Understanding the Statement of Cash Flows

Chapter 4

Ch 4 2

Contents

• Understand the cash flow statement and how it relates to other financial statements

• Direct and indirect methods of presenting operating cash flows

• Investing and financing activities

• Disclosure of noncash transactions

• Free cash flow and analysis

Ch 4 3

Importance of cash flows

• Accrual-based accounting requires reporting revenues when earned and expenses when incurred – not when cash is exchanged.

• A company cannot pay employees, creditors and others with accrual-based net income.

• Valuation models used in financial analysis are often based on projections of future cash flows.

Ch 4 4

Statement of Cash Flows

• Summarizes all activity in the cash accounts of the firm via three categories:

• Operating– Indirect format– Direct format

• Investing

• Financing

Ch 4 5

Years Ended December 31 (in millions) 2001 2000 1999Net cash provided by (used for) operating activities 1,976 (1,164) 2,140 Net cash provided by (used for) investing activities 2,477 (4,091) (960) Net cash provided by (used for) financing activities (1,820) 5,119 788

Effect of exchange rate change on cash and cash equivalents 148 (100) (33)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,781 (236) 1,935 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,301 3,537 1,602 CASH AND CASH EQUIVALENTS, END OF YEAR 6,082 3,301 3,537

Motorola, Inc. and Subsidiaries

Ch 4 6

NokiaCash flow summary (EURm)

2001 2000 1999

Operating 6,547 3,509 3,102

Investing (2,679) (2,531) (1,359)

Financing (1,895) (1,034) (574)

Ch 4 7

Operating activities • Primarily captures

– Income statement items– Short-term/operating assets– Short-term/operating liabilities

• Methods of presentation– Indirect– Direct

Ch 4 8

Cash Flows from Operating ActivitiesIndirect method

• Reconciles accrual-based net income with cash generated via operations

• Begin with accrual-basis net income– Adjust accrual items to reflect cash basis

• Noncash items (depreciation and amortization)

• Changes in working capital (current assets, current liabilities)

• Reclassify nonoperating items– Appear in other sections of the Statement

• Gains/losses on sales of fixed assets or debt extinguishment

Ch 4 9

Adjustments on Net Income to Derive Operating Cash Flows

Add back noncash expenses– Depreciation and amortization

Add working capital decreases– Decreases in current assets– Increases in current liabilities

Subtract working capital increases– Increases in current assets– Decreases in current liabilitie

Adjust nonoperating items (e.g., gain from sale of fixed assets)

•Accruals = Operating Income – Operating cash Flows

Ch 4 10

Years Ended December 31 (in millions) 2001 2000 1999OPERATINGNet earnings (loss) (3,937) 1,318 891 Adjustments to reconcile net earnings (loss) to net cash provided by (used for) operating activities:

Depreciation and amortization 2,552 2,527 2,371 Charges for reorganization of businesses and other charges 5,998 1,483 1,893 Acquired in-process research and development charges 40 332 67 Gains on sales of investments and businesses (1,931) (1,570) (1,180) Deferred income taxes (2,273) 239 (443) Changes in assets and liabilities, net of effects of acquisitions and dispositions:

Accounts receivable 2,445 (1,471) (135) Inventories 1,838 (2,305) (678) Other current assets 249 (532) (16) Accounts payable and accrued liabilities (3,030) (666) 361 Other assets and liabilities 25 (519) (991) Net cash provided by (used for) operating activities 1,976 (1,164) 2,140

Motorola, Inc. and SubsidiariesConsolidated Statements of Cash Flows

Ch 4 11

Financial year ended December 31, 2001 2000 1999EURm EURm EURm

Cash flow from operating activitiesNet profit 2,200 3,938 2,577

Adjustments, total 4,132 2,805 1,928 Net profit before change in net working capital 6,332 6,743 4,505

Change in net working capital 978 (1,377) (21) Cash generated from operations 7,310 5,366 4,484

Interest received 226 255 189 Interest paid (155) (115) (212) Other financial income and expenses 99 (454) (113) Income taxes paid (933) (1,543) (1,246)

Net cash from operating activities 6,547 3,509 3,102

NokiaConsolidated Cash Flow Statements, IAS

Ch 4 12

Cash Flows from Operating ActivitiesDirect method

• Cash from customers

• Cash to suppliers

• Cash for wages

• Cash for SGA

• Cash for interest…

Ch 4 13

Calculating Cash from customers

+ Beginning balance in Accounts Receivable

+ Revenues

- Ending Accounts Receivable

= Cash received from customers

Beginning A/R + Sales – Payments received = Ending A/R

Ch 4 14

Calculating Cash paid to suppliers

+ Cost of (sales) revenue

+/- Increase (decrease) in inventory

-/+ Increase (decrease) in accounts payable

= Cash paid to suppliers

The cost of what was sold adjusted for changes in inventory and payments made.

Ch 4 15

Motorola’s Cash from Operating Activities in Direct Method Format

Cash received from customers 32,449

Cash paid to suppliers (22,637)

Cash paid for S, G & A (1,998)

Cash paid for research and development (4,318)

Cash paid for interest (844)

Cash paid for taxes (676)

Cash from operating activities 1,976

Ch 4 16

Nokia’s Cash from Operating Activities in Direct Method Format

Cash received from customers 30,905

Cash paid to suppliers (18,156)

Cash paid for S, G & A (2,556)

Cash paid for research and development (2,558)

Cash paid for interest (155)

Cash paid for taxes (933)

Cash from operating activities 6,547

Ch 4 17

Cash Flows from Investing Activities

• Typically involves noncurrent capital (long-term) assets

• Cash acquisitions of investments, property

• Cash generated upon disposal of assets

• Noncash acquisitions/disposals are reported as Supplemental Information rather than in the body of the Statement of Cash Flows

Ch 4 18

Years Ended December 31 (in millions) 2001 2000 1999INVESTINGAcquisitions and investments, net (512) (1,912) (632) Proceeds from dispositions of investments and businesses 4,063 1,433 2,556 Capital expenditures (1,321) (4,131) (2,856) Proceeds from dispositions of property, plant and equipment 14 174 468 Sales (purchases) of short-term investments 233 345 (496) Net cash provided by (used for) investing activities 2,477 (4,091) (960)

Motorola, Inc. and Subsidiaries

Ch 4 19

Financial year ended December 31, 2001 2000 1999EURm EURm EURm

Cash flow from investing activitiesAcquisition of Group companies, net of acquired cash (131) (400) (178) Purchase of non-current available-for-sale investments (323) (111) (37) Additions in capitalized development costs (431) (393) (271) Long-term loans made to customers (1,129) (776) - Proceeds from (payment of) other long-term receivables 84 - (171) Proceeds from (payment of) short-term receivables (114) 378 128 Capital expenditures (1,041) (1,580) (1,302) Proceeds from disposal of share in Group companies, net of disposed cash - 4 27 Proceeds from sale of non-current available-for-sale investments 204 75 121 Proceeds from sale of fixed assets 175 221 318 Dividends received 27 51 6 Net cash used in investing activities (2,679) (2,531) (1,359)

NokiaConsolidated Cash Flow Statements, IAS

Ch 4 20

Cash Flows from Financing Activities

• Long-term liabilities– Cash from borrowing– Cash used for repayment of principle– Under IAS cash interest payments may be here

• Equity– Cash from stock issuance– Cash used to purchase treasury shares– Cash used for dividend payments

Ch 4 21

Years Ended December 31 (in millions) 2001 2000 1999FINANCINGNet proceeds from (repayment of) commercial paper and short-term borrowings (5,688) 3,884 (403) Net proceeds from issuance of debt 4,167 1,190 501 Repayment of debt (305) (5) (47) Issuance of preferred securities of subsidiary trust - - 484 Issuance of common stock 362 383 544 Payment of dividends (356) (333) (291) Net cash provided by (used for) financing activities (1,820) 5,119 788

Motorola, Inc. and Subsidiaries

Ch 4 22

Financial year ended December 31, 2001 2000 1999EURm EURm EURm

Cash flow from financing activitiesProceeds from share issue 77 72 152 Purchase of treasury shares (21) (160) (25) Capital investment by minority shareholders 4 7 28 Proceeds from long-term borrowings 102 - - Repayment of long-term borrowings (59) (82) (6) Proceeds from (repayment of) short-term borrowings (602) 133 (126) Dividends paid (1,396) (1,004) (597) Net cash used in financing activities (1,895) (1,034) (574)

NokiaConsolidated Cash Flow Statements, IAS

Ch 4 23

Statement of Cash FlowsAdditional Disclosures

1. Cash paid for interest

2. Cash paid for taxes

• Presented at end of statement (GAAP) or in body of statement (IAS)

• May also highlight significant noncash transactions

Ch 4 24

Years Ended December 31 (in millions) 2001 2000 1999Effect of exchange rate change on cash and cash equivalents 148 (100) (33)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,781 (236) 1,935 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,301 3,537 1,602 CASH AND CASH EQUIVALENTS, END OF YEAR 6,082 3,301 3,537

Supplemental Cash Flow InformationCASH PAID DURING THE YEAR FOR:Interest 844 529 323 Income taxes 676 130 301

Motorola, Inc. and Subsidiaries

Ch 4 25

Financial year ended December 31, 2001 2000 1999Foreign exchange adjustment (43) 80 99

Net increase in cash and cash equivalents 1,930 24 1,268 Cash and cash equivalents at beginning of period 4,183 4,159 2,891 Cash and cash equivalents at end of period 6,113 4,183 4,159

Change in net fair value of current Available-for-sale investments 12 - - As reported on balance sheet 6,125 4,183 4,159

NokiaConsolidated Cash Flow Statements, IAS

Ch 4 26

Cash analysis

• Determine and examine all sources and uses of cash

• Determine 2 definitions of free cash flows– To the Firm, available to both debt and equity

holders– To Equity, available to equity holders only– Important for valuation (present value of

expected future free cash flow)

Ch 4 27

Free Cash Flow to the Firm

Operating cash flow

Plus: Interest Paid Times (1-tax rate)

Less: Investments in Fixed Capital

Free Cash Flow to the Firm (to both debt holders and stock holders)

Ch 4 28

Free Cash Flow to Equity

Operating cash flow

Less: Investments in Fixed Capital

Plus: New Debt Borrowing

Less: Debt Repayment

Free Cash Flow to Equity

Ch 4 29

Earnings before Interest, Taxes, Depreciation and AmortizationEBITDA

Net income (loss)

Plus: Interest expense

Plus: Tax expense

Plus: Depreciation & Amortization expense

Free Cash Flow Estimate (to firm)

Ch 4 30

Relevance of Cash Flows and Income over a Company’s Life Cycle

 

+

Income

Investing cash flow

Free cash flow

Financing cash flow

Operating cash flow

DeclineGrowth MaturityInception

Ch 4 31

Earnings and Cash Flow, which is more value relevant?

• If you could trade stocks based on perfect foresight of next year’s

--earnings

--cash flow

which will help you earn higher returns?

• The power to predict future cash flows

Ch 4 32

Financial AccountingRelevance of Accounting Numbers

0%

20%

40%

60%

80%

100%

65 70 75 80 85 90 95

Year

Perc

ent o

f Sto

ck P

rice

Expl

aine

d Book Value

Earnings

Combined

Relation between Accounting Numbers and Stock Prices

Ch 4 33

Accruals--The CornerstoneRelation between Stock Prices and Various Income and Cash

Flow Measures for a Large Sample of Companies

NIBX = Net Income before Extraordinary Items and Discontinued Operations; NI = Net Income; OCF = Operating Cash Flow; FCF = Free Cash Flows; NCF = Net Cash Flow (Change in Cash).

                         

 

                         

57.62

44.36

33.02 32.62

1.000.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

NIBX NI OCF FCF NCF

Per

cent

of P

rice

Exp

lain

ed

 

Ch 4 34

Accruals--The CornerstoneRelation between Stock Returns and both Income and Operating

Cash Flows for Different Horizons of a Large Sample of Companies

Source: Dechow, P

                     

                       

 

0.10

3.18

10.88

3.24

16.20

40.26

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00

Quarter Annual Four-YearTime Horizon

Percen

t o

f S

tock R

etu

rn

s

Exp

lain

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OCF

NI

.