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Finacial Statement Analysis

Cash Flow Statement and Its Analysis

Statement of Cash Flow

WHAT EXACTLY IS THE STATEMENT OF CASH FLOW?

Statement of cash flow reports the cash receipt, cash payments and net
change in cash resulting from OPERATING, INVESTING and FINANCING
activities during a period.

Statement of Cash Flow provides information about cash inflows and


outflows during an accounting period.
It developed from Balance Sheet and Income Statement Data
Important as analytical tool

WHAT IS THE IMPORTANCE OF CASH FLOW?


Importance of Cash Flow
1. Accrual-based accounting requires reporting revenues when earned
and expenses when incurred - not when cash is exchange.
2. Explains the reasons for change in cash
3. Reconciles net income with cash flow from operations.

Valuation models used in financial analysis are often based on projection


of future cash flow.

USES OF CASH FLOW ANALYSIS


External Uses:
1. To assess the ability of a firm to manage cash flow.
2. To assess the ability of a firm to generate cash through its operation.
3. To assess the company's ability to meet its obligations and its dividend
policy
4. To provide information about the effectiveness of firm to convert its
revenues to cash.
5. To provide information to estimate or anticipate the company's need for
additional financing.

Internal Uses:
1. To assess liquidity
- to determine if short term financing is necessary.
2. To determine dividend policy
- decide to distribute; or increase or decrease.
3. To evaluat investment and financing decisions.

TWO WAYS IN PRESENTING THE CASH FLOW


1. DIRECT METHOD
2. INDIRECT METHOD

DIRECT METHOD
Under direct method, income statement items are converted to cash flows
individually.
Direct Method Shows
* Cash Collections from customers
* Interest and Dividends Collected
* Other Operating cash Receipt
* Cash Paid to suppliesr and employees
* Interest Paid
* Taxes Paid and other operating cash payments
INDIRECT METHOD
Net income or Loss is adjusted for accruals such Accounts receivable and
payable and for non cash expenses such as depreciation.

Reconcilliation of the accrual based and cash based accounting


Indirect method starts with net income and adjust for
* Deferrals
* Accruals
* Non Cash Items, such as depreciation and amortization
* Non Operating Items, such as gains and losses on asset sales.

PARTS OF STATEMENT CASH FLOW


1. Operating activities
2. Investing Activities
3. Financing Activities

Operating Activities
Cash flow related to selling goods and services; that is, the principle
business of the firm.
The cash effects of transactions and other events that enter into the
determination of income.

INFLOWS OUTFLOWS

Cash receipts from sales of goods or Cash payments to acquire materials


services, including receipts from including principal payments on
collections or sale of accounts and account and both short and long term
both short and long term notes notes payable to suppliers.
receivable from customers arising
from those sales.
Cash receipts from returns on loans, Cash payments to other suppliers and
other debt instruments of other employees for other goods or
entities and equity security- interest
and dividends. services.

All other cash receipts that do not Cash payments to governments for
stem from transactions defined as taxes, duties, fines and other fees or
investing or financial activities, such penalties.
as refunds from suppliers, amounts
received to settle lawsuits, and
proceeds of insurance settlement.

Cash payments to lenders and other


creditors for interest.

Investing Activities
Acquiring/disposing of securities that are not cash equivalent.
Cash flow related to the acquisition or sale of non current assets

INFLOWS OUTFLOWS

Receipts from collections on loans Disbursements for loans granted.


receivable.

Receipts from sales of other entities Disbursements for the purchase of


debt instruments previously debt instruments of other entities.
purchased

Receipts from sales of equity Payment to acquire equity


instruments of other enterprises and instruments of other enterprises.
from returns of investment in those
instruments
Receipt from sales of property, plant Payments at the time of purchase or
and equipment, and other productive soon before and after purchase to
assets. acquire property, plant and
equipment.
Financing Activities
This section of the cash flow statement presents the inflow of cash coming
from financing institutions or issuance of share of stocks, outflow of cash when
the firm pays its long term loan, or when the board of directors declared
dividends.
Borrowing from creditors/repaying principal
Obtaining resources from owners.
Providing owners with return on investment.

INFLOWS OUTFLOWS

Insuance of long term obligations Payments of dividends or other


such as bonds payable, mortgage distributions to owners, including
payable and long term notes payable. outlays to reacquire the enterprises
equity instruments.

Proceeds from issuing equity Repayments of amount borrowed


instruments

Other payments to creditors who have


extended long term credit

Other applications are the purchase of


treasury stock and the redemption of
preffered stock, both which require
the payment of cash.

CASH FLOW DURING ACCOUNTING PERIOD

How Cash Flows During an Accounting Period


Inflows Outflows
Operating Activities
Investing Activities

Financing Activities

Total Inflows LESS Total outflows = Change in cash for the accounting period.

Components of the Cash Flow Statements

Preparing a statement of cash flows


First Step:
Look at changes in balance sheet accounts from beginning to end of
accounting period.
Next Step:
Transfer the account changes to appropriate area of a statement cash
flow.

LIMITATION OF CASH FLOW ANALYSIS


1. Non Cash transactions are ignored.
2. Not a substitute for income statement.
3. Not a test of total financial position.
4. Historical in nature.

Analysis of the cash flow statement should, at a minimum cover the following
areas:
1. Cash flow from operating activities
2. Cash inflows
3. Cash outflows

Why Cash Flow Analysis???


1. It is an important analytical tool for creditors, investors and other users
of financial statement data.
2. Firm's Ability to generate cash flows in the future.
3. Firm's capacity to meet cash obligations.
4. Firm's future external financing needs.
5. Firm's success in productivity managing investing activities.
6. Firm's effectiveness in implementing financing and investing strategies.

Analysis of cash inflows


Generating cash from operations is the prefered method for obtaining
excess cash to finance:
1. Capital expenditure and expansion
2. Repayment of debt
3. Payment of dividends
Analysis of cash outflows
When analyzing the cash outflows, tha analyst should consider the
necessity of the outflow and how the outflow was financed.
Generally, it is best to finance short term assets whith short term debt and
long term assets with long term debt or issuance of stock.

Key Principles for the presentation of Cash Flow Statement


Operating activities are the main revenue producing activities of the
enterprise that are not investing or finacing activities, so operating cash flows
include cash received from cutomers and cash paid to suppliers and
employees.

Investing activities are the acquisition and disposal of long term assets and
other investments that are not considered to be considered as cash
equivalents.
Financing Activities are activities that alter the equity capital and barrowing
sturcture of the enterprise.
Interest and dividends received and paid may be classified as operating,
investing or financing cash flows, provided that they are classified consistently
from period to period.
Cash flows arising from taxes on income are norally classified as operating,
unless they can be specifically identified with financing or investing activities.

“ NEVER TAKE YOUR EYES OFF THE CASH FLOW BECAUSE IT IS


THE LIFE BLOOD OF THE BUSINESS”