Cash Flows Introduction

Business I: An Introduction to Cash Flows

Cash Flow Logic

• Accrual Accounting Principles:

  • Revenue recognition based on service performance or product sales.

  • Expense recognition matched to related revenues.

  • Objective: Accurate representation of profits on income statement.

• Cash Flows vs. Accounting Statements:

  • Timing of revenue and expense recognition may not relate to cash inflows/outflows.

  • Example: Revenue can be recognized without cash collection, affecting accounts receivable.

Balance Sheet Data and Cash Flow Calculation

• Cash Flow Calculation Steps:

  • Start with income statement figures and adjust using balance sheet data.

  • Result: Net cash flow.

• Examples of Adjustments:

  • Cash payment to suppliers prior to expense recognition creates a prepaid expense.

  • Expense recognized before payment leads to accrued expense.

• Objective of Cash Flow Summary:

  • Explain changes in cash and marketable securities.

  • Understand cash availability for loan repayment or dividend payments.

The Cash Flow Summary Form

• Purpose of the Cash Flow Summary Form:

  • Organizes information from financial statements.

  • Identifies inflows/outflows of cash and reconciles with cash and marketable securities changes.

• Structure Overview:

  • Items in boldface represent income statement data.

  • Major totals in bold and italicized.

  • "Change in" symbol (triangle) indicates changes in accounts.

• Major Total Sections:

  • Cash from Trading Activities: Cash effects of buying/selling goods.

  • Cash after Operations: Operating cycle's cash effect after expenses.

  • Net Cash after Operations: Operating cycle's net cash effect post-tax.

  • Cash After Financing Costs: Cash post management's fixed financial payments.

  • Cash After Debt Amortization: Similar to above related to principal repayments.

  • Financing Surplus/Requirements: Total cash impact of all activities.

  • Proof Statement: Confirm that cash and marketable securities changes are explained.

Cash Flow Mechanics – Step by Step

Income Statement Analysis

• Isolate Revenues and Expenses:

  • Adjust figures for non-cash, one-time events, or extraordinary items.

  • Focus on ongoing operations relevant for loan repayments and dividends.

• Distortion Risks: Non-operating and non-cash items can misrepresent financial health.

Balance Sheet Analysis

• Cash and Marketable Securities: Must be summed together.

• Long-term Debt Handling: Specially manage and adjust current long-term debt.

• Account Adjustments: Make necessary adjustments for all related accounts before final changes.

Detailed Adjustments and Analysis

Major Steps for Adjustments

1. Fill in the Cash Flow Summary: Based on income statement figures and balance sheet adjustments.

2. Calculate Cash Changes:

   • Determine inflows and outflows from balance sheet changes.

   • Ensure cash flow summary balances with changes noted.

3. Final Adjustments and Proofs:

   • Verify the summary balances and proof lines match to ensure accuracy.

Case Studies: Cash Flow Examples

Cash Flow Example #1

• Income Statement Highlights:

  • Sales: $2,175, Cost of Goods Sold: $1,620, Net Income: $40.

• Balance Sheet Assets and Liabilities:

  • Cash: $40, Accounts Receivable: $255, Fixed Assets: $95.

  • Total Assets: $760, Total Liabilities & Equity: $760.

Cash Flow Example #2

• Income Statement Highlights:

  • Sales: $7,570, Cost of Goods Sold: $5,830, Net Income: $90.

• Balance Sheet Overview:

  • Cash: $80, Accounts Receivable: $50, Fixed Assets: $1,000.

  • Total Assets: $1,710, Total Liabilities & Equity: $1,710.