The Statement of Cash FlowsThe Statement of Cash Flows
Cash, liquidity, and the cash flow cycle
The cash flow statement
preparing a cash flow statement– It’s as easy as 1,2,3
Cash and LiquidityCash and Liquidity
• Cash includes highly liquid marketable securities. These are items that can be converted to cash quickly without
loss of value. ( Treasury bills, notes, negotiable CDs, and commercial paper.)
• Liquidity refers to a firm’s ability to meet financial obligations when due, and the ability to fund investment opportunities.
A firm’s cash flow cycle significantly impacts its liquidity.
The Cash Flow CycleThe Cash Flow Cycle
The movement of cash through fixed assets and inventory,
into accounts receivable, and finally back to cash.
Factors affecting the cash flow cycle inventory turnover, collection period, payable period
THE CASH CONVERSION CYCLETHE CASH CONVERSION CYCLE
+ A/R Period
+ Inventory Period
- A/P Period
= Cash Conversion Period
The length of time between when we pay cash for inventory and collect cash from our customers
A/R
Cash Sale
Inventory
Labor
Assets, Taxes, Profits...
The Statement of Cash Flows
• Focuses on the liquidity of a business, by measuring cash inflows and outflows. Shows where money comes from and where it goes
• Three components of cash flow statement:
+/- Operating Cash Flows
+/- Investing Cash Flows
+/- Financing Cash Flows
The Cash Flow Statement
- Operating Activities- Investing Activities - Financing Activities
Cash flow from operations:
Net Income $ 1,000
Depreciation 500
Decrease in Accounts Rec. 100
Increase in Inventory (1,200)
Increase in Accounts Payable 600
Decrease in Accruals (100)
Operating cash flow 900
Cash flow from investing activities:
Purchase Plan & Equipment (2,000)
Investing cash flow (2,000)
Cash flow from financing activities:
Increase in Long-term Debt 1,200
Sale of Common Stock 800
Dividends (500)
Financing cash flow 1,500
Change in cash 400
Beginning cash 1,000
Ending cash 1,400
Operating Activities
Inflows:• Sale of goods• Revenue from services• Interest income
Outflows:• Pay wages• Purchase inventory• Pay other expenses• Pay interest• Pay taxes
Investing Activities
Inflows:• Sale of fixed assets• Sale of investment
securities
Outflows:• Purchase of fixed assets
• Purchase of investment securities
Financing Activities
Inflows:• New loans• Sale of stock
Outflows:• Repayment of loans• Repurchase of a firm’s own
securities (treasury stock)• Payment of dividends
Preparing a Cash Flow Statement(Three easy steps!)
1. Calculate the change in all balance sheet accounts.
2. Identify whether the changes result in increases or decreases in cash flows.
3. Identify the source of the changes: operating, investing, or financing activities.
Note: Some changes involve multiple activities.
Use the balance sheet to explain the change in cash!
• The balance sheet or accounting equation:
A = L + E• Since the accounting equation must remain
in balance:
A = L + E • The change in cash can be written as:
cash = L + E - (non-cash assets)
The change in cash:
• The change in cash can be explained in terms of all other balance sheet accounts:
cash = L + E - (non-cash assets)
CASH FLOW RULESCASH FLOW RULES
Asset Increase = Use
Asset Decrease = Source
Liability Increase = Source
Liability Decrease = Use
BUILDING THE STATEMENT OF CASH FLOWSBUILDING THE STATEMENT OF CASH FLOWS Belfry Company
Balance SheetFor the Period Ended 12/31/00
ASSETS 12/31/99 12/31/00
Cash $1,000 $1,400Accts. Receivable 3,000 2,900Inventory 2,000 3,200CURRENT
ASSETS $6,000 $7,500
Fixed AssetsPlant & Equip. $4,000 $6,000 Accum. Depr. (1,000) (1,500)
Net $3,000 $4,500
TOTAL ASSETS $9,000 $12,000
LIABILITIES 12/31/99 12/31/00
Accts. Payable $1,500 $2,100Accruals 500 400CURRENT LIABIL. $2,000 $2,500
Long-term debt $5,000 $6,200
Common Stock 500 1,300Retained Earn 1,500 2,000TOTAL EQUITY $2,000 $3,300
TOTAL LIABILITIES AND EQUITY $9,000 $12,000
Slide 8 of 9
The change in Retained Earnings
Beginning RE $1,500
+ Net Income 1,000
- Dividends - 500
Ending RE $2,000
BUILDING THE STATEMENT OF CASH FLOWSBUILDING THE STATEMENT OF CASH FLOWS
Belfry CompanyIncome Statement
For the Period Ended 12/31/00
Sales $10,000COGS 6,000Gross Margin $ 4,000
Expense $ 1,600Depreciation 500EBIT $ 1,900Interest
400EBT $ 1,500Tax
500Net Income $ 1,000
The Cash Flow Statement
- Operating Activities- Investing Activities - Financing Activities
Cash flow from operations:
Net Income $ 1,000
Depreciation 500
Decrease in Accounts Rec. 100
Increase in Inventory (1,200)
Increase in Accounts Payable 600
Decrease in Accruals (100)
Operating cash flow 900
Cash flow from investing activities:
Purchase Plan & Equipment (2,000)
Investing cash flow (2,000)
Cash flow from financing activities:
Increase in Long-term Debt 1,200
Sale of Common Stock 800
Dividends (500)
Financing cash flow 1,500
Change in cash 400
Beginning cash 1,000
Ending cash 1,400
CASH COVERAGECASH COVERAGE
A variation on TIE to better get at cash flow
Slide 2 of 3
Cash coverage = EBIT + depreciation
interest
Cash coverage = $1,900 + $500
$400 = 6.0
FIXED CHARGE COVERAGEFIXED CHARGE COVERAGE
A variation on TIE to include lease payments as fixed financial charges equivalent to interest
Interpretation: Failure from excessive debt is due to the inability to pay interest (fixed) charges which depend on the amount
of debt and the interest rate. Coverage ratios measure financial charges relative to available income.
Slide 3 of 3
Fixed charge coverage = EBIT + lease payments
interest + lease payments
Fixed charge coverage = $1,900 + $700
$400 + $700 = 2.4
