1. HARAMAYA UNIVERSITY SCHOOL OF AGRI ECONOMICS AND AGRI BUSINESS DEPARTMENT OF AGRICULTURAL ECONOMICS (MSc) PRESENTATION ON CASH FLOW STATEMENT AND ITS ANALYSIS BY: SELAM ABDULBASIT COURSE: FARM MANAGEMENT INSTRUCTOR: Prof. V.P.S. ARORA May 2019 1

2. Introduction  Introduction  Preparing the Cash Flow Statement (CFS)  Constructing the Cash Flow Statement (CFS)  Analysis of the Cash Flow Statement (CFS) 2

3. Definitions A cash flow statement is a financial statement that shows the cash inflows, cash outflows, and net change in cash from the operating, investing and financing activities of a firm in a manner that reconciles the beginning and ending cash balances. The cash flow statement explains the change during the period in cash and cash equivalents. 3 Introduction

4. Definitions (Contd.) Cash comprises of cash on hand, and demand deposits (including those in foreign currencies) net of bank overdrafts. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Cash flows: Net cash flows, or simply cash flows, refers to the current period's cash inflows less cash outflows. 4

5. Provide information about the sources and application of cash inflows and outflows for a given accounting period by separating them into three main business activities Operating Investing Financing It presents the changes in cash resulting from the business activities. It communicates information about the financial adaptability of an enterprise for a given period of time. 5 Purpose of Cash Flow Statement

6. Provide the basis for assessing the company’s ability to generate cash and cash equivalents and needs of the company to utilize those cash flows. Used to make economic decisions. Provide historical movements in cash and cash equivalents. Clarifies the dynamics of short-term liquidity and long-term solvency. Used as an indicator of the amount, timing and certainty of future cash flows. 6 Usefulness of Cash Flow Information

7. Related Questions How much cash is generated from/ used in operations? What expenses are made with cash from operations? How are dividends paid when confronting an operating loss? What’s the source for cash for debt payments? How is increase in investments financed? What’s the source of cash for new plant assets? What’s the use of cash received from new financing? 7

8. Preparation of the CFS Relevance of Cash Cash is the most liquid of assets and offers a company both liquidity and flexibility. It is both the beginning and the end of a company's operating cycle. Contrast: Accrual accounting and Cash Basis Accounting Recognize revenue when earned and expenses when incurred. Recognize revenues when cash is received and expenses when paid in cash; yet, net cash flow is the end measure of profitability. 8

9. Relevance of Cash (Contd.) Cash flow analysis helps in assessing liquidity, solvency, and financial flexibility. Liquidity is the nearness to cash of assets and liabilities. Solvency is the ability to pay liabilities when they mature. Financial flexibility is the ability to react and adjust to opportunities and adversities. 9

10. Reporting by Activities Statement of cash flows reports receipts and payments by operating, financing, and investing activities: Operating activities are the main revenue-producing activities of a company. Beyond revenue and expense activities represented in an income statement, they include the net inflows and outflows of cash resulting from related operating activities like extending credit to customers, investing in inventories, and obtaining credit from suppliers. 10

11. Reporting by Activities (Contd.) Investing activities are means of acquiring and disposing of noncash assets. Involve assets expected to generate income; lending funds and collecting the principal on these loans. Financing activities are means of contributing, withdrawing, and servicing funds to support business activities. Include borrowing and repaying funds with bonds and other loans; contributions and withdrawals by owners and their return on investment. 11

12. Constructing the CFS Indirect Method Net income is adjusted for non-cash income (expense) items and accruals to yield cash flow from operations. Direct Method Each income item is adjusted for its related accruals. Both methods yield identical results-only the presentation format differs. The format for computing net cash provided by investing and financing activities is the same for both methods. 12

13. Consider first the net cash from operations. 13 Indirect Method

14. Indirect Method (Contd.) Depreciation and amortization add-back. 14

15. Indirect Method (Contd.) Adjustments for changes in balance sheet accounts can be summarized as follows: 15

16.  Start with Net Income.  Adjust Net Income for non-cash expenses and gains.  Recognize cash inflows (outflows) from changes in current assets and liabilities.  Sum to yield net cash flows from operations.  Changes in long-term assets yield net cash flows from investing activities.  Changes in long-term liabilities and equity accounts yield net cash flows from financing activities.  Sum cash flows from operations, investing, and financing activities to yield net change in cash.  Add net change in cash to the beginning cash balance to yield ending cash. 16 Steps in Constructing the CFS

17. Direct Method Reports gross cash receipts and cash disbursements related to operations—essentially adjusting each income statement item from accrual to cash basis. Reports total amounts of cash flowing in and out of a company from operating activities. Preferred by analysts and creditors. When companies report using the direct method, they must disclose a reconciliation of net income to cash flows from operations (the indirect method) in a separate schedule. 17

18. Analysis of CFS Inferences from analysis of cash flows include: Establishing the major past sources of cash and their use where management committed its resources. where it reduced investments. where additional cash was derived from. where claims against the company were reduced. The size, composition, pattern and stability of operating cash flow. Disposition of earnings and the investment of discretionary cash flows. 18

19. Analysis of CFS Company and Economic Conditions While both successful and unsuccessful companies can experience problems with cash flows from operations, the reasons are markedly different. We must interpret changes in operating working capital items in light of economic circumstances. Inflationary conditions add to the financial burdens of companies and challenges for analysis. 19

20. Analysis of CFS Free Cash Flow Positive free cash flow reflects the amount available for business activities after allowances for financing and investing requirements to maintain productive capacity at current levels. 20

21. Analysis of CFS Cash Flow as Validators The CFS is useful in identifying misleading or erroneous operating results or expectations. Cash Flow Statement provides us with important clues on: Feasibility of financing capital expenditures. Cash sources in financing expansion. Dependence on external financing. Future dividend policies. Ability in meeting debt service requirements. Financial flexibility to unanticipated needs/opportunities. Financial practices of management. Quality of earnings. 21

22. Specialized Cash Flow Ratios Cash Flow Adequacy Ratio Three-year sum of cash from operations Three-year sum of expenditures, inventory additions, and cash dividends Cash Reinvestment Ratio Operating cash flow – Dividends Gross plant + Investment + Other assets + Working capital Operating Cash Flow Ratio Cash flow from operations Current liabilities 22

23. Specialized Cash Flow Ratios Cash Interest Coverage Ratio Cash flow from operations + Interest paid + Taxes paid Interest paid Cash Current Debt Coverage Ratio Operating cash flow—cash dividends Current debt Capital Expenditure Ratio Cash flow from operations Capital expenditures 23

24. Specialized Cash Flow Ratios Total Debt (Cash Flow to Debt) Ratio Cash flow from operations Total debt Net Free Cash Flow Ratio (Net income + Accrued and capitalized interest expense + Depreciation and amortization + Operating lease and rental expense - Declared dividends - Capital expenditures) (Accrued and capitalized interest expense + Operating lease and rental expense + Current portion of long-term debt + Current portion of capitalized lease obligations) 24

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