Understanding the Statement of Cash Flows Chapter 4 Robinson, Munter, Grant

Grant, Munter & Robinson Chapter 42 Learning Objectives Understand the cash flow statement and how it relates to other financial statements Direct and indirect methods of presenting operating cash flows Investing and financing activities Disclosure of noncash transactions Free cash flow and analysis

Grant, Munter & Robinson Chapter 43 Importance of cash flows Accrual-based accounting requires reporting revenues when earned and expenses when incurred – not when cash is exchanged. A company cannot pay employees, creditors and others with accrual-based net income. Valuation models used in financial analysis are often based on projections of future cash flows.

Grant, Munter & Robinson Chapter 44 Statement of Cash Flows Summarizes all activity in the cash accounts of the firm via three categories: Operating –Indirect –Direct Investing Financing

Grant, Munter & Robinson Chapter 45

Grant, Munter & Robinson Chapter 46 Nokia Cash flow summary (EURm) Operating6,5473,5093,102 Investing(2,679)(2,531)(1,359) Financing(1,895)(1,034)(574)

Grant, Munter & Robinson Chapter 47 Operating activities Primarily captures –Income statement items –Short-term/operating assets –Short-term/operating liabilities Methods of presentation –Indirect –Direct

Grant, Munter & Robinson Chapter 48 Cash Flows from Operating Activities Indirect method Reconciles accrual-based net income with cash generated via operations Begin with accrual-basis net income –Adjust accrual items to reflect cash basis Noncash items (depreciation and amortization) Changes in working capital (current assets, current liabilities) Reclassify nonoperating items –Appear in other sections of the Statement Gains/losses on sales of fixed assets or debt extinguishment

Grant, Munter & Robinson Chapter 49 Adjustments to Net Income Add back noncash expenses –Depreciation and amortization Add working capital decreases –Decreases in current assets –Increases in current liabilities Subtract working capital increases –Increases in current assets –Decreases in current liabilities

Grant, Munter & Robinson Chapter 410

Grant, Munter & Robinson Chapter 411

Grant, Munter & Robinson Chapter 412 Cash Flows from Operating Activities Direct method Recast the income statement to conform to cash-basis listing: Cash from customers Cash to suppliers Cash for wages Cash for selling, general and administrative costs Cash for interest…

Grant, Munter & Robinson Chapter 413 Calculating Cash from customers + Beginning balance in Accounts Receivable + Revenues -Ending Accounts Receivable = Cash received from customers Beginning A/R + Sales – Payments received = Ending A/R

Grant, Munter & Robinson Chapter 414 Calculating Cash paid to suppliers + Cost of (sales) revenue +/- Increase (decrease) in inventory -/+ Increase (decrease) in accounts payable = Cash paid to suppliers The cost of what was sold adjusted for changes in inventory and payments made.

Grant, Munter & Robinson Chapter 415 Motorola’s Cash from Operating Activities in Direct Method Format Cash received from customers32,449 Cash paid to suppliers(22,637) Cash paid for S, G & A (1,998) Cash paid for research and development (4,318) Cash paid for interest (844) Cash paid for taxes (676) Cash from operating activities 1,976

Grant, Munter & Robinson Chapter 416 Nokia’s Cash from Operating Activities in Direct Method Format Cash received from customers30,905 Cash paid to suppliers(18,156) Cash paid for S, G & A (2,556) Cash paid for research and development (2,558) Cash paid for interest (155) Cash paid for taxes (933) Cash from operating activities 6,547

Grant, Munter & Robinson Chapter 417 Cash Flows from Investing Activities Typically involves noncurrent capital (long- term) assets Cash acquisitions of investments, property Cash generated upon disposal of assets Noncash acquisitions/disposals are reported as Supplemental Information rather than in the body of the Statement of Cash Flows

Grant, Munter & Robinson Chapter 418

Grant, Munter & Robinson Chapter 419

Grant, Munter & Robinson Chapter 420 Cash Flows from Financing Activities Long-term liabilities –Cash from borrowing –Cash used for repayment of principle –Under IAS cash interest payments may be here Equity –Cash from stock issuance –Cash used to purchase treasury shares –Cash used for dividend payments

Grant, Munter & Robinson Chapter 421

Grant, Munter & Robinson Chapter 422

Grant, Munter & Robinson Chapter 423 Statement of Cash Flows Additional Disclosures 1.Cash paid for interest 2.Cash paid for taxes Presented at end of statement (GAAP) or in body of statement (IAS) May also highlight significant noncash transactions

Grant, Munter & Robinson Chapter 424

Grant, Munter & Robinson Chapter 425

Grant, Munter & Robinson Chapter 426 Cash analysis Determine and examine all sources and uses of cash Determine free cash flow –Important for valuation (present value of expected future free cash flow) –To the Firm, available to both debt and equity holders –To Equity, available to equity holders only Estimate cash flow with EBITDA

Grant, Munter & Robinson Chapter 427 Free Cash Flow to the Firm Operating cash flow Plus: Interest Paid Times (1-tax rate) Less: Investments in Fixed Capital Free Cash Flow to the Firm

Grant, Munter & Robinson Chapter 428 Free Cash Flow to Equity Operating cash flow Less: Investments in Fixed Capital Plus: New Debt Borrowing Less: Debt Repayment Free Cash Flow to Equity

Grant, Munter & Robinson Chapter 429 Earnings before Interest, Taxes, Depreciation and Amortization EBITDA Net income (loss) Plus: Interest expense Plus: Tax expense Plus: Depreciation & Amortization expense Free Cash Flow Estimate

Grant, Munter & Robinson Chapter 430 Summary Statement of cash flows –Operating (Indirect, Direct) –Investing –Financing Interaction with other statements Free cash flow