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- 1. Cash Flow Statement ____________________________________________________ Cash flow statement may provide considerable information about what is really happening in a business beyond that contained in either the income statement or the balance sheet. Analyzing this statement should not present an intimidating task, instead it will quickly become obvious that the benefits of understanding the sources and uses of a companys cash far outweigh the costs of undertaking some very straightforward analyses.Who cares about a Cash Flow Statement? Executives want to know if the cash generated by the company will be sufficient to fundtheir expansion strategy Stockholders want to know if the firm is generating enough cash to pay dividends Suppliers want to know if their customers will be able to pay if offered credit Investors want to evaluate future growth potential Employees are interested in the overall viability of their employer as indicated by itsability to fund its operationsFormat of the Cash Flow Statement The cash flow statement is divided into three sections: o Cash flow from operating activities: shows the results of cash inflows andoutflows related to the fundamental operations of the basic line or lines ofbusiness in which the company engages. (Example: cash receipts from the sale ofgoods or services and cash outflows for purchasing inventory and paying rent andtaxes.) o Cash flow from investing activities: associated with purchases and sales of non-current assets (Example: building and equipment purchases or sales ofinvestments or subsidiaries.) o Cash flow from financing activities: associated with financing the firm (Example:selling and paying off bonds and issuing stock and paying dividends) Exceptions o Short-term marketable securities are treated as long-term investments and appearin cash flow from investing activities o Short-term debt is treated as long-term debt and appears in cash flow fromfinancing activities o Although dividends are handled as a cash outflow in the cash flow from financingactivities section, interest payments are considered an operating outflow, despitethe fact that both are payments to outsiders for using their money. Example of a Statement of Cash Flow: notice how it separates the three different cashflow activities
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Statement of Cash FlowsCash Flow from Operating Activities Net Income XXX,XXX Adjustments to reconcile net income to netcash provided by operating activities:Depreciation and amortizationXX,XXXChanges in other accounts affecting operations: (Increase)/decrease in accounts receivable X,XXX (Increase)/decrease in inventories X,XXX (Increase)/decrease in prepaid expensesX,XXX Increase/(decrease) in accounts payableX,XXX Increase/(decrease) in taxes payable X,XXXNet cash provided by operating activities XXX,XXXCash Flow from Investing Activities Capital expenditures (XXX,XXX) Proceeds from sales of equipmentXX,XXX Proceeds from sales of investmentsXX,XXX Investments in subsidiary(XXX,XXX)Net cash provided by investing activities (XXX,XXX)Cash Flow from Financing Activities Payments of long-term debt (XX,XXX) Proceeds from issuance of long-term debt XX,XXX Proceeds from issuance of common stock XXX,XXX Dividends paid (XX,XXX) Purchase of treasury stock (XX,XXX)Net cash provided by financing activities (XX,XXX)Increase (Decrease) in Cash XX,XXX Operating Activities:o The cash flow from operating activities section of a cash flow statement can bepresented using the direct format or the indirect format. The bottom line is thesame, but the two begin at different points. Companies are free to use eitherformat. Below is an example of both formats.o Direct method: shows how much cash came in for sales and how much cash wentout for inventory and other operating expenditures.o Indirect method: starts with net income as a figure that summarizes most of thecash transactions for operating activities in a firm. However, net income alsoincludes transactions that ere not cash, so we must eliminate the non-cashtransactions from the net income figure to arrive at an accurate presentation ofcash flow from operating activities. 3. Cash Flow from Operating Activities (two formats) DirectIndirectCash received from customers$400,000 Net Income$30,000Cash paid to suppliers-260,000 Adjustments to reconcile netCash paid to employees -70,000 income to net cash provided,Other cash operating expenditures by operating activities: Net cash provided by operating Depreciation25,000 activities$40,000 Changes in other accounts affecting operations: (Increase) in receivables -12,000 Decrease in inventory 5,000 (Decrease) in payables -8,000Net cash provided by operating $40,000activitiesMethod used to analyze the cash flow Scan the big picture Check the power of the cash flow engine Pinpoint the good news and the bad news Put the puzzle togetherSTEP 1: Scanning The Big Picture First, place your company in context in terms of its age, industry, and size. (Maturecompanies have different cash flows from start-up companies. And service industrieslook different from heavy manufacturing industries.) Flip through the annual report and other accounting records to determine howmanagement believes the year progressed. Was it a good year? Perhaps a record-breaking year in terms of revenue or net income? Or is management explaining how thecompany has had some rough times? Look at net income. Does it show income or losses over the past few years? Is income(or loss) shrinking or growing?Step 2: Checking The Power Of The Cash Flow Engine The cash flow from operating activities section is the cash flow engine of the company.When this engine is working effectively, it provides the cash flows to cover the cashneeds of operations. To check the cash flow check if the cash flow from operating activities is greater thanzero. Also check whether it is growing or shrinking. Assuming it is positive, the nextquestion is can it cover important, routine expenditures? An exception is start-up companies often have negative cash flow from operatingactivities because they had to spend a lot to get the company started and their cash flowengines are not yet up to speed. Examine the operating working capital accounts. Inventories, receivables, and accountspayable usually grow in expanding companies. 4. Step 3: Pinpointing The Good News And The Bad News Begin with cash flow from investing activities. One systematic observation is to checkwhether the company is generating or using cash in its investing activities. A healthycompany invests continually in more plant, equipment, land, and other fixed assets toreplace the assets that have been used up or have become technologically obsolete. You must look at the entire package to evaluate whether your cash flows from financingare in the good news or bad news categories. One systematic way to begin is tocompare borrowing and payments on debt with each other across the years and note thetrends. Another way in uncovering the news in this section is to check the activities inthe stock accounts.Step 4: Putting The Puzzle Together It would be rare to find a company in which all of the evidence is positive, or in which allof the evidence is negative. To make a balanced evaluation, you must use both the good news and the bad newsidentified in each section of the statement. Sometimes there are unusual or unknown items that may need further looked into(possibly by a professional). Hertenstein, Julie and Sharon McKinnon. Solving the Puzzle of the Cash Flow Statement.Article 26: 160-167.