Understanding cash flow statements - ACFI220 - Week 4

Operating activities

Deliver or produce goods for sale and provide services.

Eg

• Receiving cash from customers

• Pay cash to suppliers

• Pay cash for operating expenses

Investing activities

Buy or sell long term assets and other investments

For examples

Property, plant, and equipment

Other companies securities

Financing activities

Obtain or repay capital. Examples:

• Borrow from creditors and repay the principal

• Issue or repurchase stock

• Pay dividends

Indirect method for presenting operating cash flows

• Begins with net income and adjusts to operating cash flows.

• Arguments for:
  - Clearly shows the reason for differences between net income and operating cash flows.

  - Mirrors forecasting approach that begins with forecast of income, then derives cash flows.

Direct method for presenting operating cash flows

• Shows each cash inflow and outflow related to receipts and disbursements.'

• Arguments for:
  - Provides information on the specific sources of operating cash receipts and payments

• Does not net

Indirect method for presenting operating cash flows

IFRS perfmit

U.S GAAP permit

Used by the majority of companies, whether reporting under IFRS or U.S GAAP

Direct method

IFRS encourage

U.S GAAP encourage, but requires a reconciliation, of net income to cash flow from operating activities

Non-Cash Transaction

Any transaction that does not involve an inflow or outflow of cash (e.g., exchange of one non-monetary asset for another).

• Not incorporated in the cash flow statement

• Must be disclosed

Preparation for statement of cash flows

Step.1 Determine the change in cash

Step 2. Determine the net cash flow from operating activities. Use both the current year’s income statement and information on current assets and liabilities from the comparative balance sheets.

Step 3. Determine net cash flows from investing and financing activities. Examine all other changes in the balance sheet accounts.

Step 4. Include summary of net increase (decrease) in cash, cash at beginning, and cash at end.

Step 5. Disclose any significant non-cash transactions separately at the bottom of the statement.

Free cash flow to the firm (FCFF)

Cash flow available to the company’s suppliers of capital (debt and equity)

• After all operating expenses (including taxes

• After all operating investments have been made for fixed capital and working capital.

Free cash flow to equity (FCFE)

cash flow available to the company’s common stockholders:

• after all operating expenses (including taxes) have been paid

• After borrowing costs (principal and interest) have been paid.

• After all operating investments have been made for fixed capital and working capital