Module 4: Analyzing Statements of Cash Flows I

What are the three sections of the statement of cash flows?

Cash flow from operating activities (CFO), cash flow from investing activities (CFI), and cash flow from financing activities (CFF).

What is cash flow from operating activities (CFO)?

Cash flows associated with the firm's core operations and transactions that generally determine net income, such as customer collections, supplier payments, employee payments, interest, and taxes depending on the reporting standard.

What is cash flow from investing activities (CFI)?

Cash flows associated with acquiring and disposing of long-term assets and non-trading investments, such as PP&E purchases, PP&E disposals, and purchases or sales of investments.

What is cash flow from financing activities (CFF)?

Cash flows that change the size or composition of the firm's debt and equity financing, such as borrowing, debt repayment, share issuance, share repurchases, and dividends paid.

What is the basic cash flow statement reconciliation formula?

Ending cash = Beginning cash + CFO + CFI + CFF.

What is the equivalent formula for the change in cash?

Change in cash = CFO + CFI + CFF.

Beginning cash is USD 500, CFO is USD 200, CFI is -USD 150, and CFF is -USD 20. Calculate ending cash.

Ending cash = USD 500 + USD 200 - USD 150 - USD 20 = USD 530.

How does the cash flow statement link two consecutive balance sheets?

CFO + CFI + CFF explains the change between the beginning and ending balances of cash, cash equivalents, and restricted cash.

How does net income link the income statement to the balance sheet?

Net income increases retained earnings, while dividends declared reduce retained earnings.

What is the retained earnings roll-forward formula?

Ending retained earnings = Beginning retained earnings + Net income - Dividends declared.

How can dividends declared be solved from retained earnings?

Dividends declared = Beginning retained earnings + Net income - Ending retained earnings.

If beginning retained earnings are USD 100m, net income is USD 25m, and ending retained earnings are USD 115m, calculate dividends declared.

Dividends declared = USD 100m + USD 25m - USD 115m = USD 10m.

Why is revenue not necessarily equal to cash collected from customers?

Accrual accounting recognizes revenue when earned, while cash may be collected before or after revenue recognition. Accounts receivable and deferred revenue capture the timing difference.

Why is expense not necessarily equal to cash paid?

Expenses are recognized when incurred, while cash may be paid earlier or later. Prepaid expenses, accrued liabilities, payables, and similar accounts capture the timing difference.

What is the accounts receivable linkage formula?

Ending A/R = Beginning A/R + Revenue - Cash collected from customers.

How can cash collected from customers be derived from the A/R identity?

Cash collected = Revenue + Beginning A/R - Ending A/R.

What is the shortcut formula for cash collected when only A/R changes?

Cash collected from customers = Revenue - Change in A/R.

What does an increase in accounts receivable indicate about cash collected relative to revenue?

Cash collected is less than revenue because some recognized revenue has not yet been collected.

What does a decrease in accounts receivable indicate about cash collected relative to revenue?

Cash collected exceeds current-period revenue because customers also paid existing receivables.

Revenue is USD 250m and A/R increases by USD 10m. Calculate cash collected.

Cash collected = USD 250m - USD 10m = USD 240m.

Revenue is USD 250m and A/R decreases by USD 10m. Calculate cash collected.

Cash collected = USD 250m + USD 10m = USD 260m.

How does an increase in deferred revenue affect cash received relative to revenue recognized?

An increase in deferred revenue means cash received exceeds revenue recognized, so the increase is added when converting revenue to cash received.

How does a decrease in deferred revenue affect cash received relative to revenue recognized?

A decrease in deferred revenue means more revenue was recognized than new cash collected, so the decrease is subtracted when converting revenue to cash received.

What is the general cash received from customers formula including deferred revenue?

Cash received from customers = Revenue - Change in A/R + Change in deferred revenue.

Revenue is EUR 3,000, A/R does not change, and deferred revenue increases by EUR 9,000. Calculate cash received.

Cash received = EUR 3,000 + EUR 9,000 = EUR 12,000.

A customer pays EUR 12,000 in advance for a 12-month contract beginning 1 October. How much revenue is recognized by 31 December?

Revenue recognized = EUR 12,000 × 3/12 = EUR 3,000.

Using the same EUR 12,000 advance-payment example, what deferred revenue remains at year-end?

Deferred revenue = EUR 12,000 - EUR 3,000 = EUR 9,000.

Using the same advance-payment example, what is the CFO cash inflow?

CFO cash inflow = EUR 12,000 because the full cash payment was received during the period.

What is the indirect-method reconciliation for the EUR 12,000 advance-payment example?

CFO = Net income effect of EUR 3,000 + Increase in deferred revenue of EUR 9,000 = EUR 12,000.

What balance-sheet accounts usually map to CFO?

Current operating assets and current operating liabilities.

What balance-sheet accounts usually map to CFI?

Long-term non-current assets such as PP&E and non-trading investments.

What balance-sheet accounts usually map to CFF?

Long-term debt, short-term interest-bearing debt, and equity accounts.

Are all current liabilities operating cash-flow accounts?

No. Short-term interest-bearing debt and dividends payable generally relate to financing rather than operating activities.

How are trading securities generally classified in the cash flow statement under the curriculum treatment?

Trading securities are generally associated with operating activities even though they are financial assets.

What is a cash equivalent?

A short-term, highly liquid investment that is readily convertible into a known amount of cash and subject to insignificant risk of value changes.

What is the original-maturity threshold for a cash equivalent?

Original maturity of three months or less from the date of acquisition.

Does a security qualify as a cash equivalent merely because it has less than three months remaining to maturity at year-end?

No. The relevant test is its original maturity when acquired.

Are transfers between cash and cash equivalents reported as cash flows?

No. They are movements within the cash and cash-equivalent balance, not cash inflows or outflows.

What is restricted cash?

Cash that cannot be used freely for general operations because its use is contractually or legally restricted.

Is restricted cash included in the overall cash reconciliation?

Yes. Cash, cash equivalents, and restricted cash are included in the reconciliation totals under the treatment in the notes.

Does depreciation generate cash?

No. Depreciation is a non-cash expense.

Why is depreciation added back under the indirect method?

It reduced net income without using cash, so adding it back reverses the non-cash deduction.

If a company had zero depreciation but otherwise identical operations and cash movements, would depreciation itself change CFO?

No. Depreciation does not create cash; it only affects the reconciliation from net income to CFO.

What is the difference between the direct and indirect methods?

They are alternative presentations of CFO only. Total CFO is identical; CFI and CFF are presented the same under both.

Does the direct method produce a different CFO total from the indirect method?

No. CFO under the direct method must equal CFO under the indirect method.

What does the direct method report?

Major gross operating cash receipts and payments, such as cash received from customers and cash paid to suppliers, employees, interest, and taxes.

What does the indirect method report?

A reconciliation from net income to CFO by adjusting for non-cash items, non-operating gains/losses, and changes in operating working capital.

What is the universal cash-flow rule for an increase in an operating asset?

Increase in operating asset = Use of cash = Subtract from CFO.

What is the universal cash-flow rule for a decrease in an operating asset?

Decrease in operating asset = Source of cash = Add to CFO.

What is the universal cash-flow rule for an increase in an operating liability?

Increase in operating liability = Source of cash = Add to CFO.

What is the universal cash-flow rule for a decrease in an operating liability?

Decrease in operating liability = Use of cash = Subtract from CFO.

What is a useful mnemonic for working-capital adjustments?

Operating assets move opposite cash; operating liabilities move with cash.

How does an increase in A/R affect CFO under the indirect method?

Subtract the increase from net income.

How does a decrease in A/R affect CFO under the indirect method?

Add the decrease to net income.

How does an increase in inventory affect CFO under the indirect method?

Subtract the increase because cash has been invested in inventory.

How does a decrease in inventory affect CFO under the indirect method?

Add the decrease because inventory has been converted or released without an equivalent current-period cash purchase.

How does an increase in accounts payable affect CFO under the indirect method?

Add the increase because the company has delayed paying suppliers.

How does a decrease in accounts payable affect CFO under the indirect method?

Subtract the decrease because cash payments exceeded the related purchases/expense recognition.

How does an increase in prepaid expenses affect CFO under the indirect method?

Subtract the increase because cash was paid before the expense was recognized.

How does a decrease in prepaid expenses affect CFO under the indirect method?

Add the decrease because current expense exceeded current-period cash prepayment.

How does an increase in accrued operating liabilities affect CFO under the indirect method?

Add the increase because expenses were recognized without equivalent cash payment.

How does a decrease in accrued operating liabilities affect CFO under the indirect method?

Subtract the decrease because cash payments exceeded current-period expense.

What is the basic direct-method formula for cash received from customers when deferred revenue is absent?

Cash received from customers = Revenue - Increase in A/R + Decrease in A/R.

What is the compact direct-method formula for cash received from customers?

Cash received from customers = Revenue - Change in A/R + Change in deferred revenue.

Revenue is USD 254.6m and A/R falls from USD 73.2m to USD 68.3m. Calculate cash received from customers.

Decrease in A/R = USD 73.2m - USD 68.3m = USD 4.9m. Cash received = USD 254.6m + USD 4.9m = USD 259.5m.

What is the first step in calculating cash paid to suppliers?

Convert COGS into purchases from suppliers.

What is the formula for purchases from suppliers?

Purchases = COGS + Change in inventory.

How does an increase in inventory affect purchases relative to COGS?

Purchases exceed COGS because the company acquired more inventory than it expensed.

How does a decrease in inventory affect purchases relative to COGS?

Purchases are less than COGS because some COGS came from inventory acquired in previous periods.

What is the second step in calculating cash paid to suppliers?

Adjust purchases for the change in accounts payable.

What is the formula for cash paid to suppliers?

Cash paid to suppliers = Purchases - Change in accounts payable.

What is the combined cash paid to suppliers formula?

Cash paid to suppliers = COGS + Change in inventory - Change in accounts payable.

How does an increase in inventory affect cash paid to suppliers, all else equal?

It increases cash paid to suppliers.

How does an increase in accounts payable affect cash paid to suppliers, all else equal?

It decreases cash paid to suppliers because some purchases remain unpaid.

How does a decrease in accounts payable affect cash paid to suppliers, all else equal?

It increases cash paid to suppliers because the company paid down prior obligations.

COGS is USD 175.9m and inventory increases by USD 8.8m. Calculate purchases.

Purchases = USD 175.9m + USD 8.8m = USD 184.7m.

Purchases are USD 184.7m and A/P increases by USD 2.6m. Calculate cash paid to suppliers.

Cash paid to suppliers = USD 184.7m - USD 2.6m = USD 182.1m.

COGS is USD 9,283, inventory increases by USD 511, and A/P decreases by USD 190. Calculate cash paid to suppliers.

Cash paid to suppliers = USD 9,283 + USD 511 + USD 190 = USD 9,984.

Why is a decrease in accounts payable added when calculating cash paid to suppliers?

A decrease in A/P means the company paid more cash than the amount of current-period purchases left unpaid, so cash paid exceeds purchases.

What is the formula for cash paid to employees?

Cash paid to employees = Salary expense - Change in salary payable.

Salary expense is USD 4,123 and salary payable increases by USD 10. Calculate cash paid to employees.

Cash paid to employees = USD 4,123 - USD 10 = USD 4,113.

Salary expense is USD 4,123 and salary payable decreases by USD 10. Calculate cash paid to employees.

Cash paid to employees = USD 4,123 + USD 10 = USD 4,133.

What is the general formula for cash paid for other operating expenses?

Cash paid for other operating expenses = Operating expense + Change in prepaid expenses - Change in accrued operating liabilities.

How does an increase in prepaid expenses affect cash paid for operating expenses?

It increases cash paid because the firm paid cash for costs not yet recognized as expense.

How does a decrease in prepaid expenses affect cash paid for operating expenses?

It decreases current-period cash paid relative to expense because some current expense came from prior-period prepayments.

How does an increase in accrued liabilities affect cash paid for operating expenses?

It reduces cash paid relative to expense.

How does a decrease in accrued liabilities affect cash paid for operating expenses?

It increases cash paid relative to expense.

What is the formula for cash interest paid?

Cash interest paid = Interest expense - Change in interest payable.

Interest expense is USD 246 and interest payable decreases by USD 12. Calculate cash interest paid.

Cash interest paid = USD 246 + USD 12 = USD 258.

Interest expense is USD 246 and interest payable increases by USD 12. Calculate cash interest paid.

Cash interest paid = USD 246 - USD 12 = USD 234.

What is the basic formula for cash income taxes paid when only taxes payable changes?

Cash taxes paid = Income tax expense - Change in income taxes payable.

Income tax expense is USD 1,177 and taxes payable increase by USD 5. Calculate cash taxes paid.

Cash taxes paid = USD 1,177 - USD 5 = USD 1,172.

What is the more complete cash taxes paid formula including deferred tax accounts?

Cash taxes paid = Tax expense - Change in taxes payable + Change in deferred tax asset - Change in deferred tax liability.

How does an increase in a deferred tax asset affect cash taxes paid relative to tax expense?

It increases cash taxes paid relative to tax expense, all else equal.

How does an increase in a deferred tax liability affect cash taxes paid relative to tax expense?

It decreases cash taxes paid relative to tax expense, all else equal.

What are the three major adjustment categories under the indirect method?

Non-cash items; non-operating gains/losses; changes in operating working capital.

What is a compact indirect-method CFO formula?

CFO = Net income + Non-cash charges - Non-operating gains + Non-operating losses +/- Working-capital adjustments.

How is depreciation treated under the indirect method?

Add back depreciation.

How is amortization treated under the indirect method?

Add back amortization.

How is depletion treated under the indirect method?

Add back depletion.