Module 5

Cash Flow Analysis

M. MANAYAO, CPA, MBA

Learning Objectives
➢ Understand the usefulness of the statement of cash
flows as far as decision making is concerned.
➢ Know the classifications of the cash flow activities.
➢ Identify various sources and applications of cash.
➢ Be familiar with the content and form of the
Statement of Cash Flows.
➢ Calculate cash flow from operating activities using
direct and indirect method.
Introduction
➢ Clearly, income statements and
statements of financial position are
the most common financial
documents available to the public.
But managers who make financial
decisions may find themselves at
something of a loss if they only have
these two documents (reports on
past performance) on which to base
their decisions for today and into
the future.)
Introduction
➢ Financial managers and investors,
however, are far more interested in actual
cash flows than they are in the somewhat
artificial, backward-looking accounting
profit listed on the income statement.
This is very important distinction
between the accounting and finance point
of view. Finance professionals know that
the firm needs cash, not accounting
profit, to pay the firm’s obligations as
they come due, to fund the firm’s
operations and growth, and to
compensate the firm’s ultimate owners
(its shareholders). Thus, the statement of
cash flows is a financial statement that
firm generated and distributed during a
particular time period.
 ➢ “Happiness is a positive cash flow” is certainly true.
Although net income provides a long-term measure of
a company’s success or failure, cash is its lifeblood.
Without cash, a company will not survive. For small
and newly developing companies, cash flow is the
single most important element for survival. Even
Usefulness of medium and large companies must control cash flow.

Creditors examine the cash flow statement carefully

the Statement
➢
because they are concerned about being paid. They
begin their examination by finding net cash provided
of Cash Flows by operating activities. A high amount indicates that a
company is able to generate sufficient cash from
operations to pay its bills without further borrowing.
Conversely, a low or negative amount of net cash
provided by operating activities indicates that a
company may have to borrow or issue equity securities
to acquire sufficient cash to pay its bills.

M. Manayao, CPA, MBA

Usefulness of the
Statement of Cash Flows
➢ The primary purpose of cash flow
statement is to provide relevant
information about a company’s cash
receipts and cash payments during an
accounting period that is useful in
evaluating the preceding items. In this
regard, the PAS 7 states that the
information in a statement of cash
flows, if used with information in the
other financial statements, should
help users to assess and evaluate:
Usefulness of the Statement of Cash Flows

A company’s ability to A company’s ability to

A company’s need for
generate positive future meet its obligations and
external financing,
net cash flows. pay dividends,

The reasons for Both the cash and non-

differences between a cash aspects of a
company’s net income company’s financing
and associated cash and investing
receipts and payments; transactions during the
and accounting period.
 ➢ Readers of financial statements often assess liquidity by
using the current cash debt coverage ratio. It indicates
whether the company can pay off its current liabilities from
its operations in a given year. The formula for this ratio is:

Financial ➢ The higher the current cash debt coverage ratio, the less
likely a company will have liquidity problems.
Liquidity
 ➢ The cash debt coverage ratio provides information on
financial flexibility. It indicates a company’s ability to
repay its liabilities from net cash provided by
operating activities, without having to liquidate the
assets employed in its operations. Notice its similarity
to the current cash debt coverage. However, because it
Financial uses average total liabilities in place of average
current liabilities, it takes a somewhat longer-range.
Flexibility The formula for this ratio is:
 Financial
Flexibility
➢ The higher this ratio, the less likely
the company will experience difficulty
in meeting its obligations as they
come due. It signals whether the
company can pay its debt and survive
if external sources of funds become
limited or too expensive.

M. Manayao, CPA, MBA

Free Cash
Flow
➢ A more sophisticated way to
examine a company’s flexibility is
to develop a free cash flow analysis.
Free Cash Flow is the amount of
discretionary cash flow a company
has. It can use this cash flow to
purchase additional investments,
retire its debt, purchase treasury
shares, or simply add to its
liquidity.
 If the free cash flow is positive, the business
firm could have satisfactory financial
flexibility. Companies that have strong
financial flexibility can:
Take advantage of profitable investment
Free Cash even in tough terms; and
Flow
Be free from worry about survival in poor
economic terms.

M. Manayao, CPA, MBA

The Basic Approach to a
Cash Flow Statement
In preparing a statement of cash flows, the term
cash is broadly defined include both cash and cash
equivalents.

Cash equivalents consist of short-term, highly

liquid investments such as treasury bills, SEC
registered commercial papers and money market
funds. Such investments are made solely for the
purpose of generating a return on funds that are
temporarily idle. Instead of holding cash, most
companies invest their excess cash reserves in these
types of interest-bearing assets that can be easily
converted into cash.
 A statement of cash flows is a component of financial
statements that provides information about historical
changes in Cash and Cash Equivalents of an entity by
classifying cash flows during the period according to:

Classification Operating activities

of Cash Flow
Activities Investing activities

Financing activities

M. Manayao, CPA, MBA

 ➢ The amount of cash flows arising from operating
activities is a key indicator of the extent to which the
operations of the enterprise have generated
sufficient cash flows to repay loans, maintain the
operating capability of the enterprise, pay dividends
and make new investments without recourse to
external sources of financing. Information about the
Operating specific components of historical operating cash
flow is useful, in conjunction with other

Activities information, in forecasting future operating cash

flows.

➢ Operating activities include delivering or producing

goods for sale and providing services; and the cash
effects of transactions and other events that enter
into the determination of income.

M. Manayao, CPA, MBA

 Investing
Activities
➢ The separate disclosure of cash flows arising from
investing activities is important because the cash
flows represent the extent to which expenditures
have been made for resources intended to
generate future income and cash flows.

➢ Investing activities include acquiring and selling,

or otherwise disposing of (a) securities that are
not cash equivalents and (b) productive assets
that are expected to benefit the firm for long
periods of time and lending money and collecting
on loans.

M. Manayao, CPA, MBA

Financing Activities

➢ The separate disclosure of cash flows

arising from financing activities is
important because it is useful in
predicting claims on future cash flows by
providers of capital to the enterprise.

➢ Financing activities include borrowing

from creditors and repaying the principal;
and obtaining resources from owners and
providing them with a return on the
investment.
Summary Operating
Activities

Current Assets Current Liabilities

Noncurrent Assets Noncurrent Liabilities

Equity

Investing Financing
Activities Activities
 ➢ Direct Method

In reporting the cash flows from operating activities enterprises are

Calculating encouraged to report major classes of gross cash receipts and gross cash
payments and the net cash flow from operating activities. At minimum, the
following classes of operating cash receipts and payments should be separately

Cash Flows
reported:

1. Cash collected from customers, including lessees, licenses and the like

from 2.

3.
Interest, fees, royalties and dividends receive
Other operating cash receipts, if any

Operating 4.

5.
Cash paid to employees and other suppliers of goods or services
Interest paid

Activities 6.

7.
Income taxes paid
Other operating payments, if any

 Contracts held for dealing or trading purposes

 Indirect Method
Enterprises that choose not to provide the major
Calculating
➢
classes of operating cash receipts and payments by the
direct method shall determine and report the same
Cash Flows amount of net cash flow from operating activities
indirectly by adjusting net income or reconcile it to
from net cash flow from operating activities.
➢ Regardless of whether the direct and indirect method
Operating of reporting net cash flow from operating activities is
used, the reconciliation of net income to net cash flow
Activities from operating activities shall be presented.
Problem 1 (page 151)
Operating activities (817,000)
Investing activities (2,567,000)
Financing activities 3,459,000
Net cash increase (decrease) 75,000
Cash – beginning 950,000
Cash – ending 1,025,000
Problem 3 (page 151)
EBIT 45,000,000
Taxes (17,000,000)
Depreciation expense 8,000,000
Operating cash flows 36,000,000

Free cash flow = Operating cash flow – Investment in

operating capital
23M = Operating Cash flow – 13M
➢QUESTIONS????
➢REACTIONS!!!!!
END