Chapter 6 Statement of Cash Flows

Statement of Cash Flows--Purpose To provide information about cash receipts, cash payments, and the net change in cash resulting from  operating,  investing, and  financing activities of a company during the period.

Statement of Cash Flows--Purpose Provides answers to the following: Where did the cash come from during the period? What was the cash used for during the period? What was the change in the cash balance during the period?

Composition Cash Flows from Operations Cash Flows from Investing Activities Cash Flows from Financial Activities

Cash From Operations

Cash From Investing

Cash From Financing

Material Non-cash Transactions Examples: Issuance of common stock to purchase assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges of plant assets. Reported at the bottom of the statement of cash flows or in a separate note to the financial statements.

Direct & Indirect Method Convert net income from an accrual basis to a cash basis. Use either indirect or direct format. Both methods arrive at same totals. Investing and financing activities are the same for both methods. 99% of firms use the indirect method.

Preparing the Cash Flow Statement (Indirect Method)

Preparing Cash From Operations-- Example Krauss Company’s financial statements for the year ended December 31, 2007, contained the following condensed information.

Cash From Operations—Example (Indirect Method)

Adjustments to Cash From Operations

Statement of Cash Flows (Indirect Method)

Cash Flow Issues CFO trends, especially related to net income; CFO is expected to be larger than net income (e.g., depreciation increases CFO) & should parallel net income over time The Dow 30 had an average CFO of $9.9 billion, 47% above net income Potential problem where net income is positive and CFO is negative—this is a possible indicator of manipulation (this was one of the signals at Enron of problems)

Free Cash Flows (FCF) Free cash flows is a measure of cash available for discretionary uses (that is; cash provided by operations less expenditures that are considered required): According to the book, the calculation is: CFO-Capital Expenditures-Cash dividends (in other words, cash available after fixed asset investments and maintaining dividends.) Alternative definitions: FCF1 = CFO – Capital Expenditures; FCF2 = CFO – CFI Cash flows can highlight certain problems such as lagging cash collections

Free Cash Flows Amount of discretionary cash flow a company has for purchasing additional investments, retiring its debt, purchasing treasury stock, or adding to its liquidity.

Current Cash Debt Coverage Ratio Cash From Operations Average Current Liabilities Ratio indicates whether the company can pay off its current liabilities from its operations. A ratio near 1:1 is good. A Liquidity measure (similar to operating cash flow).

Cash Debt Coverage Ratio Cash From Operations Average Total Liabilities Ratio indicates a company’s ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations. A solvency (leverage) measure.

Corporate Life Cycle