1. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Financial Statement Analysis K R Subramanyam John J Wild

2. 7-2 07 CHAPTER Statement of Cash Flows

3. 7-3 How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? Purpose of the Statement of Cash Flows

4. 7-4 Purposes of Statement of Cash Flows  Help investors, creditors, & others to: –Assess the enterprise’s ability to generate positive future net cash flows. –Assess the enterprise’s ability to meet its obligations, its ability to pay dividends, & its needs for external financing. –Assess the reasons for differences between net income & associated cash receipts & payments.

5. 7-5 Transactions affecting cash flows - Examples

6. 7-6  Operating Activities –Involve the cash effects of transactions that create revenues and expenses & enter into the determination of net income.  Investing Activities –Involve the acquisition and disposal of long-term assets.  Financing Activities –Involve changes in the size and composition of the contributed equity and borrowings. Classifying Cash Flows

7. 7-7 Outflows Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Outflows Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Inflows Receipts from customers Cash dividends received Interest from borrowers Inflows Receipts from customers Cash dividends received Interest from borrowers Operating Activities

8. 7-8 8 Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans Investing Activities

9. 7-9 9 Outflows Pay dividends Purchasing treasury stock Repaying cash loans Paying owners’ withdrawals Outflows Pay dividends Purchasing treasury stock Repaying cash loans Paying owners’ withdrawals Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Financing Activities

10. 7-10 Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred stock to common stock. Leasing of assets in a capital lease transaction. Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred stock to common stock. Leasing of assets in a capital lease transaction. Noncash Investing and Financing

11. 7-11 Types of activities affecting cash flow

12. 7-12 Format of the Statement of Cash Flows

13. 7-13 Statement of Cash Flows – An example

14. 7-14

15. 7-15 Impact of Product Life Cycle on Cash Flows

16. 7-16 Impact of Product Life Cycle on Cash Flows An example

17. 7-17 There are two acceptable methods to determine Cash Flows from Operating Activities: Direct Method Indirect Method Methods to prepare Statement of Cash Flows

18. 7-18 Preparation Methods Direct Method vs. Indirect Method  Different in calculating net cash flow from operating activities:  The DIRECT method deducts from operating cash receipts the operating cash disbursements.  The INDIRECT method adjusts net income for items that affected reported net income but did not affect cash.

19. 7-19 Cash flows from Operating activities (Direct method) Cash receipts Cash payments Net cash provided by Operating Activities To suppliers To employees For operating expenses For interest For taxes From sales of goods & services to customers From receipts of interest & dividends on loans & investments Net Cash Provided by Operating Activities

20. 7-20 Cash Flows from Investing Activities Cash proceeds from the disposal of plant assets. Cash proceeds from the sale of investment in securities. Cash payment for purchases of new plant assets. Cash payments for investing in securities. Net cash flows from investing activities AdditionsDeductions

21. 7-21 Cash Flows from Financing Activities Cash payment for repayments of loans. Cash payments for dividends. Net cash flows from financing activities AdditionsDeductions Cash received from issuing shares or debts.

22. 7-22 Analyzing the Cash Account B&G company

23. 7-23 23

24. 7-24 Advantages of Direct Method More consistent with the objective of statement of cash flows – to provide information about cash receipts & cash payments. Shows sources & purposes of cash receipts & payments.

25. 7-25 Net Income vs. Net Cash Flow from Operating Activities Earned revenues Incurred expenses Net Income Net cash flow from operating activities Eliminate noncash revenues Eliminate noncash expenses

26. 7-26 Cash Flows from Operating Activities (Indirect Method) Noncash expenses Nonoperating losses Decreases in current assets Increases in current liabilities Nonoperating gains Increases in current assets Decreases in current liabilities Net Income AdditionsDeductions Net cash flow from operating activities

27. 7-27 Let’s prepare a Statement of Cash Flows for B&G Company using the Indirect Method. Indirect Method

28. 7-28

29. 7-29 Additional Information for 2013: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash. Additional Information for 2013: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash. B&G company

30. 7-30

31. 7-31 Advantages of Indirect Method Focus on the differences between net income & net cash flow from operating activities.  Reveals a link between the financial statements. Less costly to prepare. Must be prepared even if the direct method is used.

32. 7-32 How to use cash flows information?

33. 7-33 Analyzing Cash Sources and Uses

34. 7-34 Analysis of Cash Flows In evaluating sources and uses of cash, the analyst should focus on questions like:  Are asset replacements financed from internal or external funds?  What are the financing sources of expansion and business acquisitions?  Is the company dependent on external financing?  What are the company’s investing demands and opportunities?  What are the requirements and types of financing?  Are managerial policies (such as dividends) highly sensitive to cash flows?

35. 7-35 Analysis of Cash Flows Free Cash Flow

36. 7-36 Specialized Cash Flow Ratios Cash Flow Adequacy Ratio – Measure of a company’s ability to generate sufficient cash from operations to cover capital expenditures, investments in inventories, and cash dividends: Three-year sum of cash from operations Three-year sum of expenditures, inventory additions, and cash dividends Cash Reinvestment Ratio – Measure of the percentage of investment in assets representing operating cash retained and reinvested in the company for both replacing assets and growth in operations: Operating cash flow – Dividends Gross plant + Investment + Other assets + Working capital