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CFA Level 1 - Quantitative Methods > Understanding Cash Flow Statements > Flashcards

Understanding Cash Flow Statements Flashcards

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1
Q

Cash flow statements provide information beyond that available from the income statement which is based on accrual accounting.

A

It Includes:

  • Information on cash receipts and cash payments during an accounting period.
  • Operating, financing and investment activity
  • An understanding of the impact accrual accounting has on cash flows.
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2
Q

Items on the cash flow statement come from:

A
  1. Income statement

2. Changes in the balance sheet

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3
Q

Operating cash flow:

A

consists of inflows and outflows of cash resulting from a firms’ net income.

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4
Q

Investing cash flow:

A

inflows and outflows of cash resulting from the acquisition and disposal of LT assets and certain investments.

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5
Q

Financing cash flows:

A

inflows and outflows of cash that result from transactions that alter the firms’ capital structure.

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6
Q

Unique examples in statement of cash flows:

A
  • interest and dividends received, and interest paid by firm is an operating activity.
  • Dividends paid to shareholders are financing activities.
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7
Q

Noncash transactions are not presented in cash flows statements, but should be mentioned in the footnote of the report.

A

…

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8
Q

In Constant Cash Flows, GAAP and IFRS handles dividends and interest paid as,…

A

GAAP - dividends paid = financing
- interest paid = operating
IFRS - dividends and interest can be applied as operating or financing.

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9
Q

How are taxes handled in GAAP and IFRS,

A

GAAP: operating expenses
IFRS: income taxes are operating, but taxes for financing or investments are netted out of the gain/loss

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10
Q

Direct method is encouraged by IFRS and GAAP.

A

Difference between the two is how operating activities are presented.

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11
Q

Under the direct method, each line item of the accrual-based income statement is converted into cash receipts or payments.

A

In the indirect method, net income is converted to operating net cash flow by making adjustments for transactions that affect net income but are not cash transactions. (going from net income to operating income).

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12
Q

The advantage of direct method is that it is present in the firms operating cash receipts and payments, while indirect method only presents the net results of the receipts and payments.

A

Disadvantage of indirect method is that it focuses on the differences in net income and operating cash flow. This is useful when predicting future cash flows.

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13
Q

Under IFRS, interest and taxes must be disclosed separately in the cash flow statement, under either method.

A

…

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14
Q

The cash flow statement reconciles the beginning and ending balances of cash over an accounting period.

A
  • Operating cash flows + Investing cash flows + Financing cash flows = change in cash balances.
  • Change in cash balances + beginning cash balances = ending cash balance
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15
Q

Increase in assets means use of cash.

A

Decrease in assets means source of cash.

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16
Q

The direct method only shows cash payments and cash receipts over the period. the sum of inflows and outflows is the operating cash flow.

A

Components of cash flow under direct method:

  • cash collected from customers
  • cash used in productions/services
  • cash operating expenses
  • cash paid for interest
  • cash paid for taxes

*When using direct method, ignore depreciation expense.

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17
Q

Investing cash flows are calculated by examining the change in the gross assets account that result from investing activities.

A

…

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18
Q

Financing cash flows are determined by measuring the cash flows occurring between the firm and its suppliers of capital.

A

Financing cash flows are the sum of:

  1. net CF of creditors = new borrowings - principal amounts repaid
  2. net CF of shareholders = new equity issued - shares repurchased - dividends paid
19
Q

Indirect method

A

Financing and investing CFs are same as direct method, except for operating CFs

20
Q

For operating CFs, start with net income and adjust for differences between accounting items and actual cash receipts and disbursements,

A

ex. ) add depreciation to net income because cash outlay not required
ex. 2) adjusting for change in balance sheets accounts. If Accounts Receivable > Cash, decrease cash flow because Accounts Receivables is on credit.
ex. 3) Subtract gains on the disposal of assets.

21
Q

To calculate operating CFs:

A
  1. Begin with net income
  2. subtract gains or add losses in financing and investing activities
  3. Add all noncash charges to income (such as depreciation or amortization) and subtract all noncash components of revenue.
  4. Add or subtract changes in balance sheets accounts
22
Q

If dividends are not declared,

Beginning RE + net income - ending RE

A

example on pp 120-123.

23
Q

Under direct method, there are two major sections:

A
  1. cash inflows (receipts)

2. cash outflows ( payments)

24
Q

Adjustments for cash collected:

A
  1. begin with net sales from Income Statements
  2. Subtract (add) any increase (decrease) in the accounts receivable balance as reported by indirect method.
  3. Add (subtract) any increase (decrease) in unearned revenue.
25
Q

Adjustments for cash payments to suppliers:

A
  1. Begin with COGS, on Income Statement
  2. If depreciation and/or amortization has been included in COGS, add back to noncash expenses when computing cash paid to suppliers.
  3. Reduce COGS by any increase in Accounts Payable
  4. Add (subtract) any increase (decrease) in the inventory balance as disclosed in indirect method. (COGS doesn’t use inventory in own calculations).
  5. Subtract any inventory write-off. (reduces ending inventory and increase COGS for period)

Example pp125, book 3.

26
Q

Operating cash flows provide a check of the quality of a firms earnings. If stable operating cash flows , the historic trend of quality earnings for firm.

A
  • Early on, firms likely to have “<0” cash flows.
27
Q

If investing cash flows increase, it is usually a sign of growth. Or, if investing CF decreases, it may e a signal of growth as cash is being freed up.

A

…

28
Q

Financing cash flows look to see if the firm is creating cash by issuing debt or equity.

A

…

29
Q

A revenue based commons sized cash flow statement is useful in identifying trends in forecasting future cash flows.

A

…

30
Q

Free cash flow to the firm (FCFF)

A

a measure of cash that is available for discretionary purposes. Available once the firm has covered its capital expenditures.

  • it is the cash flow available to all investors.
31
Q

Free cash flow =

A

= Net Income + Noncash charges+ [interest expense * (1 - tax rate)] - fixed capital investment - working capital investment

  • fixed capital investment is the cash spent on fixed assets minus cash received on the sale of fixed assets.

= CFO + [ Interest * (1- tax rate)] - fixed capital investment

32
Q

Free cash flow to equity (FCFE)

A

The cash flow that would be available for distribution to common shareholders.

= Operating cash flows - fixed capital investment + net borrowing

  • dividends in CFO must be added back to FCFE when calculating.
33
Q

Cash-flow-to-revenue

A

= CFO / net revenue

  • operating cash generated per dollar of revenue
34
Q

Cash-return-to-assets ratio

A

= CFO / avg. total assets

-operating cash flows attributed to all providers of capital

35
Q

Cash-return-on-equity

A

= CFO / avg. total equity

  • operating CF attributed to shareholders
36
Q

Cash-to-income ratio

A

= CFO / operating income

  • ability to generate cash from firm operations
37
Q

Cash flow per share

A

= (CFO - preferred dividends) / weighted avg. number of commons shares

-similar to EPS but operating CFs and not net income

38
Q

Debt coverage ratio

A

= CFO / total debt

-measures financial risk and leverage

39
Q

interest coverage ratio

A

= (Operating CFs + interest paid + taxes paid) /interest paid

  • measures firms ability to meet interest obligations
40
Q

Reinvestment ratio

A

= CFOs / cash paid for LT assets

  • firms ability to acquire LT assets with operating CFs
41
Q

Debt payment ratio

A

= CFO / cash LT debt repayment

  • measures firms ability to satisfy LT debt with operating CFs
42
Q

Dividend payment ratio

A

= Operating CFs / dividends paid

  • firms ability to make dividend payments from CFO
43
Q

Interest and Financing Ratio

A

= Operating CFs / cash outflows from investing and financing

  • measures firms ability to purchase assets, satisfy debt and pay dividends

CFA Level 1 - Quantitative Methods (29 decks)

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