Reading 30: Analyzing Statements of Cash Flow I

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Book 2: FSA

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29 Terms

1
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What signals a high quality of earnings?

When CFO > net income

A firm’s earnings is being backed up by the cash being collected

2
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What does each section of the cash flow statement relate to with respect to the balance sheet?

CFO ==> current assets and current liabilities

CFI ==> noncurrent assets

CFF ==> noncurrent liabilities and equity

3
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Which section of the CFS is different in the two ways of recording the CFS?

the CFO

CFI and CFF are the same for both methods

4
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Direct Method

shows only cash payments and cash receipts over the period

5
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Steps for Direct Method

1.) Start with revenue

2.) Examine the balance sheet for any assets or liabilities relating to the income statement

3.) Compute the change in the balance sheet asset or liability

4.) Adjust the income statement for the change in the balance sheet

  • subtract an increase in an asset (use of cash) or add a decrease in an asset (source of cash)

  • add an increase in a liability (source of cash) or subtract a decrease in a liability (use of cash)

5.) Move to the next applicable item

6.) Ignore noncash charges

7.) Sum the amount to get CFO

6
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In the example on the wall for Direct Method, what balance sheet adjustments needed to be made?

Cash collected from customers

Cash paid to suppliers

Wages paid

Interest paid

Cash paid to tax authorities

7
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Cash collected from customers

Sales - increase in AR + increase in deferred rev = cash collected

8
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Cash paid to suppliers

COGS + decrease in inv - increase in AP = cash paid to suppliers

9
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Wages paid

wage expense - decrease in wages payable = cash paid to employees

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Interest paid

interest expense + increase in interest payable = cash interest paid

11
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Cash paid to tax authorities

tax expense + increase in taxes payable + increase in DTLs

12
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Indirect Method Steps

1.) Begin with net income

2.) Adjustments

  • Add back all noncash charges

  • Subtract noncash components of revenue

  • Subtract gains and losses that resulted from financing or investing cash flows

3.) Adjust WC by adding or subtract changes to balance sheet operating accounts

  • Add back

    • Decreases in current operating assets

    • Increases in current operating liabilities

  • Subtract

    • Increases in current operating assets

    • Decreases in current operating liabilities

13
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How do GAAP and IFRS differ in their preference toward Direct Method or Indirect Method?

US GAAP: prefers Direct Method but accepts Indirect Method. If using Indirect Method, there is a required disclosure of net income must be stated

IFRS: prefers Direct Method but accepts Indirect Method

14
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CFI def

consists of CFs that result from acquiring or disposing of long-term assets and certain investments

15
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CFF def

consists of CFs resulting from transactions affecting a firm’s capital structure

16
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US GAAP Operating Activity Inflows

Cash collected from customers

Interest and dividend received from acquisition of debt and equity investments and loans made to others

Sale proceeds from trading securities

17
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US GAAP Operating Activity Outflows

Cash paid to employees

Cash paid for other expenses

Acquisition of trading securities

Interest paid on debt or leases

Taxes paid

18
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US GAAP Investing Activity Inflows

Sale proceeds from PP&E and intangibles

Sale proceeds from debt and equity investments

Principal received from loans made to others

19
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US GAAP Investing Activity Outflows

Acquisition of PP&E and other intangibles

Acquisition of debt and equity investments

Loans made to others

20
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US GAAP Financing Activity Inflows

Principal amounts of debt issued

Proceeds from issuing stock

21
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US GAAP Financing Activity Outflows

Principal paid on debt or leases

Payments to reacquire stock

Dividends paid to shareholders

22
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Counterintuitive classification examples from the US GAAP CFS classification standards

1.) Debt and equity investments (other than trading securities) and loans made to others are reported as Investing Cash Outflows whereas the income from these investments (interest and dividends received) are reported under Operating Inflows

2.) Principal amounts borrowed are reported as Financing Inflows whereas interest paid is an Operating Outflow

3.) Trading securities are the exception to all equity and debt investments that are bought and sold and are considered to be Operating Cash Flows, not Investing Cash Flows

23
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Differences Between US GAAP and IFRS CFS Reporting: Interest Received

US GAAP: CFO

IFRS: CFO or CFI

24
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Differences Between US GAAP and IFRS CFS Reporting: Interest Paid

US GAAP: CFO

IFRS: CFO or CFF

25
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Differences Between US GAAP and IFRS CFS Reporting: Dividends Received

US GAAP: CFO

IFRS: CFO or CFI

26
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Differences Between US GAAP and IFRS CFS Reporting: Dividends Paid

US GAAP: CFF

IFRS: CFO or CFF

27
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Differences Between US GAAP and IFRS CFS Reporting: Bank overdrafts

US GAAP: treated as a balance sheet debt

IFRS: treated as balance sheet cash

28
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Differences Between US GAAP and IFRS CFS Reporting: Taxes

US GAAP: CFO

IFRS: Either CFO, CFI, or CFF; depends on what it is being soldDifferences Between US GAAP and IFRS CFS Reporting: Interest Received

29
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Steps to go from Indirect Method to Direct Method

1.) Aggregate all revenues and gains and all expenses and losses

2.) Remove all noncash charges and disaggregate the remaining items

3.) Convert from accruals to cash flows by adjusting for the change in working capital