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AFM 212 > Module 11 > Flashcards

Module 11 Flashcards

1
Q

What sections of the balance sheet does the three types of cash flows roughly correspond with

A

operating -> current assets and liabilities
investing -> long-term assets
financing -> long term liabilities and shareholders’ equity

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2
Q

what are examples of cash inflows for operating activities

A
  • receipts from customers for sales made or services rendered
  • receipts of interest and dividends
  • other receipts that are not related to investing or financing activities, like lawsuit settlements, refunds from suppliers
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3
Q

what are examples of cash outflows for operating activities

A
  • payments to employees or suppliers
  • payments to purchase inventories
  • payments of interest to creditors
  • payments of taxes to government
  • other payments that are not related to investing or financing activities like contributions to charity
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4
Q

what does investing activities involve

A
  • increasing or decreasing a company’s liquidity
  • acquisition and disposal of PP&E and intangibles
  • purchase and sale of stock and bonds and other securities
  • lending and subsequent collection of money
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5
Q

what are examples of cash inflows for investing activities

A
  • receipts from sale of PP&E and intangibles
  • receipts from sales of investments in stocks, bonds, and other securities (other than cash equivalents)
  • receipts from repayments of loans by borrowers
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6
Q

what are examples of cash outflows for investing activities

A
  • payments to purchase PP&E assets and intangible assets
  • payments to purchase stocks, bonds, and other securities (other than cash equivalents)
  • payments made to lend money to borrowers
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7
Q

what are financing activities

A

when companies:
- obtain resources from owners
- return resources to owners
- borrows resources from creditors
- repays amounts borrowed

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8
Q

what are examples of cash inflows for financing activities

A
  • receipts from issuance of common stock and preferred stock and from sales of treasury stock
  • receipts from issuances of bonds payable, mortgage notes payable, and other notes payable
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9
Q

what are examples of cash outflows for financing activities

A
  • payments to acquire treasury stock
  • payments of dividends
  • payments to settle outstanding bonds payable, mortgage notes payable, and other notes payable
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10
Q

what is the classification of activities for IFRS

A
  • interest received can be operating or investing
  • interest paid can be operating or financing
  • dividends received can be operating or investing
  • dividends can be operating or financing
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11
Q

what is the classification of activities for US GAAP

A
  • interest received is operating
  • interest paid is operating
  • dividends received is operating
  • dividends paid is financing
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12
Q

when looking at firms with different accounting standards, what should analysts do

A
  • pay attention to the different cash flow classification
  • ex. if looking at companies with IFRS, look at how they are classifying different activities
  • they will need to make adjustments based on the differences (especially if the differences make significant differences)
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13
Q

what are the two ways to calculate operating cash flow

A
  • indirect method
  • direct method
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14
Q

what is the indirect method

A
  • start with net income
  • adjust it to make it the net cash flow from operating activities
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15
Q

why do most companies use the indirect method to report operating cash flows even though US GAAP and IFRS encourage direct method

A
  • because its easier
  • if they report direct method, they also need to show indirect method in their reports
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16
Q

what is the adjustment to net income when there is increases in asset accounts (like receivables, inventories, and prepaid expenses)

A

subtract change from net income

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17
Q

what is the adjustment to net income when there is decreases in asset accounts (like receivables, inventories, and prepaid expenses)

A

add the change to net income

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18
Q

what is the adjustment to net income when there is increases in liability accounts (like payable, accruals, and unearned revenue)

A

add them to net income

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19
Q

what is the adjustment to net income when there is decreases in liability accounts (like payable, accruals, and unearned revenue)

A

subtract them from net income

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20
Q

what adjustments are made first to net income

A
  • revenues and expenses with no cash flow effects
  • gains and losses with no cash flow effects
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21
Q

what are the adjustments of revenues and expenses and what do you do with them

A
  • add them to net income
    includes:
  • depreciation and amortization
  • stock based compensation
  • asset impairments
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22
Q

what are the adjustments to gains and losses of disposals

A
  • add losses to net income
  • subtract gains to net income
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23
Q

what are the next adjustments made to net income

A

adjustments for current operating assets and liabilities

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24
Q

what do you do with changes in investments

A

increases in investments are subtracted (money spent to buy investments)

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25
Q

what do you do with changes in PP&E

A
  • sale of PP&E is added (money received from sale)
  • purchase of PP&E is subtracted (money spent)
26
Q

what do you do with changes in common stock

A
  • increases means issued stock
  • issuance of stock is added (issued stock and people bought it for money that you received)
27
Q

what do you do with changes in debt

A
  • increase in debt is added (money received from borrowing)
  • decrease is debt is subtracted (money paid to pay back debt)
28
Q

what do you do with changes in retained earnings

A
  • its the changes of dividends
  • payments of dividends are subtracted (payments made to shareholders)
29
Q

what is the direct method

A
  • the net cash flow from operating activities by showing the major categories of operating cash receipts and payments
  • amounts are usually determined by converting the accrual revenues and expenses to corresponding cash amounts
30
Q

where is the differences between indirect and direct method

A
  • operating activities section
  • investing and financing sections are the same
31
Q

how do you calculate the direct method

A

calculate:
- amount earned from customers
- amount paid for merchandise
- amount paid for expenses (employees, insurance, income taxes)
*dont include depreciation or any gains or losses

32
Q

how do you determine the cash received from customers

A

sales - increases in accounts receivable

33
Q

how do you determine the amount paid for merchandise

A
  • determine how much you merchandise you got (purchased): cogs - inventory sold
  • determine how much you paid: purchases + decrease in accounts payable
34
Q

if there is no wages payable what does it mean

A

wages expense = cash paid for wages

35
Q

how do you determine how much cash was paid for insurance

A

insurance expense + increase in prepaid insurance

36
Q

how to determine the cash paid for income taxes

A

income tax expense - increase in income tax payable

37
Q

what is operating cash flow generally viewed as

A
  • as less easy to manipulate compared to operating income or net income
  • those two can be manipulated by selling assets, changing depreciation method, etc.
38
Q

what does large differences between earnings and OCF or increases in such differences mean

A

there could be indication of earnings manipulation

39
Q

what are positive signs of operating cash flow

A
  • OCF should be the primary source of cash flow for a mature company
  • OCF should be positive and higher than net income
  • OCF could be negative in order to grow for new or growth-stage companies
  • OCF should be consistently increasing
  • OCF should be sufficient to cover CAPEX
40
Q

what is a non sustainable way to cover CAPEX

A

increasing debt or equity to cover it

41
Q

what are the primary determinants of investing cash flow

A
  • negative cash flows (cash outflows since investments are bought) from investing activities isn’t necessarily bad since its needed to support growth (for mature companies)
  • compare capex with depreciation, CAPEX should be > depreciation
42
Q

what are different questions that are asked for investing cash flow

A
  • if there is major capex, how does the company fund capex?
  • how much investing cash flow is for CAPEX and how much is for liquidity investment? (stock and bonds)
  • analysts should investigate what the purpose of asset selling is (if the company sold a significant amount of assets)
43
Q

what are the different ways a company can fund CAPEX and which one is the better way

A
  • through OCF
  • asset selling
  • financing
  • should be from OCF
44
Q

why is negative cash flow from financing activities not always bad

A
  • because it can be using excess cash flow to reduce financial leverage (pay back debt)
  • pay dividends and do share buybacks with excess cash to avoid excess liquidity
45
Q

is paying back debt with excess cash flow good?

A

its a good strategy if it lowers the financial leverage to an acceptable level

46
Q

why is using excess cash to pay dividends or have share buybacks good for shareholders

A

because they get more money/value of their existing shares increases

47
Q

why is it important that the dividends paid and shares bought back are done with excess cash

A
  • suspicious if its not
  • like companies selling their buildings then leasing them back to get extra cash to then pay special dividends (also not cash from operating activities)
  • can lead to bankruptcy really fast
48
Q

what do you need to assess with financing cash flow

A
  • why capital is being raised or repaid
  • its bad if they use financing cash flow to fund net losses and negative operating cash flows over the long run
49
Q

if a company is borrowing each year, what should you consider and how

A
  • when the repayment may be required
  • done by knowing the repayment schedule
50
Q

what are the 2 approaches for common size analysis of the statement of cash flows

A
  • express each line item of the cash inflow (outflow) as a % of net revenue
  • express each line item of the cash inflow (outflow) as a % of total inflow (outflow)
51
Q

what is the 4 stages in the product life cycle

A
  • introduction
  • growth
  • maturity
  • decline
52
Q

what is the normal behaviour of revenues in the product life cycle

A
  • revenue grows in the first 2 stages (introduction and growth)
  • then levels peaks at maturity
  • then declines at decline
53
Q

what is the normal behaviour of net income in the product life cycle

A
  • negative in the introduction stage (net losses)
  • then peaks at maturity stage
  • then it gradually decreases in the decline stage
54
Q

what is the normal behaviour of cash flows in the product life cycle

A
  • cash outflows for investing (purchases, negative cash flows) and cash inflows for financing (getting financing, positive cash flows) in the introduction stage
  • in decline stage: cash outflows for financing (paying back debt, buying back stock, paying dividends, negative cash flows), get cash inflows from investing (selling assets, positive cash inflows)
  • operating moves similar to investing, just peaks higher, earlier and falls lower faster
55
Q

why is understanding the life cycle stage important

A

because life cycle affects the firms production behaviour, its investing activities, its market share, etc.

56
Q

what does research show about cash flow patterns (net inflow or outflow)

A

that they provide a reliable way to assess the overall life cycle

57
Q

if investing cash flows suddenly increase, while financing cash flows decrease, what could it mean

A
  • lots of assets were sold (investing cash inflows)
  • debt is repaid, dividends are paid out (financing cash outflows)
58
Q

what does the results quality of cash flow mean

A

if the underlying economic performance is good

59
Q

what are the different examples of good results quality

A
  • positive OCF
  • from sustainable sources (normal operations)
  • adequate to cover capex, debt repayment, and dividends
  • low volatility
60
Q

what does the reporting quality of cash flow mean

A

if it reasonably reflects the underlying economic performance

61
Q

what are different factors about the reporting quality of cash flows

A
  • timing (if they are selling receivables or delaying paying payables to boost OCF)
  • classification of cash flow

AFM 212 (7 decks)

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