UNIT II
CASH FLOW ANALYSIS
Noncash revenues and expenses
Net income includes items that were neither cash inflow nor cash outflows:
Depreciation expense
Accretion expense on asset retirement obligation
Amortization of intangibles
Impairment loss on goodwill and intangibles
Earnings of affiliated companies accounted for using the equity method
Impairment losses on other noncurrent assets
Compensation expense related to stock options
Net income also includes gains and losses from investing and financing activities
Gain ≠ cash received (unless carrying value was zero)
Even when there is a loss, cash might have been received
Net income must be adjusted for these items to get the cash provided by operations
For other items, there are revenues/expenses as well as cash flows but the amounts are
different:
Bond interest expense ≠ bond interest paid (if bonds were sold at premium or
discount)
Sales were not all collected in cash (bad debts, other changes in Accounts Receivable)
Purchases were not necessarily paid for during period (change in Accounts Payable)
Income tax expense ≠ income taxes paid due to deferred tax assets/liabilities as well
as income taxes refunds receivable or unpaid taxes owed
Company, Inc.
Statement of Cash Flows
For the year ended December 31, 199X
Cash Flows from Operating Activities
Cash received from customers
Cash received as interest income *
Cash received as dividend income
Cash paid for cost of goods sold *
Cash paid for selling expenses
Cash paid for general & administrative expenses
Cash paid for interest (including interest on capital leases)
Cash paid for income taxes
Cash that would have been paid for taxes except for “excess tax deduction” related to
stock based compensation
Net cash provided by (or used by) operating activities
Cash Flows from Investing Activities
Cash received from sale of property, plant, & equipment
Cash received from sale of investments
Cash received from repayment of note receivables
Cash paid to acquire property, plant, and equipment
Cash paid to acquire investments
Cash paid out as a loan
Net cash provided by (or used by) investing activities
Cash Flows from Financing Activities
Cash received as proceeds from issuance of debt
Cash received as proceeds from issuance of stock
Cash received as proceeds from reissuance of treasury stock
Cash paid to repay debt (principal payment)
Cash paid on principal related to capital leases
Cash paid to reacquire stock (purchase treasury stock)
Cash paid as dividends
Cash retained due to “excess tax deduction” related to stock options
Net cash provided by (or used by) financing activities
Net increase (decrease) in cash
Beginning cash and cash equivalents balance
=Ending cash and cash equivalents balance
Schedule of Noncash Investing and Financing Activities
Assets for Liabilities &/or Equity
Liabilities &/or Equity for Assets
Liabilities for Equity and Equity for Liabilities
Capital lease (acquisition of asset and obligation for lessee)
A reconciliation of net income to cash provided by operations
*Brackets indicate items that are normally combined
Operating Activities
(Usually associated with working capital accounts like
Accounts receivable, inventory, salaries payable, etc.)
Inflows:
From sale of goods and services
From receiving dividends investments
From receiving interest from investments or loans
From sale of trading securities
From reduced income taxes due to “excess tax
deduction” related to stock options
Outflows:
To suppliers for inventory and other materials
To employees for services
To other entities for services (insurance, etc.)
To government for taxes
To lenders for interest
To purchase trading securities
Interest expense is an operating item! Investment earnings (dividends & interest) is an
operating item! Buying and selling trading securities are operating activities! These things
may not make sense to you – so “memorize.”
Investing Activities
(Usually associated with long-term assets)
Inflows:
From sale of property, plant and equipment
From sale of debt or equity investments of other
entities*
From collections of principal on loans to other
entities
Outflows:
To purchase property, plant and equipment
To purchase debt or equity securities of other
entities
To make loans to other entities
*except investments classified as trading securities which are included in operating activities
Financing Activities
(Usually associated with long-term liability and equity items)
Inflows:
From issuance of debt (bonds and notes)
From issuance of equity securities
Common stock
Preferred stock
Re-issuance of treasury stock
Outflows:
To stockholders as dividends
To repay or retire long-term debt, including capital
leases for lessee (interest on leases is classified as
operating)
To reacquire capital stock (treasury stock)
Analyze the operating section of the cash flow statement
• This is the most important section because it shows how the firm's actual line of business is
performing in terms of raising cash.
• An analysis of the operating section of the statement of cash flows determines the adequacy
of cash flow from operating activities.
• An operating cash outlay for refunds given to customers for deficient goods indicates a
quality problem with the merchandise.
• Payments of penalties, fines, and law suit damages reveal poor management practices that
result in non-beneficial expenditures.
• Investors want to find positive cash flows from operations. Positive cash flows show the
company can earn money from its business.
Analyze the investing section of the cash flow statement:
• This section shows how the company is building its capital.
• With a positive investing section, the company will be receiving income from its
investments, such as the purchase of stock in a company.
• A negative investing section could signal growth in the business as it makes more property,
plant, equipment or other investments.
• An increase in fixed assets indicates capital expansion and future growth. A reduction in
business arising from the sale of fixed assets without adequate replacement is a negative sign.
• An analysis of the investing section can identify investments in other companies. These
investments may lead to an attempt to assume control of another company for purposes of
expansion.
Analyze the financing section of the cash flow statement:
• This section shows how efficient the company has been for the past year in raising money.
• If the company has positive cash flows from financing, it means it has been conducting
activities like selling more stock. This could signal growth in the business.
• A negative financing cash flow can show the company is either repurchasing its own stock
or paying dividends to investors.
• An evaluation of the financing section reveals the company`s ability to obtain financing in
the money and capital markets as well as its ability to meet obligations.
