CASH FLOW ANALYSIS

IMPORTANCE
•Cash is considered to be the lifeblood of the firm.
•Gives managers, equity analysts, commercial lenders and
investment bankers a thorough explanation of the changes
that occurred in the firm’s cash balances.
•Understanding the flow of cash is critical to having a
handle on the pulse of the firm.
RELEVANCE OF CASH
➢Cash is the most liquid of assets and offers a company both liquidity and
flexibility.
➢The 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
BASIC ELEMENTS
The statement of cash flows is prepared using a concept of cash that includes
not only cash itself but also short-term, highly liquid investments. This is
referred to as the “cash and cash equivalent” focus.

The cash flow statement analysis explains the change in these focus accounts
by examining all the accounts on the balance sheet other than the focus
accounts.

The statement of cash flows classifies cash receipts and cash payments into
operating, investing, and financing activities.
STATEMENT OF CASH FLOWS – PURPOSE
➢A company’s ability to generate future net cash inflows
from operations to pay debts, interest and dividends;
➢A company’s need for external financing;
➢The reasons for the differences between net income and
net cash flow from operating activities;
➢The effects of cash and noncash investing and financing
transactions.
 THE CASH FLOW STATEMENT
❖A financial statement that summarizes the cash inflows and outflows of a
company for a period of time.
❖Operating – cash flows from a firm’s regular operations. Cash flows from
operating activities are generally the cash effects of transactions and other
events that enter into the determination of net income.
❖Investing – cash flows from a firm’s investing activities include lending
money and collecting on those loans and acquiring and selling investments
and productive long-term assets.
❖Financing – cash flows from a firm’s financing activities include cash flows
relating to liability and owners’ equity.
OPERATING ACTIVITIES
Typical cash inflow
From sale of goods or services
From return on loans (interest)
From return on equity securities (dividends)
Typical cash outflow
Payments for purchase of inventory
Payments to employees
Payments to government (taxes)
Payments of interest expense
Payments to suppliers for other expenses
INVESTING ACTIVITIES
Typical cash inflow
From receipts of loans collected
From sale of debt or equity securities of other corporations
From sale of property, plant and equipment
Typical cash outflow
Loans to other entities
Purchase of debt or equity securities of other entities
Purchase of property, plant and equipment
FINANCING ACTIVITIES
Typical cash inflow
From sale of equity securities
From sale of bonds, mortgages and other short or long-term borrowings
Typical cash outflow
Payment of dividends
Reacquisition of the firm’s capital stock
Payment of amounts borrowed
The income statement and balance sheet are based
on accrual accounting which was developed based
on the principle of matching as per Generally
Accepted Accounting Principles.
Many revenues and expenses result from accruals and allocations
that do not affect cash.

A company can operate at a profit and continually be short of

cash conversely, it can also generate huge inflows of cash and
still report a loss.
The statement of cash flows can explain how these situations might
occur. Answers to these questions cannot be found in the other financial
statements.

There are two types of items that cause difference between income
flows and outflows: noncash income or expense and non-operating
income or expense.
PREPARATION OF THE CASH FLOW STATEMENT – INDIRECT METHOD
1. Compute the change in cash for the period. This figure is the difference between
the ending and beginning cash balances shown on the balance sheets. It must
equal the net cash inflow or outflow shown in the statement of cash flows.
2. Compute the cash from operating activities. Identify cash flows associated with the
working capital and adjust the period’s income statement to an operating cash
flow basis.
3. Identify the cash flows from investing activities. Identify the cash flows associated
with the sale and purchase of long-term assets.
4. Identify the cash flows from financing activities. Identify cash flows associated with
long-term debt and capital stock.
5. Prepare the statement of cash flows based on the above steps.
IMPORTANT TIPS
SOURCES OF CASH / FUNDS
ANY DECREASE IN AN ASSET ITEM
ANY INCREASE IN A CLAIM
(LIABILITY OR STAKEHOLDERS’
EQUITY)
USES OF CASH / FUNDS
ANY INCREASE IN AN ASSET ITEM
ANY DECREASE IN A CLAIM
(LIABILITY OR STAKEHOLDERS’
EQUITY)
EXERCISE TEST
Which of the following are sources of funds and which are uses of funds. List also its placement in the
statement of cash flows: operations (O), financing (F), investing (I):
TRANSACTIONS TRANSACTIONS

INCREASE IN ACCOUNTS RECEIVABLE PAY BANK NOTE

ISSUE COMMON STOCK SELL MARKETABLE SECURITIES

RETIRE BONDS DECLARE STOCK DIVIDEND

PURCHASE EQUIPMENT CONVERT BONDS TO PREFERRED STOCK

PAY DIVIDEND INCREASE IN ACCOUNTS PAYABLE

SALE OF LAND DECREASE IN ACCRUED TAXES

DECREASE IN RAW MATERIALS INVENTORY DEPRECIATION CHARGES

Discussion Point:

The signs (positive or negative) of a firm’s net cash provided (used) by

operating, investing, and financing activities form a particular cash
flow pattern.

What type of pattern should we generally expect to find?

For a healthy growing firm, generally expect:
❑Positive cash flow from operating activities

❑Negative cash flow from investing activities

❑Positive or negative cash flow from financing activities

(which may move back and forth from time to time)
CASH FLOW STATEMENT – INDIRECT METHOD
Cash Flow from Operating Activities Explanation
Net Income XXX Shows impact of transactions not defined
Depreciation XXX as investing or financing activities.
Cash provided (used) by current assets These cash flows are generally the cash
and operating-related liabilities effects of transactions that enter into the
Decrease in Accounts receivable XXX determination of net income.
Increase in Inventories (XXX)
Increase in Accounts payable XXX
Decrease in Accrued expenses (XXX)
Net cash provided (used) by operating
activities XXX
CASH FLOW STATEMENT – INDIRECT METHOD
Cash Flow from Investing Activities Explanation
Additions to fixed assets (XXX) Shows impact of buying and selling
Payment for long-term investment (XXX) fixed assets and debt or equity securities
of other entities.
Net Cash provided (used) by
investing activities (XXX)
CASH FLOW STATEMENT – INDIRECT METHOD
Cash Flow from Financing Activities
Increase in short-term borrowings XXX
Additions to long-term borrowing XXX
Dividends paid (XXX)
Explanation
Shows impact of all cash transactions
with shareholders and the borrowing
and repaying transactions with lenders.

Net cash provided (used) by

financing activities XXX
 ABC Enterprises, Inc.
Statements of Financial Position at December 31, 2011 and 2010
(in thousands)
Changes
2011 2010 Source Use
Assets
Current Assets
Cas h 2,030.50 1,191.00 840 Control
Marketable s ecurities 2,636.00 4,002.00 1,366
Accounts receivable 4,704.00 4,383.50 321
Allowance for doubtful accounts (224.00) (208.50) (16)
Inventories 23,520.50 18,384.50 5,136
Prepaid expens es 256.00 379.50 124
Total current as s ets 32,923.00 28,132.00

Property, Plant and Equipment

Land 405.50 405.50
Buildings and leas ehold improvements 9,136.50 5,964.00 3,173
Equipment 10,761.50 6,884.00 3,878
20,303.50 13,253.50
les s : Accumulated depreciation and amortization (5,764.00) (3,765.00) (1,999)
Net property, plant and equipment 14,539.50 9,488.50

Other Assets 186.50 334.00 148

Total Assets 47,649.00 37,954.50

Liabilities
Current Liabilities
Accounts payable 7,147.00 3,795.50 3,352
Notes payable - banks 2,807.00 3,006.00 199
Current maturities of long-term debt 942.00 758.00 184
Accrued liabilities 2,834.50 2,656.50 178
Total current liabilities 13,730.50 10,216.00

Long-Term Liabilities
Deferred Income Taxes 421.50 317.50 104
Long-term Debt 10,529.50 8,487.50 2,042
Total long-term liabilities 10,951.00 8,805.00

Total Liabilities 24,681.50 19,021.00

Equity
Ordinary s hares , par value P1, authorized 10,000,000 s hares
is s ued 2,297,000 s hares in 2010 and 2,401,500 s hares in 2011
2,401.50 2,297.00 105

Additional paid-in capital 478.50 455.00 24

Retained earnings 20,087.50 16,181.50 3,906

Total Equity 22,967.50 18,933.50

Total Liabilities & Equity 47,649.00 37,954.50

Totals 11,531 11,531

 ABC Enterprises, Inc.
Income Statements
For the years ended December 31, 2011, 2010 and 2009

2011 2010 2009

Net Sales 107,800.00 76,500.00 70,350.00

Cost of goods sold 64,682.00 45,939.50 40,803.00
Gross profit 43,118.00 30,560.50 29,547.00

Operating expenses:
Selling and administrative 16,332.00 13,191.00 12,749.00
Advertising 7,129.00 5,396.00 4,770.50
Lease 6,529.00 3,555.50 3,633.50
Depreciation and amortization 1,999.00 1,492.00 1,250.50
Repairs and maintenance 1,507.50 1,023.00 1,515.50
Total expenses 33,496.50 24,657.50 23,919.00

Operating profit 9,621.50 5,903.00 5,628.00

Other income (expenses)

Interest income 211.00 419.00 369.00
Interest expense (1,292.50) (1,138.50) (637.00)

Earnings before taxes 8,540.00 5,183.50 5,360.00

Income taxes 3,843.00 2,228.50 2,412.00

Net Income 4,697.00 2,955.00 2,948.00

 ABC Enterprises, Inc.
Statements of Cash Flows
For the year ended December 31, 2011
(in thousands)

Cash flow from Operating activitie s:

Ne t Income 4,697
Add: De pre ci ati on & Amorti zati on 1,999
Total 6,696

Cash provided (used) from Working Capital

De cre ase , Marke tabl e Se curi ti e s 1,366
De cre ase , Pre pai d Ex pe nse s 124
Incre ase , Accounts payabl e 3,352
Incre ase , Curre nt porti on l ong-te rm l oan 184
Incre ase , Accrue d l i abi l i ti e s 178
Incre ase , Accounts re ce i vabl e ( 305)
Incre ase , Inve ntori e s ( 5,136)
De cre ase , Note s payabl e - Bank ( 199)

Net cash provided from Operating activities 6,260

Cash flow from Inve sting activitie s

Incre ase , Bui l di ngs and l e ase hol d i mprove me nts ( 3,173)
Incre ase , Equi pme nt ( 3,878)
De cre ase , Othe r asse ts 148

Net cash provided from Investing activities (6,903)

Cash flow from Financing activitie s:

Incre ase , De fe rre d Tax e s 104
Incre ase , Long-te rm de bt 2,042
Incre ase , Equi ty share s 105
Incre ase , Addi ti onal pai d-i n Capi tal 24
Di vi de nds pai d ( 791)

Net cash provided from Financing activities 1,483

Net Increase in Cash 840

Cash, bal ance be gi nni ng 1,191

Cash, balance ending 2,031

 ABC Enterprises, Inc.
Statements of Cash Flows
For the year ended December 31, 2011
(in thousands)
Percent
Inflows Outflows Inflows Outflows
Cash flow from Operating activities:
Net Income 4,697 33%
Depreciation & amortization 1,999 14%
Sale of Marketable Securities 1,366 10%
Use of Prepayment 124 1%
Increase in Accounts payable 3,352 23%
Increase in Current portion of long-term loan 184 1%
Increase in Accrued liabilities 178 1%
Increase in Accounts receivable 305 2%
Increase in Inventories 5,136 38%
Payment of Notes Payable - Bank 199 1%

Net cash provided (used) from Operating activities 11,899 5,640 83% 42%

Cash flow from Investing activities

Increase, Buildings and leasehold improvements 3,173 24%
Increase, Equipment 3,878 29%
Decrease, Other assets 148 1%

Net cash provided (used) from Investing activities 148 7,050 1% 52%

Cash flow from Financing activities:

Increase, Deferred Taxes 104 1%
Increase, Long-term debt 2,042 14%
Increase, Equity shares 105 1%
Increase, Additional paid-in Capital 24 0%
Dividends paid 791 6%

Net cash provided (used) from Financing activities 2,274 791 16% 6%

Total Cash Inflows 14,321 14,321 100%

Total Cash Outflows 13,481 13,481 100%

Net Increase in Cash 840

Cash, balance beginning 1,191

Cash balance, 12/31/2011 2,031

CASH FLOW ANALYSIS
Cash Inflows Cash Outflows

Cash Inflows Cash Outflows

Cash flow
Cash flow from Operating activities: Cash flow from Investing activities
from Cash flow from
Investing Financing Cash flow from Financing activities:
activities activities:
1% 16%
6%

42%

Cash flow from

Operating
activities: 52%
83%
FINANCIAL RATIOS AND THE STATEMENT OF CASH
FLOWS
1. Operating cash flow / current maturities of long-term debt and current notes payable
– a ratio that indicates a firm’s ability to meet its current maturities of debt. The higher the
ratio, the better the firm’s liquidity.
2. Operating cash flow / total debt – indicates a firm’s ability to cover total debt with
operating cash flow. The higher the ratio, the better the firm’s ability to carry its total debt.
3. Operating cash flow per share – indicates the funds flow per common share outstanding.
Operating Cash Flow – Preferred Dividends
Diluted Weighted Average Common Shares Outstanding

4. Operating cash flow / cash dividends – indicates a firm’s ability to cover cash dividends
with the yearly operating cash flow. The higher the ratio, the better the firm’s ability to
cover cash dividends.