NOTE ON CASH FLOW STATEMENT

- Objective: report on a company’s operating, financing and investing activities in order to show how and where the company is
generating and using cash
- Company’s worth is a function of its ability to generate future cash flows in excess of its investments in capital and operations

IMPORTANCE OF THE CA SH FLO W STA TEMENT

- Mandatory when producing a complete set of financial statements under IFRS and US GAAP
- Realize the importance that cash flow management plays in the liquidity, financial flexibility, and solvency of a company and demand
that companies report it in their cash flows
- Balance sheet: “snapshot” of a company’s assets, liabilities, and equities at a specific point in time
o If looking at BS overtime, it is possible to construct an overview of the changes to various accounts which would allow an
external user to infer some of the information on the CFS
- Income statement: focuses on illustrating the revenues generated and the expenses incurred by a company over a specific period of
time, and is prepared using the accrual concept
o This information is found on the operations section of the CFS
o Influenced by accrual accounting and the matching concept, therefore includes many non-cash transactions

OPERATING, F INANCING , INVESTING

- Operating
o Sources and uses illustrate a company’s ability to generate enough cash to cover day-to-day operations
o Ex. cash receipts, operating expenses, income taxes, adjustments due to the accrual nature of the accounting model such
as increases in A/R or A/P
o Add back amortization for the period as it is non-cash
o Users can determine whether or not the cash generated from operating activities is sufficient to support annual expenses,
cover loans, pay dividends and make new investments
- Financing
o Shows changes to capital structure
o Ex. proceeds from share capital issued, increased loans, dividend payments
- Investing
o Indicates whether company is investing in future income and cash flow generating resources, or whether it is divesting
itself of capital assets or other investments

ISSUES REGARDING COM PARABILITY AND ANALY SIS

- Be aware of the discretion that companies have when classifying cash flows on the CFS
- As users pay attention to cash flows from operations as a metric of operating performance, there may be bias to maximize operating
cash flows at the expense of investing and financing
- IFRS has significant discretion when classifying cash flows
o Discretion to classify interest and dividends received and paid as operating, investing or financing as long as treatment is
consistent
o Taxes on income are normally classified as operating, but can be investing or financing under certain circumstances
- Analysts must be aware of the implications of various accounting policy choices on the CFS
o Ex. if a company capitalizes certain expenses (long-term assets)
 Increasing income on the IS and long-term assets on the BS
 Cash expenditure will be classified as investing as opposed to operating
 Will inflate cash flows from operations

DIRECT AND INDIRECT METHODS OF REPORTING

- Standards encourage preparers of cash flow statements to use the direct method for reporting
- Direct method
o Requires major classes of gross cash receipts and gross cash payments to be disclosed rather than be derived through
reconciling the accrual statements
- Indirect method
o Based on reconciling a company’s net income with its cash flows from operations
o #1: Net income is converted into its cash equivalent by adding back all non-cash expenses, and any non-cash items that
have been recorded through accrual accounting are eliminated by subtracting out all non-cash revenues
o #2: Gains and losses that will be reported in other sections of the CFS must be subtracted or added to avoid double
counting these cash flows

PREPARATION OVERVIEW

- 3 steps in preparing the CFS all in the company’s financial position (BS), from one period to another
o Identification involves determining the differences between the BS accounts from the beginning to the end of the
reporting period
o Reconciliation is the process of determining which transactions occurred during the reporting period to cause the
differences to occur
 Also involves determining how the transactions affected the company’s cash flows
o Classification involves determining where the differences should be reported and communicated on the CFS
 Was the change the result of an operating, financing or investing activity?

ANAYSIS USING THE CA SH FLO W STA TEMENT

- Can estimate whether or not the company is able to generate sufficient cash to meet its day-to-day operating expenditures, repay
debt obligations to creditors, and make dividend payments to investors
- Compare a company’s objectives and strategies to its actual sources and uses of cash
- Calculate a variety of cash flow ratios which are most useful when evaluated over time
o Operating funds ratio = net income/total cash flows from operations
 Compares the proportion of operating cash flows that are provided by net income, and how cash flows are
affected by fluctuations in net income
o Investment ratio = capital expenditures/(depreciation + sale of assets)
 Indicates whether a company’s productive asset base is increasing or decreasing by looking at a company’s
relative asset base
o Cash flow adequacy ratio = total cash flows from operations/(long-term capital expenditures + dividends)
 Reveals whether or not a company is generating enough cash through its operations to fund its current capital
structure and future asset base
o Cash source percentages = each individual cash flow source/total sources of cash
 Relative importance of the various different cash flow sources on the overall cash flows of a company
o Dividend payout ratio = cash dividends paid/total cash flows from operations
 Indicates company’s commitment to a dividend policy and company’s commitment to reinvestment