Lecture 10 - Cash Flows

Question 1

Mention the 2 types of cash and explain the second

Answer 1

1) Cash
2) Cash equivalents
-Highly liquid short-term investment that can be converted to cash immediately and are not subject to significant risks of change in value
-Eg. Fixed short term deposits, investment in government securities

Question 2

Mention 4 purposes of the Cash Flow Statement

Answer 2

1) Predict future cash flows

2) Determine a company’s ability to pay dividends and interest

3) Evaluate management decisions

4) Show the relationship of net income to cash flows

Question 3

Operating activities:

1) What do they create?
2) What do they increase and decrease?
3) Why are they important

Investing activities:
1) What do they increase and decrease?
2) Define them
3) Why are they important?

Financing activities:
1) What does it consists of?
2) What does it increase and decrease?
3) Why are they important?

Answer 3

Operating activities:
1) Revenue, expenses, gains and losses = net income
2) Current assets and current liabilities
3) Because a succesful entity much generate most of its cash from operating activities

Investing activities:
1) Non-current assets
2) Purchases and sales of non-current assets (PPE, intangibles, investments in other companies)
3) Important for medium- and long-term operations as they represent to which extend investment has been made for resources intended to generate future income and cash flow

Financing Activities:
1) Obtain and pay cash to investors and creditors + equity transitions
2) Non-current liabilities and shareholders’ equity
3) To help readers predict claims on future cash flows by providers of capital to the entity

*Loans:
Interest expense = operating activities
Principal = financing activities

Question 4

What are the 2 formats for preparing cash flows from operating activities?

Answer 4

Direct and Indirect method

Question 5

Describe the Direct Method for preparing cash flows from operating activities and the 4 steps

Answer 5

-Uses actual cash inflows and outflows
-More intuitive but time consuming

Steps:
1) Cash sales
2) Add: Payment received from costumer
3) Less: Payment made to vendors
4) Less: Payment made for expense, tax, ect.

Question 6

Describe the Indirect Method for preparing cash flows from operating activities and the 4 steps

Answer 6

-Requires changing accrual accounting into cash basis
-Easy to prepare / less time consuming
-Usually used when preparing cash flows from operating activities

1) Net income
2) Add: non-cash expense (eg. depreciation)
*Has no effect on cash but decreases income = remove it
3) Add/less: Gain/loss of long-term assets
Included in investment, not operating, but has been added to the income statement = remove them
4) Add/less: Increase/decrease in current assets and liabilities**
*Cash has been foregone to get assets
** Payments kept on hold = no outflow of cash

Question 7

Define Free Cash Flow + provide formula

Answer 7

-Amount fo cash available from operating activities after paying for capital expenditures: Typically investments in new PPEs

= Net cash provided by operating activities
- cash payments for investments in PPEs