week 6 (module 11) - cash flow statement preparation and analysis Flashcards
what are the 3 types of cash flows that correspond with sections of b/s
operating -> current assets, current liabilities
investing -> long-term assets
financing -> long term liabilities, sh/e
what is th efocus of operating activities
generate cash from selling goods/services at a profit
what are cash inflows from operating activities?
receipts from customers for sales made/services
recipts of interest and dividends
other receipts unrealted to investing/financing activities (lawsuit settlesments, refunds from supplier)
what are cash outflows from operating activities?
payments to employees/suppliers
payments to purchase inven
payments of interest to creditors
paymenst of taxes to gov
otehr payments unrelated to investing/financing activities (contributions to charit)
what are investing activities?
acquisition and disposal of ppe assets and intangible assets
purchase and sale of stock/bonds/other securities
lending and subsequent collection of money
what are exampels of cash inflows from investinga ctivities
receipts from sale of pp&e and intangible assets
sales of investments in stocsk/bonds/other securities(other than cash equiavlents)
receipts from repayments of loans from borrowers
what are exampels of cash outflows from investing activities
payments to purchase pp&e and intang assets
payments to purchase stocks/bond/other securities (other than cash equivalents)
payments mde to lend money to borrowers`
what are financing activities?
obtain resources from owners
return resources to onwers
borrow resources form creditors
repays amounts borrowed
what are examples of cash inflows from financing activities?
receipts from issuances of common stock/preferred stock and sales of treasury stock
recipts from issuances of bonds payable, mortgage notes payable, other notes payable
what are examples of cash outflows from financing activities?
payments to acquiry treasury stock
payments of dividends
payments to setlle outstanding bonds payable, mortgage notes payable and other notes payable
what are ifrs requirements vs us gaap requirements
INTEREST RECEIVED:
ifrs - operating or investing
GAAP - must be operating
INTEREST PAID:
ifrs - operating or financing
gaap - must be operating
DIVIDENDS RECEIVED:
ifrs - operating or investing
gaap - must be operating
DIVIDENDS PAID:
ifrs - operating or financing
gaap - must be financing
what is the first section of a statement of cash flows
presents firm’s net cash flow from operating activities
what are the 2 formats to report operaitng cash flow?
indirect and direct method
what is the indirect method?
starts with net income and applies series of adjustments to convert net income to net cash flow from operating activities
what are the adjustments for current operating accounts?
RECEIVABLES:
increase - deduct increase from net income
decrease - add to net income
INVENTORIES:
increase - deduct from net income
decrease - add to net income
PREPAID EXPENSES:
increase - deduct from net income
decrease - add to net income
PAYABLES AND ACCRUALS:
increase - add to net income
decrease - deduct from net income
UNEARNED (DEFERRED) REVENUE:
increase - add to net income
decrease - deduct from net income
how to convert net income to operating cash flow under INDIRECT method
net income
+ depreciation/amortization
+ stock-based compensation
+ asset impairments
+/- (subtract) losses (gains) on asset/liabilities dispositions
adjust for changes in current operating ASSETS:
- subtract increases in curr operating assets
+ add decreases in curr operating assets
adjust for changes in current operating LIABILITIES:
+ add increases in curr op liab
- sub decreases in curr op liab
net cash flow from operating activities
what are the steps to determining operaitng activities?
step 1: begin with net income
step 2: adjust for noncash revenues, expenses, gains and losses
revenues and expenses with no cash flow effects:
+ depreciation/amortization (writeoffs of prev recorded assets) to net income
+ stock based compensation (expense settled in stock and not paid in cash) to net income
gains and losses with no cash flow effects:
financing activity, needs to be eliminated
- gain on sale of land
step 3: adjust for changes in operating assets and curr liabilities
adjust net inc for effect of changes in current operating assets/liabilities, some changes affect net inc but have no effect on cash flow, other changes have no net income effect but do affect cash flow
calculate change in each curr op asset and liab
apply guide:
- incr in curr assets
+ decr in curr assets
+ incr in curr liab
- decr in curr assets
NET CASH FROM OPERATING ACTIVITIES
net income 32k
add(deduct) items to convert net inc to cash basis:
depreciation 10k
add stock based compensation 2k
gain on sale of land -8k
a/r increase -5k
inventory decrease +6k
prepaid insurance increase -13k
a/p decrease -9k
income tax increase +2k
NET CASH PROVIDED BY OPERATING ACTIVITIES 17K
what are the steps to determining investing activities?
- change in investments
- increase = investments have been purchased - change in pp&e
- purchase equip for 5k
- sold land for 28k (inflow)
- 8k gain on sale of land costing 20k
- net is decrease of 15k (5k - 20k sale) - change in accum depreciation
- increased by 10k
- increases when depreciation is recorded
- no cash flow related to recording of dep expense
- previously adjusted for expense in computation of net cash flows from operating - change in patent
- increased 60k
- additional data indicates common stock was issued to obtain it
- noncash investing transaction, combined with noncash financing transaction
- both r disclosed as supp. info to statement of cash flows
CASH FLOWS FROM INVESTING ACTIVITIES:
purchase of investments -15k
purchase of equipment -5k
sale of land +28k
NET CASH PROVIDED BY INVESTING ACTIVITIES +8k
what are the steps to financing activities?
- change in common stock
- incr 76k, issued stock
- common stock with 60k par value issued in exchange for patent (noncash investing/financing)
- incr of 14k cash resulted from issuance of stock for cash
- issued 2k for stock based compensation (noncash expense and no cash financing outflow reported), was added back to net inc to compute operating cash flow
net change in common stock
+ 14k
- change in debt
- LT debt decrease 12: comp paid down debt
- repayment of LT debt: -12k - analyze change in retained earnings
- retained earnings grew by 19k, net result of 32k in net income and 13k cash div
- only cash dividend remains to be considered
CASH FLOWS FROM FINANCING ACTIVITIES:
issuance of common stock +14k
repayment of LT debt -12k
payment of dividends -13k
NET CASH USED BY FINANCING ACTIVITIES -11k
how are cash inflows/outflows from similar types of investing/financing activities reported?
reported SEPARATELY rather than reporting only net difference
- proceeds from sale of pp&e are reported separately from outlays made to acquire pp&e
- funds borrowed are reported separately from debt repayments
- proceeds from issuing stock are reported separately from outlays to acquire treasury stock
what are supplemental disclosures for the indirect method?
cash paid for int and cash paid for income taxes
schedule/description of all noncash investing and financing transactions
firm’s policy for determining which highly liquid, ST investments are treated as cash equivalents
what are noncash investing and financing activities?
issuance of stocks/bonds/leases in exchange for PP&E assets/intangible assets
exchange of LT assets for other LT assets
conversion of LT debt into common stock
what is the direct method?
presents net cash flow from operating activities by showing major categories of operating cash receipts and payments
operating cash receipts/payments are usually determined by converting accrual revenues and expenses to corresponding cash amounts
only operating section of statement of cash flows is diff from the statement of cash flows prepared using indirect method
investing/financing sections are identical
what are the adjustments made to convert income statement items to operating act cash flows
sales:
+ decr a/r
- incr a/r
+ incr in unearned/deferred rev
- decr in unearned/deferred rev
= receipts from customers
COGS
+ incr in inventory
- decr in inven
+ decr in a/p
- incr in a/p
= payments for merchandise
operating expenses, interest expense, income tax expense
+ incr in related prepaid expense
- decr in related prepaid exp
+ decr in related accrued liability
- incr in related accrued liability
= payments for expenses
depreciation expense, depletion expense, amortization expense
exclude: addback noncash expenses that do not impact cash flow
= 0
gains/losses (investing and financing)
exclude: not related to cash from operating activities
= 0
how to convert sales to cash received by customers
- during year, a/r increased 5k
- means that cash collections on account (decrease a/r) were less than credit sales (increase a/r)
- compute cash received from customers:
sales (250k)
- increase in a/r (-5k)
= cash received from customers (245k)
how to convert cogs to cash paid for merch purchased
2 step process:
1. cogs is adjusted for change in inven to determine amnt of purcjases during the year
2. purchases is adjusted for the change in a/p to derive the cash paid for inven purchases
- compute cash paid for merch:
1. cogs (148k) - decr in inven (-6k)
= purchases (142k)
- purchases (142k)
+ decr in a/p (9k)
= cash paid for merch purchased (151k)
how to convert wages expense to cash paid to employees
no adjustment to wages expense of 52k is needed
absence of beginning/ending accrued liability for wages payable means wages expense/cash paid to employees as wages are same amnt
stock based compensation expense of 2k did not involve cash
how to convert insurance exp to cash paid for insurance
prepaid insurance incr 13k
increase reflects excess of cash paid for insurance over insurance exp
insurance exp (5k)
+ increase in prepaid insurance (13k)
= cash paid for insurance (18k)
how to convert income tax expense to cash paid for income taxes
increase in inc tax payable means income tax expense (incr inc tax payable) was greater than tax payments (decr income tax payable)
income tax expense (11k)
- increase in income tax payable (-2k)
= cash paid for income taxes (9k)
what does the final direct method statement of cash flows: operating look like?
cash received from customers (245k)
cash paid for merch purchased (-151k)
cash paid to employees (-50k)
cash paid for insurance (-18k)
cash paid for income taxes (-9k)
net cash provided by operating activities (17k)
what are supplemental disclosures for the direct method?
separately disclose the following:
- reconciliation of net income to net cash flwo from operating activities
- essentially indirect method of computing cash flow from operating activites
- thus when direct method is used in statement of cash flows, indirect is a req separate disclosure - schedule/description of all noncash investing and financing transactions
- firm’s policy for determining which highly liquid, ST investments are treated as cash equivalents
how to analyze operating cash flow?
- generally viewed as being less easily manipulated than operating income/net income
- large diff between earnings and OCF or increases in such difference can be indication of earnings manipulation
positive signs, OCF:
- primary source of cash flow for mature company
- positive and higher than net income
- negative to grow for new/growth stage companies
- consistently increasing
- sufficient to cover capex
how to analyze investing cash flow?
negative ICF not necessarily bad as necessary investment support growth
compare capex with depreciation:
- if there is major capex, how does the comp fund the capex thru OCF, asset selling/financing?
- how much ICF is for capex, how much is for liquidity investment (stock/bonds)
- if comp sold significant amnt of assets, analyst should investigate purpose of asset selling
how to analyze financing cash flow?
- negative FCF is not necessarily bad
- using excess cash flow to reduce financial leverage is sound strategy if it lowers financial leverage to an acceptable level
- distributing excess cash to shareholders via dividends and share repurchases is a way to avoid excess liquidity
- important to assess why capital is being raised/repaid
- red flag when a comp uses FCF to fund net losses and negative OCF over long run
- if comp is borrowing each year, you should consider when repayment may be required
how to complete common size analysis of statement of cash flows
2 approaches:
1. express each line item of cash inflow (outflow) as % of net revenue
2. as a % of total inflow (outflow)
how to do cash flow as a % of revenues
net income, depre/amort, stock-based compensation, cash from operations, cash from investing, capex, cash from financing
determine what activities represent/make up percentages of cash from operating/investing/financing
what are cash flow patterns for each of the product life cycle stages
introductory:
- cash outflows for investing and cash inflows for financing
decline:
- comps distribute cash to repay debt, buy back stock, pay dividends and realize incoming investing cash flows as assets are gradually sold off
- growth in revenue for first two stages, then levelling out at maturity and finally decline
- net losses in introductory, net income peaks during maturity before gradual decrease in decline
introduction
operating -
investing -
financing +
growth
operating +
investing -
financing +
maturity
operating +
investing +/-
financing -
decline
operating -
investing +
financing +/-
how does the life cycle stage affect a firm?
- production behaviour, investing activities, market sahre, etc
- cash flow patterns (net inflow/outflow) are a reliable way to assess overall life stage of comp
- using cash flow patterns to identify life cycle stage, research finds profitability ratios are consistent with expected econ behaviour at each life cycle stage
how to determine cash flow qualities?
results quality = whether underlying econ performance is good
- positive operating cash flows
- sustainable sources
- adequate to cover capex, debt repayment and dividends
- low volatility
reporting quality = whether reasonably reflect undering econ performance
- timing (ex. whether comp selling receivables or delaying paying payables to boost ocf)
- classification of cash flow
- trading securities vs available for sale
- interest capitalization vs expense
- operating lease vs finance lease
- r&d capitalization vs expense
