Slide 1Slide 2Statement of Cash FlowsSlide 4Slide 5Statement of Cash FlowsSlide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Analysis Implications of Cash FlowsSlide 21Slide 22Slide 23Slide 24Analysis of Cash FlowsAnalysis of Cash FlowsSlide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Specialized Cash Flow RatiosCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinFinancial Statement AnalysisK R SubramanyamJohn J Wild7-207CHAPTE RCash Flow Analysis7-3Statement of Cash Flows •Cash is the most liquid of assets.–Offers both liquidity and flexibility. –Both the beginning and the end of a company’s operating cycle.•Contrast: Accrual accounting and Cash basis accounting.–Net cash flow as the end measure of profitability. –Cash flow analysis helps in assessing liquidity, solvency, and financial flexibility.Relevance of Cash7-4Statement of Cash Flows •Statement of cash flows (SCF) helps address questions such as:How much cash is generated from or used in operations?What expenditures are made with cash from operations?How are dividends paid when confronting an operating loss?What is the source of cash for debt payments?How is the increase in investments financed?What is the source of cash for new plant assets?Why is cash lower when income increased?What is the use of cash received from new financing?Relevance of Cash7-5Statement of Cash Flows •The SCF reports cash receipts and cash payments by operating, financing, and investing activities:•Operating activities are the earning-related activities of a company. Reporting by ActivitiesBeyond revenue and expense activities represented in an income statement, they include the net inflows and outflows of cash resulting from related operating activities like extending credit to customers, investing in inventories, and obtaining credit from suppliers.7-6Statement of Cash Flows•Investing activities are means of acquiring and disposing of noncash assets. –Involve assets expected to generate income; lending funds and collecting the principal on these loans. •Financing activities are means of contributing, withdrawing, and servicing funds to support business activities. –Include borrowing and repaying funds with bonds and other loans; contributions and withdrawals by owners and their return on investment.Reporting by Activities7-7Statement of Cash FlowsReporting by Activities7-8Statement of Cash Flows •Indirect Method–Net income is adjusted for non-cash income (expense) items and accruals to yield cash flow from operations•Direct Method–Each income item is adjusted for its related accruals•Both methods yield identical results-only the presentation format differs.Constructing the Cash Flow Statement7-9Statement of Cash Flows •Consider first the net cash from operations.Preparation of the SCF (Indirect method)7-10Statement of Cash Flows •Depreciation and amortization add-back.Preparation of the Statement of Cash Flows7-11Statement of Cash Flows Income v/s Cash Flows - ExampleConsider a $100 sale on account(1) In period of sale, net income is increased by $100 but no cash has been generated.Net Income 100Depreciation and amortization expense 0Gains (losses) on sale of assets 0Change in accounts receivable (100)Net Cash flow from operations 0•In period of collection no income is recorded.Net Income 0Depreciation and amortization expense 0Gains (losses) on sale of assets 0Change in accounts receivable 100Net Cash flow from operations 1007-12Statement of Cash Flows •Adjustments for changes in balance sheet accounts can be summarized as follows:Preparation of the Statement of Cash Flows7-13Statement of Cash Flows Constructing the Statement1. The company purchased a truck during the year at a cost of $30,000 that was financed in full by the manufacturer.2. A truck with a cost of $10,000 and a net book value of $2,000 was sold during the year for $7,000. There were no other sales of depreciable assets.3. Dividends paid during Year 2 are $51,0007-14Statement of Cash Flows Steps in Constructing the Statement(1) Start with Net Income(2) Adjust Net Income for non-cash expenses and gains(3) Recognize cash inflows (outflows) from changes in current assets and liabilities(4) Sum to yield net cash flows from operations(5) Changes in long-term assets yield net cash flows from investing activities(6) Changes in long-term liabilities and equity accounts yield net cash flows from financing activities(7) Sum cash flows from operations, investing, and financing activities to yield net change in cash(8) Add net change in cash to the beginning cash balance to yield ending cash7-15Statement of Cash Flows7-16Statement of Cash Flows •Equity Method Investments–The investor records as income its percentage interest in the income of the investee company and records dividends received as a reduction of the investment balance. –The portion of undistributed earnings is noncash income and should be eliminated from the SCF. •Acquisitions of Companies with Stock–Such acquisitions are non-cash. –Changes in balance sheet accounts reflecting the acquired company will not equal cash inflows (outflows) reported in the SCF.Special Topics7-17Statement of Cash Flows •Postretirement Benefit Costs–The excess of net postretirement benefit expense over cash benefits paid must be added to net income in computing net cash flows from operations•Securitization of Accounts Receivable–Companies account for the reduction in receivables as an increase in cash flow from operations since that relates to a current asset. –Analysts should question whether they represent true improvement in operating performance or a disguised borrowing.Special Topics7-18Statement of Cash Flows •The direct (or inflow-outflow) method reports gross cash receipts and cash disbursements related to operations—essentially adjusting each income statement item from accrual to cash basis–Reports total amounts of cash flowing in and out of a company from operating activities–Preferred by analysts and creditors–Implementation costs–When companies report using the direct method, they must disclose a reconciliation of net income to cash flows from operations (the indirect method) in a separate scheduleDirect Method7-19Statement of Cash Flows Converting from Indirect to Direct Method7-20Analysis Implications of