FI3300 Corporation FinanceConsider the Income StatementQuestionsLearning ObjectivesNet Profit vs. Net Cash FlowStatement of Cash FlowsUseful TipWhat’s Next?Cash Flow from Operating Activities 1Cash Flow from Operating Activities 2Slide 11Cash Flow from Investing Activities 1Cash Flow from Investing Activities 2Slide 14Cash Flow from Investing Activities 3Slide 16Useful RelationsCash Flow from Financing Activities 1Cash Flow from Financing Activities 2Slide 20Cash Flow from Financing Activities 3Slide 22Useful Relation:Analyzing the Statement of Cash Flows 1Analyzing the Statement of Cash Flows 2Analyzing the Statement of Cash Flows 3Analyzing the Statement of Cash Flows 4SummaryFI3300Corporation FinanceSpring Semester 2010Dr. Isabel TkatchAssistant Professor of Finance12Consider the Income StatementIllustration Company, Income StatementFor the Year ending December 31, 2006 (in $ millions)Net Sales400COGS280 Gross Profit120Operating Expenses40Depreciation20 Operating Income60Interest Paid10 Earnings Before Taxes50Taxes20 Net Income303Questions☺Was the company profitable?☺Did the company generate a positive cash flow?☺How did the company generate its cash flow?4Learning Objectives☺Understand the basic difference between net profit and net cash flow☺Construct the statement of cash flows☺Use the statement of cash flows to analyze major strengths and weaknesses of a company5Net Profit vs. Net Cash Flow ☺Firm’s preferred choice under accrual method of accounting☺Easily manipulated☺Helps evaluate the firm’s ability to generate cash☺Hard to manipulateNet Profit ≠ Net Cash Flow6Statement of Cash Flows ☺Provides information about cash inflows and outflows during an accounting period☺Focuses on CASH ☺Three sections to the statement of cash Flows:☺Cash flow from Operating Activities☺Cash flow from Investing Activities☺Cash flow from Financing Activities7Useful TipFor any item on the statement of cash flows☺IF the item represents a cash INFLOW  you ADD that item☺IF an item represents a cash OUTFLOW you SUBTRACT that item8What’s Next?We have to associate the two: Balance Sheet Accounts:- Accounts Receivable- Inventories…- Retained EarningsSections of theStatement of Cash Flows:1.CF from Operating Activities2.CF from Investing Activities3.CF from Financing Activities9Cash Flow from Operating Activities 1☺We use the indirect method: ☺Start with the net profit (income) and “modify” until you get the net cash flow☺Starting point: Net Income☺Step 1: add Depreciation☺To find CF from Operating Activities consider only cash flows that are directly related to the production and sales of goods and servicesExample: page 69 in the book10Cash Flow from Operating Activities 2☺Step 2: subtract changes in Current Assets (excluding cash):☺Accounts receivable☺Inventories☺Step 3: add changes in Current Liabilities (excluding notes payable and current portion of LTD):☺Accounts Payable☺Accruals☺Result: CF from Operating Activities11ClassificationBalance Sheet Item 2005 2006 Difference (Change)Cash10 14 14 – 10 = 4Operating Accounts Receivable30 25 25 – 30 = -5Operating Inventories50 57 57 - 50 = 7Investing Gross Fixed Assets160 190 190 – 160 = 30 Less Acc. Depreciation(50) (70) 70 – 50 = 20Net Fixed Assets110 120Total Assets200 216Financing Notes Payable40 29 29 – 40 = -11Operating Account Payable20 35 35 – 20 = 15Operating Accruals28 32 32 – 28 = 4Financing Current portion of LTD0 0 0 – 0 = 0Financing Long Term Debt (LTD)52 56 56 – 52 = 4Financing Common Stock40 34 34 – 40 = -6Financing Retained Earnings20 30 30 – 20 = 10Total Liabilities and Equity200 21612Cash Flow from Investing Activities 1Investing activities:Buying or selling productive long-lived assets such as plants and equipment Gross Fixed Assets are cash investments(Depreciation is not cash investment)Buying or selling financial securities (e.g., stocks or bonds of other companies)13Cash Flow from Investing Activities 2☺Starting point: zero☺Step 1: ☺subtract change in Gross Fixed Assets☺subtract change in Financial Assets (securities of other companies)☺Result: CF from Investing Activities14ClassificationBalance Sheet Item 2005 2006 Difference (Change)Cash10 14 14 – 10 = 4Operating Accounts Receivable30 25 25 – 30 = -5Operating Inventories50 57 57 - 50 = 7Investing Gross Fixed Assets160 190 190 – 160 = 30 Less Acc. Depreciation(50) (70) 70 – 50 = 20Net Fixed Assets110 120Total Assets200 216Financing Notes Payable40 29 29 – 40 = -11Operating Account Payable20 35 35 – 20 = 15Operating Accruals28 32 32 – 28 = 4Financing Current portion of LTD0 0 0 – 0 = 0Financing Long Term Debt (LTD)52 56 56 – 52 = 4Financing Common Stock40 34 34 – 40 = -6Financing Retained Earnings20 30 30 – 20 = 10Total Liabilities and Equity200 21615Cash Flow from Investing Activities 3☺Investing activities refer to changes on the lower left-hand side of balance sheet☺Warning: we are looking for changes in Gross Fixed Assets, not Net Fixed Assets! ☺What if Gross Fixed Assets are not reported in balance sheet?16Assets Liabilities and Owners EquityCashMarketable securities Net A/RInventoriesTotal Current AssetsGross Fixed Assets(less Accum. Depreciation)Net Fixed AssetsTotal AssetsNotes PayableAccounts PayableAccrued ExpensesCurrent Portion of LTDTotal Current LiabilitiesLong term (L.T.) DebtTotal LiabilitiesPreferred StockCommon StockRetained EarningsTotal Liabilities and equityLiquidityAssets Claims on AssetsBalance SheetS.T. FundsL.T. Capital17Useful RelationsChange in Gross Fixed Assets = + Change in Net Fixed Assets + Depreciation (on the income statement)Depreciation (on the income statement) = Change in Accumulated Depreciation (on the balance sheet)Calculate using book example on page 69.18Cash Flow from Financing Activities 1Financing activities:☺New loans (long-term, short-term debt)☺Repayment of principal☺Sale or repurchase of stock (common or preferred)☺Payment of dividends19Cash Flow from Financing Activities 2Financing activities refer to:☺Items on lower right-hand side of the balance sheet☺Changes in long-term Debt☺Changes in Equity☺Short-term loans☺Changes in Notes Payable ☺Changes in the Current Portion of long-term Debt☺Dividends paid to shareholders20Assets Liabilities and Owners EquityCashMarketable securities Net A/RInventoriesTotal Current AssetsGross Fixed Assets(less Accum.