Reading 26 - Understanding Cash Flow Statements Flashcards
Give a summary of cash flow statements and why they’re useful.
The cash flow statement provides important information about a company’s cash receipts and cash payments during an accounting period as well as information about a company’s operating, investing, and financing activities. Although the income statement provides a measure of a company’s success, cash and cash flow are also vital to a company’s long-term success. Information on the sources and uses of cash helps creditors, investors, and other statement users evaluate the company’s liquidity, solvency, and financial flexibility.
How are cash flow activities classified?
Cash flow activities are classified into three categories: operating activities, investing activities, and financing activities. Significant non-cash transaction activities (if present) are reported by using a supplemental disclosure note to the cash flow statement.
What are the differences in cash flow statements under IFRS and US GAAP?
Cash flow statements under IFRS and US GAAP are similar; however, IFRS provide companies with more choices in classifying some cash flow items as operating, investing, or financing activities.
What are the choices for companies in reporting their operating cash flows? Define each.
Companies can use either the direct or the indirect method for reporting their operating cash flow:
- The direct method discloses operating cash inflows by source (e.g., cash received from customers, cash received from investment income) and operating cash outflows by use (e.g., cash paid to suppliers, cash paid for interest) in the operating activities section of the cash flow statement.
- The indirect method reconciles net income to operating cash flow by adjusting net income for all non-cash items and the net changes in the operating working capital accounts.
Where are cash flow statements linked?
The cash flow statement is linked to a company’s income statement and comparative balance sheets and to data on those statements.
In cash flow analysis, what can an analyst do when dealing with indirect method format used by companies?
Although the indirect method is most commonly used by companies, an analyst can generally convert it to an approximation of the direct format by following a simple three-step process.
What should an evaluation of cash flow statements involve?
An evaluation of a cash flow statement should involve an assessment of the sources and uses of cash and the main drivers of cash flow within each category of activities.
How can analysts use common-size statement analysis for cash flows and how do they develop them?
The analyst can use common-size statement analysis for the cash flow statement. Two approaches to developing the common-size statements are the total cash inflows/total cash outflows method and the percentage of net revenues method.
What can be used to determine free cash flow to the firm (FCFF) and free cash flow to equity (FCFE)?
The cash flow statement can be used to determine free cash flow to the firm (FCFF) and free cash flow to equity (FCFE).
How are ratios used in cash flow statement analysis?
The cash flow statement may also be used in financial ratios that measure a company’s profitability, performance, and financial strength.
Under both IFRS and U.S. GAAP, cash flows are classified into the following categories:
Cash flow from operating activities (CFO)
Cash flow from investing activities (CFI)
Cash flow from financing activities (CFF)
Under both IFRS and U.S. GAAP, define cash flow from operating activities (CFO).
Cash flow from operating activities (CFO): These are inflows and outflows of cash related to a firm’s day‐to‐day business activities.
Under both IFRS and U.S. GAAP, define cash flow from investing activities (CFI).
Cash flow from investing activities (CFI): These are inflows and outflows of cash generated from the purchase and disposal of long‐term investments. Long‐term investments include plant, machinery, equipment, intangible assets, and nontrading debt and equity securities.
Note: Investments in securities that are considered highly liquid (cash equivalents) are not included in investing activities. Neither are securities held for trading. Cash flows associated with the purchase and sale of highly liquid cash equivalents and of securities for trading purposes are classified under cash flow from operating activities.
Under both IFRS and U.S. GAAP, define cash flow from financing activities (CFF).
Cash flow from financing activities (CFF): These are cash inflows and outflows generated from issuance and repayment of capital (interest‐bearing debt and equity).
Note: Indirect short-term borrowings from suppliers that are classified as accounts payable, and changes in receivables from customers are not considered financing activities; they are classified as operating activities.
Identify the inflows and outflows of cash flow from operating activities (CFO).
CFO
Inflows:
Cash collected from customers.
Interest and dividends received.
Proceeds from sale of securities held for trading.
Outflows:
Cash paid to employees.
Cash paid to suppliers.
Cash paid for other expenses.
Cash used to purchase trading securities.
Interest paid.
Taxes paid.
Identify the inflows and outflows of cash flow from investing activities (CFI).
CFI
Inflows:
Sale proceeds from fixed assets.
Sale proceeds from long-term investments.
Outflows:
Purchase of fixed assets.
Cash used to acquire LT investment securities.
Identify the inflows and outflows of cash flow from investing activities (CFF).
Inflows:
Proceeds from debt issuance.
Proceeds from issuance of equity instruments.
Outflows:
Repayment of LT debt.
Payments made to repurchase stock.
Dividends payments.
What is a very important note about cash flows?
Note: There is a difference in how some cash flows are classified under IFRS and U.S. GAAP. These differences are discussed in LOS 27c and are very important from the examination perspective.
Describe how non-cash investing and financing activities are reported on cash flow statements.
Noncash investing and financing activities are not reported on the cash flow statement because these transactions do not involve any receipt or payment of cash.
In the context of cash flow statements, give examples of noncash investing and financing activities include:
- Barter transactions where one nonmonetary asset is exchanged for another.
- Issuance of common stock for dividends or when holders of convertible bonds or convertible preferred stock convert their holdings into ordinary shares of the company.
- Acquisition of real estate with financing provided by the seller.
What must we remember about company’s requirements to disclose any significant noncash investing and financing activities?
Remember that companies are required to disclose any significant noncash investing and financing activities in a separate note or a supplementary schedule to the cash flow statement.
Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and U.S. generally accepted accounted principles (U.S. GAAP).
Cash flow statements prepared under IFRS and U.S. GAAP differ along the following lines:
Classification of cash flows: Certain cash flows are classified differently under IFRS and U.S. GAAP. IFRS offers more flexibility regarding the classification of certain cash flows.
Presentation format: There is a difference in the presentation requirements for cash flow from operating activities. Table 2 highlights important differences between IFRS and U.S. GAAP with respect to cash flow statements.
In cash flow statements: what are the differences between IFRS and U.S. GAAP?
Topic: IFRS – U.S. GAAP
Classification of cash flows:
Interest received: Operating or investing – Operating
Interest Paid: Operating or financing – Operating
Dividends received: Operating or investing – Operating
Dividends paid: Operating or financing – Operating
Bank overdrafts: Considered part of cash equivalents – Not considered part of cash and cash equivalents and classified as financing
Taxes Paid: Generally operating, but a portion can be allocated to investing or financing if it can be specifically identified with these categories – Operating
Format of statement:
Format of statement: Direct or indirect; direct is encouraged – direct or indirect; direct is encouraged. A reconciliation of net income to cash flow from operating activities must be provided regardless of method used.
Under both IFRS and U.S. GAAP, there are two acceptable formats for presenting the cash flow statement. What are these two acceptable formats?
The direct method and the indirect method. These methods differ only in the presentation of the CFO section of the cash flow statement; calculated values for CFO are the same under both. Further, the presentation of CFF and CFI are exactly the same under both formats.