments

TYPICALLY RELATE TO NON CURRENT ASSETS

Question 4

CFF =

Answer 4

inflows and outflows of cash from transactions affecting the capital structure.

TYPICALLY RELATE TO NON CURRENT LIABILITES AND EQUITY

Question 5

Non cash investing & financing activity =

Answer 5

If there are no cash inflows or outflows activity DOES NOT appear on the CFS.

Must be disclosed in footnote/supplement - should be incorporated into analysis (effect on past/current performance and future cash flows)

ie. acquiring real estate with financing from the seller - no cash changes hands.
ie. exchanging debt for equity - debt is reduced, equity increases, but no cash changes hands.

Question 6

Flow statements: IFRS/GAAP =

Answer 6

GAAP: dividends paid - FCF. Dividends/interest received and interest paid - OCF

IFRS: All can be either FCF or OCF

TAXES

GAAP: ALL taxes paid are OCF.

IFRS: income taxes are OCF unless the expense is related an investing or financing transaction.

Question 7

Direct Method - presenting OCF =

Answer 7

allowed under both GAAP and IFRS - most firms use the indirect method.

DM converts an accrual basis IS into a cash basis IS.

ADVANTAGE: presents operating cash receipts and payments (not just the net) -> more info. Can be used for estimating future cash flows.

IFRS: payment for interest and taxes must be disclosed separately in the CFS

GAAP: they can be reported in the CFS or in footnotes. Adjustments needed to reconcile net income to cash flow (same info presented in indirect method) must be disclosed.

Question 8

Indirect method - presenting OCF =

Answer 8

Allowed under GAAP and IFRS - most firms use indirect and not direct

Starts with net income.

Advantage: focuses on difference between net income and OCF. An analyst can forecast net income and then find OCF by adjusting for the differences between accrual and cash basis accounting.

IFRS: payment for interest and taxes must be disclosed separately in the CFS

GAAP: they can be reported in the CFS or in footnotes.

Question 9

Link to IS and BS =

Answer 9

Question 10

BS: In/Direct method CHEAT SHEET =

Answer 10

Question 11

OCF: Direct Method: (1) =

Answer 11

Typical components:

• Cash collected from customes (primary component)
• Cash inputs (production of G&S)
• Cash operating expenses
• Cash paid for interest
• Cash paid for taxes

Question 12

ICF: Direct Method =

Answer 12

changes in gross asset accounts from INVESTING ACTIVITES - PP&E, intangible assets, inv securities.

Related depreciation and amortization accounts ARE IGNORED as they are not cash expense.

Beginning gross assets + cash paid for new assets - gross cost of assets sold = ending gross assets

gross cost of assets sold = book value +/- gain/loss on sale

Question 13

FCF: Direct Method =

Answer 13

cash flows between the firm and its suppliers of capital.

net CF from creditors = new borrowings - prinicipal repayments

net CF from shareholders = new equity issued - share repurchases - cash dividends paid

[cash dividends paid may need to be calculated from changes in dividends declared and dividends payable]

Question 14

Direct Method: TOTAL CASH FLOW =

Answer 14

OCF + ICF + FCF

If calculated correcty total cash flow will equal the cahnge in cash from one BS to the next.

BS(Y1) +/- TCF = BS(Y2)

Question 15

OCF: Indirect method =

Answer 15

Net Income

Adjusted for differences between accounting items and actual cash receipts/payments.

Items like depreciation/amortization that are subtracted to reach net income MUST BE ADDED BACK IN.

Gains/Losses on sales of assets need to be subtracted/added in as these are ICF.

Net income needs to be adjusted changes in BS accounts - if Acc Rec goes up, sales>cash received, so net income needs to be reduced to reflect true OCF. If Acc Payable

Question 16

OCF: Indirect method - 4 steps =

Answer 16

1. Net income
2. subtract gains/add losses from ICF and FCF
3. Add back non cash charges to income (ie depr/amort), subtract all non cash components of revenue
4. Adjust BS operating accounts-
   a) subtract increases in operating asset accounts, add decreases (when assets go up, cash goes down and vice versa)
   b) add increases in operating liability accounts, subtract decreases (when liabilities go up, cash goes up and vice versa)

Question 17

Calculating ICF and FCF =

Answer 17

BASE calculations from NY training?

Beginning, Addition, Subtraction, Ending

Question 18

FCFF - free cash flow to the firm =

Answer 18

= net income

+ non cash expenses (depr + amort)

+ interest expense(1-t)

• Fixed Capital investment
• Working Capital Investment

= NI +NCExp + IntExp (1-t) - FCInv - WCInv

Can also be calculated from OCF by adding the tax adjusted interest expense and subtracting the fixed capital investment

Question 19

FCFE =

Answer 19

cash flow available to common shareholders

= OCF + net borrowing - fixed capital investment