Analysis of Cash Flow Statement
Content
CASH FLOW STATEMENT Cash flow statement may provide considerable information about what is really happening in a business beyond that contained in either the income statement or the balance sheet. Analyzing this statement should not present an intimidating task, instead it will quickly become obvious that the benefits of understanding the sources and uses of a company’s cash far outweigh the costs of undertaking some very straightforward analyses.
CASH FLOW STATEMENT
• Who cares about a Cash Flow Statement?
– • Executives want to know if the cash generated by the company will be sufficient to fund their expansion strategy – • Stockholders want to know if the firm is generating enough cash to pay dividends
– • Suppliers want to know if their customers will be able to pay if offered credit
– • Investors want to evaluate future growth potential
– • Employees are interested in the overall viability of their employer as indicated by its ability to fund its operations
ANALYSIS OF CASH FLOW STATEMENT
Analysis of Cash flow statement is useful in providing users of the financial statements with a basis to assess the ability of the enterprise to generate cash and cash-equivalents and needs of the enterprise to utilize those cash flows. “An enterprise should prepare cash flow statement and should present it for each period of the financial statements are prepared and presented”
It should help the financial manager to assess and identify: • A Company’s ability to generate future net cash inflows from operations to pay debts, interests, and dividends. • A Company’s need for external financing • The reason for difference between net income and net cash flow from operating activities. • The effects of cash and non-cash investing and financing transactions.
PRESENTATION OF A CASH FLOW STATEMENT
The Cash flow statement should report cash flows during the period classified by operating, investing and financing activities. 1. 2. 3. Operating activities Investing Activities Financing Activities
Operating Activities
Cash flow from operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Examples of cash flow from operating activities are as follows: a) b) c) d) e) f) Cash receipt from sale of goods and rendering of services. Cash receipt from royalties, fees, commissions, and other revenues. Cash payment to supplier of goods and services. Cash payments to and on behalf of employees. Cash receipts and cash payments of an insurance enterprise for premium and claims, annuities and other policy benefits. Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and Cash receipts and payments relating to future contracts, forward contracts, option contracts, and swap contracts when the contracts are held for dealing or trading purposes.
g)
Investing Activities
Cash flow from investing activities represents expenditures that have been made for resources intended to generate future income and cash flows. Examples of cash flow from investing activities are as follows: a) Cash payment to acquire fixed assets (including intangibles), including capitalization for research and development and self constructed fixed assets. Cash receipt from disposal of fixed assets (including intangibles) Cash payment to acquire shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than payment for those instruments considered to be cash – equivalent and those held for dealing or trading purposes) Cash receipt from disposal of shares, warrants, or debt instruments or other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash – equivalents and those held for dealing or trading purposes)
b) c)
d)
Investing Activities
Cash flow from investing activities represents expenditures that have been made for resources intended to generate future income and cash flows. Examples of cash flow from investing activities are as follows: e) f) Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise) Cash receipt from the repayment of advances and loans made to the third party (other than advances and loans of a financial enterprise) Cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and Cash receipt from futures contracts, forward contracts, option contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities; and
g)
h)
Financing Activities
Cash flow from investing activities represents claims on future cash flows by providers of funds (both Capital and borrowings) to the enterprise. Examples of cash flow from financing activities are as follows: a) b) c) Cash proceeds from issuing shares or other similar instruments. Cash proceeds from issuing debentures, loans, notes, bonds, and other short-term or long-term borrowings; and Cash repayment of amounts borrowed.
Reporting Cash flow from Operating Activities
An enterprise should report cash flows from operating activities using either: a) b) Direct Method, whereby major classes of gross cash receipts and gross payments are disclosed; or The indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.
Reporting Cash flow from Investing and Financing Activities
An enterprise should report separately major classes of gross receipts and gross cash payments arising from investing and financing activities, expect to the extent that cash flows, as described below, are reported on a net basis Reporting Cash flows on Net Basis a) Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the enterprise; and b) Cash receipt and payments for items in which the turnover is quick, the amount are large and the maturities are short
Reporting Cash flow from Investing and Financing Activities
Reporting Cash flows on Net Basis
Cash flows arising from each of the following activities of a financial enterprise may be reported on a net basis: a) Cash receipt and payments for the acceptance and repayment of deposits with a fixed maturity date b) The placement of deposits with and withdrawal of deposits from other financial enterprises; and c) Cash advances and loans made to customers and repayment of those advances and loans
FORMAT OF CASH (INDIRECT METHOD)
FORMAT OF CASH (INDIRECT METHOD)
FORMAT OF CASH (DIRECT METHOD)
FORMAT OF CASH (DIRECT METHOD)
CASH FLOW STATEMENT
• Method used to analyze the cash flow
– • Scan the big picture – • Check the power of the cash flow engine – • Pinpoint the good news and the bad news – • Put the puzzle together
SCAN THE BIG PICTURE
• First, place your company in context in terms of its age, industry, and size. (Mature companies have different cash flows from start-up companies. And service industries look different from heavy manufacturing industries.) • Flip through the annual report and other accounting records to determine how management believes the year progressed. Was it a good year? Perhaps a record-breaking year in terms of revenue or net income? Or is management explaining how the company has had some rough times? • Look at net income. Does it show income or losses over the past few years? Is income (or loss) shrinking or growing?
CHECKING THE POWER OF THE CASH FLOW ENGINE
• The cash flow from operating activities section is the cash flow engine of the company. When this engine is working effectively, it provides the cash flows to cover the cash needs of operations. • To check the cash flow check if the cash flow from operating activities is greater than zero. Also check whether it is growing or shrinking. Assuming it is positive, the next question is can it cover important, routine expenditures? • An exception is start-up companies often have negative cash flow from operating activities because they had to spend a lot to get the company started and their cash flow engines are not yet up to speed. • Examine the operating working capital accounts. Inventories, receivables, and accounts payable usually grow in expanding companies.
PINPOINTING THE GOOD NEWS AND THE BAD NEWS
• Begin with cash flow from investing activities. One systematic observation is to check whether the company is generating or using cash in its investing activities. A healthy company invests continually in more plant, equipment, land, and other fixed assets to replace the assets that have been used up or have become technologically obsolete. • You must look at the entire package to evaluate whether your cash flows from financing are in the “good news” or “bad news” categories. One systematic way to begin is to compare borrowing and payments on debt with each other across the years and note the trends. Another way in uncovering the news in this section is to check the activities in the stock accounts.
PUTTING THE PUZZLE TOGETHER
• It would be rare to find a company in which all of the evidence is positive, or in which all of the evidence is negative. • To make a balanced evaluation, you must use both the good news and the bad news identified in each section of the statement. • Sometimes there are unusual or unknown items that may need further looked into (possibly by a professional).
CASH FLOW STATEMENT
• Who cares about a Cash Flow Statement?
– • Executives want to know if the cash generated by the company will be sufficient to fund their expansion strategy – • Stockholders want to know if the firm is generating enough cash to pay dividends
– • Suppliers want to know if their customers will be able to pay if offered credit
– • Investors want to evaluate future growth potential
– • Employees are interested in the overall viability of their employer as indicated by its ability to fund its operations
ANALYSIS OF CASH FLOW STATEMENT
Analysis of Cash flow statement is useful in providing users of the financial statements with a basis to assess the ability of the enterprise to generate cash and cash-equivalents and needs of the enterprise to utilize those cash flows. “An enterprise should prepare cash flow statement and should present it for each period of the financial statements are prepared and presented”
It should help the financial manager to assess and identify: • A Company’s ability to generate future net cash inflows from operations to pay debts, interests, and dividends. • A Company’s need for external financing • The reason for difference between net income and net cash flow from operating activities. • The effects of cash and non-cash investing and financing transactions.
PRESENTATION OF A CASH FLOW STATEMENT
The Cash flow statement should report cash flows during the period classified by operating, investing and financing activities. 1. 2. 3. Operating activities Investing Activities Financing Activities
Operating Activities
Cash flow from operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Examples of cash flow from operating activities are as follows: a) b) c) d) e) f) Cash receipt from sale of goods and rendering of services. Cash receipt from royalties, fees, commissions, and other revenues. Cash payment to supplier of goods and services. Cash payments to and on behalf of employees. Cash receipts and cash payments of an insurance enterprise for premium and claims, annuities and other policy benefits. Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and Cash receipts and payments relating to future contracts, forward contracts, option contracts, and swap contracts when the contracts are held for dealing or trading purposes.
g)
Investing Activities
Cash flow from investing activities represents expenditures that have been made for resources intended to generate future income and cash flows. Examples of cash flow from investing activities are as follows: a) Cash payment to acquire fixed assets (including intangibles), including capitalization for research and development and self constructed fixed assets. Cash receipt from disposal of fixed assets (including intangibles) Cash payment to acquire shares, warrants or debt instruments of other enterprises and interests in joint ventures (other than payment for those instruments considered to be cash – equivalent and those held for dealing or trading purposes) Cash receipt from disposal of shares, warrants, or debt instruments or other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash – equivalents and those held for dealing or trading purposes)
b) c)
d)
Investing Activities
Cash flow from investing activities represents expenditures that have been made for resources intended to generate future income and cash flows. Examples of cash flow from investing activities are as follows: e) f) Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise) Cash receipt from the repayment of advances and loans made to the third party (other than advances and loans of a financial enterprise) Cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and Cash receipt from futures contracts, forward contracts, option contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities; and
g)
h)
Financing Activities
Cash flow from investing activities represents claims on future cash flows by providers of funds (both Capital and borrowings) to the enterprise. Examples of cash flow from financing activities are as follows: a) b) c) Cash proceeds from issuing shares or other similar instruments. Cash proceeds from issuing debentures, loans, notes, bonds, and other short-term or long-term borrowings; and Cash repayment of amounts borrowed.
Reporting Cash flow from Operating Activities
An enterprise should report cash flows from operating activities using either: a) b) Direct Method, whereby major classes of gross cash receipts and gross payments are disclosed; or The indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.
Reporting Cash flow from Investing and Financing Activities
An enterprise should report separately major classes of gross receipts and gross cash payments arising from investing and financing activities, expect to the extent that cash flows, as described below, are reported on a net basis Reporting Cash flows on Net Basis a) Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the enterprise; and b) Cash receipt and payments for items in which the turnover is quick, the amount are large and the maturities are short
Reporting Cash flow from Investing and Financing Activities
Reporting Cash flows on Net Basis
Cash flows arising from each of the following activities of a financial enterprise may be reported on a net basis: a) Cash receipt and payments for the acceptance and repayment of deposits with a fixed maturity date b) The placement of deposits with and withdrawal of deposits from other financial enterprises; and c) Cash advances and loans made to customers and repayment of those advances and loans
FORMAT OF CASH (INDIRECT METHOD)
FORMAT OF CASH (INDIRECT METHOD)
FORMAT OF CASH (DIRECT METHOD)
FORMAT OF CASH (DIRECT METHOD)
CASH FLOW STATEMENT
• Method used to analyze the cash flow
– • Scan the big picture – • Check the power of the cash flow engine – • Pinpoint the good news and the bad news – • Put the puzzle together
SCAN THE BIG PICTURE
• First, place your company in context in terms of its age, industry, and size. (Mature companies have different cash flows from start-up companies. And service industries look different from heavy manufacturing industries.) • Flip through the annual report and other accounting records to determine how management believes the year progressed. Was it a good year? Perhaps a record-breaking year in terms of revenue or net income? Or is management explaining how the company has had some rough times? • Look at net income. Does it show income or losses over the past few years? Is income (or loss) shrinking or growing?
CHECKING THE POWER OF THE CASH FLOW ENGINE
• The cash flow from operating activities section is the cash flow engine of the company. When this engine is working effectively, it provides the cash flows to cover the cash needs of operations. • To check the cash flow check if the cash flow from operating activities is greater than zero. Also check whether it is growing or shrinking. Assuming it is positive, the next question is can it cover important, routine expenditures? • An exception is start-up companies often have negative cash flow from operating activities because they had to spend a lot to get the company started and their cash flow engines are not yet up to speed. • Examine the operating working capital accounts. Inventories, receivables, and accounts payable usually grow in expanding companies.
PINPOINTING THE GOOD NEWS AND THE BAD NEWS
• Begin with cash flow from investing activities. One systematic observation is to check whether the company is generating or using cash in its investing activities. A healthy company invests continually in more plant, equipment, land, and other fixed assets to replace the assets that have been used up or have become technologically obsolete. • You must look at the entire package to evaluate whether your cash flows from financing are in the “good news” or “bad news” categories. One systematic way to begin is to compare borrowing and payments on debt with each other across the years and note the trends. Another way in uncovering the news in this section is to check the activities in the stock accounts.
PUTTING THE PUZZLE TOGETHER
• It would be rare to find a company in which all of the evidence is positive, or in which all of the evidence is negative. • To make a balanced evaluation, you must use both the good news and the bad news identified in each section of the statement. • Sometimes there are unusual or unknown items that may need further looked into (possibly by a professional).
