Ignacio Lezaun

English edition
2021

Fundamentals of Finance
 UNIT
2

Unit 2:
Statement of cash flows
OBJECTIVES UNIT
2

2.1 Understand differences between net income and cash flow:

a. Revenue and collections
b. Expenses and payments

2.2 Calculating cash flow

c. Direct versus indirect method
d. Calculating cash flow activities
e. Cash flow statement
f. Exercise

2.3 Cash flow metrics and calculations

g. EBIDTA as a proxy
h. Operating cash flow
i. Free Cash Flow (FCF)
j. Free Cash Flow to Firm (FCFF)
k. Free Cash Flow to Equity (FCFE)
l. Exercise
 Income statement example: Spotify
UNIT
2

Net income
 UNIT
2

What is cash flow?

What is cash flow?
UNIT
◼ CASH FLOW= COLLECTION MINUS PAYMENTS
2
◼ Cash flow is based on financial (monetary) flow of collections and
payments

◼ It is the result of financial transactions across three activities:

1. Operating activities

2. Investing activities

3. Financing activities

(+/-) CASH FLOWS FROM OPERATING ACTIVITIES

(+/-) CASH FLOWS FROM INVESTMENT ACTIVITIES Cash flow for the period
(+/-) CASH FLOWS FROM FINANCING ACTIVITIES
Cash flow activities
UNIT
2
1. Operating activities include cash activities related to net income
e.g. cash generated from the sale of goods (revenue) and cash paid for merchandise (expense)
are operating activities because revenues and expenses are included in net income

2. Investing activities include cash activities related to noncurrent assets,

including (1) long-term investments; (2) property, plant, and equipment;
and (3) the principal amount of loans made to other entities.
e.g. cash generated from the sale of land and cash paid for an investment in another company
are included in this category
(note that interest received from loans is included in operating activities)

3. Financing activities are cash activities used to fund the company

e.g. transactions involving debt, equity, and dividends
 Spotify: Cash flow statement
UNIT
2

Cash flow

INITIAL BALANCE

(+/-) CASH FLOWS FROM OPERATING ACTIVITIES

(+/-) CASH FLOWS FROM INVESTMENT ACTIVITIES

(+/-) CASH FLOWS FROM FINANCING ACTIVITIES

(=) FINAL BALANCE
Balance sheet UNIT 1

Accounting perspective Financial perspective

NON-OPERATING
ASSETS

EQUITY EQUITY

ASSETS
FINANCIAL
DEBT
BUSINESS
LIABILITIES

 Double accounting: Every change in the balance sheet has a corresponding effect
 The financial perspective explains how the financiers look at the company
Cash Flow Statement

CASH FROM OPERATIONS (BUSINESS)

+NET INCOME

- NON-CASH INCOME
+ NON INCOME CASH

CASH FROM INVESTMENT (BUSINESS)

CASH FROM FINANCING

Who´s financing the business?

WHO WHAT´S AT RISK? WHAT´S THE RETURN?

• Required minimal
• Equity (investment)
profitability
SHAREHOLDERS • Additional
(industry+ Company
commitments?
risk)

• Debt repayment /
BANKS insolvency
• Interest rate

• Debt repayment
• Political/social
OTHER? (Gov) • Visibility-
objectives
Reputational risk
Valuation of a Company

ENTERPRISE VALUE (BUSINESS)

+ NON-OPERATING ASSETS

- FINANCIAL DEBT

= EQUITY VALUE

Valuation ≠ Book value

 UNIT
2

Differences between net income and

cash flow
 Differences between net income and
cash flow UNIT
2

◼ Cash generated is calculated through the cash flow statement (not income
statement)

◼ The cash flow helps us analyse the financial viability of the company. A
project can be viable from an economic point of view but not from a
financial point of view because it does not generate the necessary funds to
recover investment made 

◼ In this way, a firm that has a positive net income can still be generating
insufficient cash, and vice versa
Examples of net income without cash
UNIT
Case 1 • Company X had a net income of $60,000 in its first year 2
• But paid out $65,000 near the end of the year to acquire equipment that will
be put into service on the first day of its second year
• During its first year the company had $65,000 of net income, but may
end the year with $0 cash.

Case 2 • Company Y provides $10,000 of services in 1 st month of operations

• Allows clients to pay 30 days later
• Also incurs $2,000 of expenses of which it pays $1,100 immediately and
will pay $900 in 30 days
• In its first month, the company had a net income of $8,000 (revenues of
$10,000 minus $2,000 of expenses)
• But its cash decreased by $1,100 (cash receipts of $0 with cash payments of
$1,100)
• If it has no other business transactions, the company's net income in the
second month will be $0 (no revenues minus no expenses) but it will
have a $9,100 increase in cash (receipts of $10,000 minus payments of
$900).
Spotify: income and cash flow statements
UNIT
2

Net income

Cash flow
Key Differences
UNIT
2

Income Cash
Calculated Income statement Cash flow statement

Represents Flow of goods and Monetary transactions

services

Shows us Economic viability of the Financial viability of the

company (is the company company (is the company
profitable?) sustainable?)
 UNIT
2

2.2 Calculating cash flow

Calculating cash flow: Direct method
UNIT
◼Collections minus payments 2
◼Easy to understand but requires information on all collections and
payments of the company during the time period
◼For this we have to go to the accounting of the cash or bank
statement to see all the inflows and outflows of funds
◼It provides more information than the indirect method since it
gives a breakdown of the origin of collections and payments
Calculating cash flow: Indirect method
UNIT
◼Calculations are easier to do but procedure is more difficult
2 to
understand
◼Part of financial accounting (from the income statement of the
period for which we want to calculate the cash flows)
◼Takes the initial and final balances of said period as a
reference, then makes the appropriate adjustments and
eliminations until reaching the concept of cash
◼The following documents are required:
◼Initial balance sheet
◼Income statement for the period in question
◼Final balance sheet
Class exercise: Laserlus company

GROSS ASSETS
31/12/20
150,000.00 €
31/12/21
150,000.00 € CAPITAL
31/12/20
120,000.00 €
UNIT
31/12/21
120,000.00 €
DEPRECIATION
NON-CURRENT
-30,000.00 € -35,000.00 € RESERVES 18,000.00 € 2 21,600.00 €
ASSETS 120,000.00 € 115,000.00 € NET INCOME 6,000.00 € 7,500.00 €
INVENTORIES 18,500.00 € 5,000.00 € NET EQUITY 144,000.00 € 149,100.00 €
CUSTOMERS 38,000.00 € 20,000.00 € NON-CURRENT LIABILITIES -€ -€
CASH 24,900.00 € 33,975.00 € SUPPLIERS 15,000.00 € 4,125.00 €
CURRENT ASSETS 81,400.00 € 58,975.00 € TAXES PAYABLE 2,400.00 € € 750.00
OTHER DEBTS 40,000.00 € 20,000.00 €
CURRENT LIABILITIES 57,400.00 € € 24,875.00
TOTAL ASSETS 201,400.00 € 173,975.00 € TOTAL EQUITY + LIABILITIES 201,400.00 € 173,975.00 €

INCOME STATEMENT 2021

Sales 120,000.00 € Exercise:
Cost of materials 30,000.00 €
Direct labor cost 37,500.00 € Calculate the collections
Indirect costs 35,000.00 €
Depreciation 5,000.00 € from clients for 2021
Gross margin 12,500.00 €
General expenses 2,000.00 €
EBIT 10,500.00 €
Interests € 500.00
EBT 10,000.00 €
Tax 2,500.00 €
Net Income 7,500.00 €
Calculating cash flow: Indirect method
UNIT
◼Add and subtract the items that have involved movements of funds
2 and that
have not gone through the income statement,
For example: investments in fixed assets, entry and return of financial debt and increase in
warehouse

◼Subtract the items that have been deducted in the income statement and that
have not entailed movements of funds
For example: the deductions that have been made to the profit figure in the income statement
through the provisions for amortizations and provisions whose constitution did not suppose any
cash inflow or outflow

◼Add and subtract those items that (due to the application of the accrual
principle) add as income or subtract as expenses in the income statement
but have not been collected or paid
We refer to declared sales but those that have not been collected due to granted credit to
customers and whose balance appears on the balance sheet