FR&A - Cash Flow Statement

12:45 pm

Understanding the Cash Flow Statement

Net income is not the same thing as cash earnings

Investing activities - noncurrent assets
Financing - longterm liabilities and equity

Trading securities falls under operating cash flows, not investing

Acquisition of debt/equity instruments is listed under investing, but the income is reported as operating income.

Similarly, amounts borrowed fall under financing, but the interest expense is an operating activity.

Noncash items (e.g. financed acquisition of land, debt/equity exchanges) do not hit CF statement

• Must be disclosed in a footnote or supplementary schedule
• Analysts must be aware of these and their impact

US GAAP, dividends paid are financing, interest paid is operating.  Both int and dividends received are operating income.

IFRS allows more flex in accounting for dividends and interest payments

• Div and int received, can be either operating OR investing
• Div and int paid can be either operating OR financing

Tax calc is also different

• US, taxes are all reported in operating
• IFRS, also in operating UNLESS expense is associated w investing or financing transactions
• Ex, you sell land for $1 mm.  Taxes are $160,000.  
• US, you record cash from investing as $1 mm and cash for taxes in operating at $(160,000).  
• IFRS, you can just record $840,000 in investing

Both indirect and direct are permissible under US and IFRS but direct is encouraged

• Direct - convert each line of income statement into cash terms
• Indirect - start with net income
• Convert net income to operating cash flow
• Make adjustments for transactions that affect net income but not cash
• This can include nonoperating gains/losses
• Direct provides more info - operating cash receipts/pmts
• Main advantage of indirect is focus on differences b/w net income and op cash flow

Disclosure - under US GAAP, if you use direct, you must also show indirect.  Not required by IFRS.

When using direct method, ignore depreciation information - it is a noncash charge - common CFA trick

Direct method notes

• If assets were sold during period must account for this when calcing cash paid for a new asset
• Cash paid = ending assets - beginning assets + cost of old assets sold
• If calculating cash from asset sold, add in any gain/loss on the sale
• Interest paid is technically a cash flow to creditors but falls under operating cash flow
• Financing cash flow:
• Net cash from creditors = new borrowings - principal repaid
• PLUS
• Net cash from shareholders = new equity issued - share repurchases - cash dividends
• Total cash flow = CFO + CFI + CFF = change in cash from one balance sheet to next

Indirect method notes

• Subtract gains from sale on land from Net Income - this goes to investing cash flow

Converting from Indirect to Direct

• Only difference is presentation of CFO section
• Key is to adjust each income statement item for its corresponding balance sheet accounts and to eliminate noncash/nonoperating transactions
• Cash collections
• Start with net sales
• Subtract increase in AR and vv
• Add increase in unearned revenue and vv
• Cash payments to suppliers
• Start with COGS
• If D&A included, add back
• Reduce for increase in AP and vv
• Add for increase in inventory and vv
• Subtract any writeoff that occurred - it's not a real expense
• Same principal for taxes
• Cash operating expenses
• Start with SG&A
• Adjust for prepaid expenses

An increase in assets/decrease in liabilities is a use of cash

A decrease in assets/increase in liabilities is a source of cash

Analyzing cash flow statements

• Examine major sources and uses of cash.  These change over the company life cycle.
• Over long term, must be able to cover capex and provide return to debt/equity holders
• Operating cash flow
• Where does cash come from?  NWC adjustments are not a sustainable source
• Stable relation b/w operating cash flow and net income is an indication of quality of earnings
• Earnings > cash flow may indicate aggressive accounting.  Variability is also important.
• Investing cash flow
• Increasing capex usually a sign of growth
• Delaying capex or selling just to generate liquidity is not good - requires future payments
• Generally want to make operating cash flow that covers capex
• Financing cash flow
• Is company getting cash from debt or equity
• Is it repaying debt, reacquiring stock, or paying dividends

Common size cash flow statement

• Express each as a percent of sales OR
• Express each inflow as % of total inflows and each outflow as % of total outflows

Free Cash Flow to Firm - cash available to all investors, both debt and equity

• FCFF = Net Income + D&A + Interest * (1-tax) - CapEx - Working Capital investment
• Can also calc from operating cash flow:
• FCFF = CFO + Interest * (1-tax) - CapEx
• This already accounts for noncash and WC impacts
• IFRS - don't need to include interest expense that falls under financing section
• Also, note that IFRS can report dividends paid as operating - so add these back too (goal is to cal cash available to shareholders)

Free Cash Flow to Equity - cash available to common shareholders

• FCFE = CFO - CapEx + net borrowing (debt issued - debt repaid)
• IFRS need to add back dividends if they've been taken out of CFO

Ratios

• Cash Flow to Revenue = CFO / net revenue
• CFO generated per dollar of revenue
• Cash return on assets = CFO / average total assets
• Cash Return on Equity = CFO / average total equity
• Cash to Income = CFO / operating income
• Ability to generate cash from operations
• Cash Flow per Share = (CFO - preferred dividends) / wtd avg # common shares

Coverage Ratios

• Debt coverage = CFO / total debt
• Interest coverage = (CFO + interest paid + taxes paid) / interest paid
• Reinvestment = CFO / cash paid for LT assets
• Measures ability to buy assets with OCF
• Debt payment = CFO / cash long-term debt repayment
• Dividend payment = CFO / dividends paid
• Investing and Financing = CFO / cash outflows from investing and financing activities
• Measures ability to purchase assets, satisfy debts, and pay dividends

End

2:00 pm

1.25 hours