4.1. Measuring and Reporting Cash Flow

Common Misunderstanding About Cash

• that rapid growth means that your business is doing fine

• that a good profit situation equals a good cash situation

• that just because your company is “making money“, it will be easy to receive a loan

Profit vs Cash Flow: Accrual Accounting vs Cash Accounting

• revenue is recognized when earned rather than when cash is collected

• it is possible for a company to have a healthy net income (profits) but not have enough cash to fulfill obligations.

• Significance of profit diminished unless earnings translate into cash

• there are time lags between profit generation and cash generation

Overview of the Cash Flow Statement

• provides information about cash receipts and cash payments during an accounting period

• tells how cash was generated and used

Differences Between Income Statement and Cash Flow Statement

• Cash flow statement is cash-based as opposed to accrual like in income statement

• Cash flow statement reflects when the cash was collected not when the revenue was earned

• Cash flow statement specifies where the cash was generated and how they are spent

2 Key Questions Answered by the Cash Flow Statement

• Does the company generate enough cash from its operations to pay for its news investment, or is the company relying on new debt issuance to finance them?

• Does the company pay its dividends to common stockholders using cash generated from operations, from selling assets, or from issuing debt?

The sources of cash are useful for evaluating liquidity, solvency, financial flexibility, and sustainability

How the Following Scenarios Will Affect the Cash Flow Statement

Layout of Cash Flow Statement

It is important to understand where in the business the cash is being generated and spent, so divided into 3 sections

“+“ in Operating Activities: should be the main source of cash inflow for healthy company

“-” in Investing Activities: as cash is needed to invest in non-current assets to support

“±” in Financing Activities

Cash Flow from Operating Activities

Cash flows for operating activities are cash inflows and outflows directly related to earnings from normal operations

Inflows:

• Customers

• Dividends and interest on investments (could operation or finance, IFRS is flexible)

Outflows:

• Purchase of services (e.g., utilities) and goods for resale

• Salaries and wages

• Income taxes

• Interest on liabilities

Cash Flow from Investing Activities

Cash flows from investing activities are related to the acquisition or sale of long-lived productive assets and investments in the securities of other companies.

Inflows:

• Sale or disposal of PP&E

• Sale or mutiny of investment in securities

Outflows:

• Purchase of PP&E

• Purchase of investments in securities

Cash Flow from Financing Activities

Cash flows from financing activities are related to external sources of financing (owners and creditors) for the enterprise

Inflows:

• Borrowings on notes, mortgages, bonds from creditors

• Issuing stock to owners

Outflows:

• Repayment of principal creditors (excluding interest which is an operating activity)

• Repurchasing stock from owners

• Dividends to owners

2 Formats for Reporting Cash Flow from Operating Activities

• Direct Method

  • reports the net cash effect of each operating activity

  • more informative as it provides detailed information on cash inflow & outflow, encouraged by both IFRS & GAAP

• Indirect Method

  • starts with accrual net income from income statement, then eliminates noncash items to arrive at net cash flow from operating activities

  • more popular among companies, as it is deemed easier and less costly

  • net income (profit) ± adjustments for non items = net cash flow from operating activities