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Cash Flow Statement

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The Big Number, Forget About Profit,
Cash Flow Is King

The ability to generate cash may be the most important measure of a business's health.
Plenty of companies with paper profits have failed because they lacked the cash to
keep operating. At the most basic level, companies improve cash flow by collecting
receivables more quickly and paying bills more slowly. If money is going out faster
than it's coming in, a company must find a way to fund operations for those days in
between.
Cash flow can also serve as the basis for calculating the corporate equivalent of
disposable income. Subtracting capital expendituresor critical investments in things
like plants and machineryfrom a company's cash flow shows how much of its
resources are left available for such purposes as paying dividends, financing
buybacks, making acquisition or funding other investments.
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Objective
Information about the cash flows of an enterprise is useful in providing
users of financial statements with a basis to assess the ability of the
enterprise to generate cash and cash equivalents and the needs of the
enterprise to utilise those cash flows.
The economic decisions that are taken by users require an evaluation of
the ability of an enterprise to generate cash and cash equivalents and the
timing and certainty of their generation.
An enterprise should prepare a cash flow statement and should present
it for each period for which financial statements are presented.
Links Balance Sheet and Income Statement elements to change in cash
position.
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Business Activities and Cash Flows
The Statement of Cash Flows focuses
attention on:

Operations
Cash received and paid
for day-to-day activities
with customers, suppliers,
and employees.

Investing Financing
Cash paid and received Cash received and paid
from buying and selling for exchanges with
long-term assets. lenders and stockholders.
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Statement of Cash Flows

Operating Activities Investing Activities Financing activities


Direct or Indirect Method of Cash used/generated by changes Cash used/generated by
Computation in long-term assets changes in equity & debt
Cash generated by selling goods &
services Interest and dividends received Dividends paid is cash flows
Increases in current assets represent should be classified as cash flows from financing activities
a use of cash in operations. from investing because they are cost of
Decreases in current assets are obtaining financial
Cash payments to acquire fixed resources
sources of cash from operations. assets (including intangible assets),
Increases in current liabilities Cash proceeds from issuing
cash payments to acquire shares, shares , issuing debentures,
represent a source of cash from warrants or debt instruments of
operations. Decreases in current loans, notes, bonds, and
other enterprises, cash advances other short or long-term
liabilities are uses of cash from and loans made to third parties.
operations. borrowings is considered as
Non-cash items are informally called Cash receipts from disposal of fixed Cash inflow from financing
sources of cash. (indirect method) assets (including intangibles), cash activity
Cash flows arising from taxes on receipts from disposal of shares, Cash repayments of amounts
income should be classified as cash warrants or debt instruments of borrowed, Buy-back of shares
flows from operating activities other enterprises. are the cash outflow due to
financing activity 5
DIFFERENT TYPES
OF CASH FLOWS

Accounting
Standard
Difference
Accounting Standard Difference

Item IFRS U.S. GAAP


Interest received Operating or investing Operating
Interest paid Operating or financing Operating
Dividends received Operating or investing Operating
Dividends paid Operating or financing Financing
Classifying Cash Flows

ABC Company Ltd


Condensed Statement of Cash flows
For the Year Ended December 31, 2008

(in millions)
Net cash provided (used) by Operating Activities 79
Net cash provided (used) by Investing Activities (38)
Net cash provided (used) by Financing activities 21
Net change in Cash and Cash Equivalents 62
Cash and Cash Equivalents, beginning of year 40
Cash and Cash Equivalents, end of year 102
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Rs. Rs.
Cash flow (A) Cash flow from operating activities:
statement Net profit before tax
Income tax paid 500
of ABC Ltd -250
Net cash from operating activities 250
(Indirect method)
(B) Cash flow from investing activities:
Purchase of fixed assets -200
Sale of fixed assets 100
Net cash used in investing activities -100
(C) Cash flow from financing activities :
Issue of equity shares 300
Repayment of bank loan -300
Dividend paid -50
Net cash used in financing activities -50
Net increase in cash (A+B+C) 100
Add: Opening Balance 50
Closing Balance 150
Rs. Rs.
Cash flow (A) Cash flow from operating activities:
Cash receipts from customers 2800
statement Cash payments to suppliers -2000
of ABC Ltd Cash paid for wages and salaries -100
Cash paid for overhead expenses -200
(Direct method) Income tax paid -250
Net cash from operating activities 250
(B) Cash flow from investing activities:
Purchase of fixed assets -200
Sale of fixed assets 100
Net cash used in investing activities -100
(C) Cash flow from financing activities :
Issue of equity shares 300
Repayment of bank loan -300
Dividend paid -50
Net cash used in financing activities -50
Net increase in cash (A+B+C) 100
Relevance of Statement of Cash Flows
Statement of cash flows (SCF) helps address questions such as:
The SCF reports cash receipts and cash payments by operating, financing, and investing
activities
How much cash is generated from or used in operations?
What expenditures are made with cash from operations?
Cash flows from operations (CFO) is a broader view of operating activities than is net
income. It is not a measure of profitability.
What is the source of cash for debt payments?
How is the increase in investments financed?
What is the source of cash for new plant assets?
Why is cash lower when income increased?
What is the use of cash received from new financing?
Where management committed its resources, Where it reduced investments, Where
additional cash was derived from 12
A 17 July report by Bhaskar N. Basu, research
analyst at Bank of America Merrill Lynch

Aug 01 2013 Basu, in the report, cautioned that Tata


Steels cash flows wont be adequate to
fund its capital expansion. According to
Bloomberg data, Tata Steels free cash flow
was minus Rs.4,989.86 crore in fiscal
2013.

A companys free cash flow is


calculated by deducting the capital
expenditure, or the amount a company
spends on the purchase of tangible
fixed assets, from the cash flow it
generates from operations.
13 www.livemint.com
Example
The net Income reported in the Income Statement for the year was Rs. 110,000 and
depreciation of fixed assets for the year was Rs. 44000. The balances of the current assets
and current liabilities at the beginning and end of the year are as follows. Calculate cash
from operating activities.
Solution
Decription Rs.
Net Income 1,10,000
Add Depreciation 44,000
Operating Profit before working capital changes 1,54,000
Add :
Decrease in inventories 10,000
Decrease in prepaid expenses 1000
Deduct :
Increase in Debtors -20000
Decrease in Account payables -14,000
Net Cash flow fromcoperating Activities 1,31,000
After two years of fairly robust increases of 30% on an average,
cash flows of these companies were crimped in the financial year
2014-15 in a sluggish economic environment. Not surprisingly, the
India Inc is hard pressed for cash; collective cash flows profit before tax for the pack dropped 10% in the last financial year.
from operations for a clutch of 56 top firms grew by just
3% last fiscal, the slowest growth in three years
Bajaj Auto: relatively weak demand impacted the business
resulting in a fall of 13% year-on-year in the profit before
tax. Higher inventories and provisions for advances and
liabilities led to a fall of 39% in operating cash flows.

Crompton Greaves: negative cash flow of Rs 680 crore,


the first time in a decade, as trade receivables for its
standalone operations jumped more than three times to Rs
1,080 crore. The outflow was higher due to advances
towards loss-making overseas subsidiaries.
Reliance Industries: a 20% decline in operating cash
outflow on account of lower trade payables although the
PBT was higher.
Oberoi realty: a more than four-old jump in inventories to
HUL and Asian Paints: Declines in trade payables
Rs 1,832 crore along with lower dividend income and
(amounts billed to a company by suppliers for goods or
profit on sale of investments resulted in a negative cash
services provided on credit) and a higher proportion of
flow of Rs 971 crore despite reporting marginal growth in
PBT paid as net taxes also weighed on the operating cash
profits (PBT). 16
flows
Why Change in Accounts
Receivable is needed to
find the Cash flow from
Operation?

Accounting - Text & Cases 12E


By Anthony 17
After two years of fairly robust increases of 30% on an average,
cash flows of these companies were crimped in the financial year
2014-15 in a sluggish economic environment. Not surprisingly, the
India Inc is hard pressed for cash; collective cash flows profit before tax for the pack dropped 10% in the last financial year.
from operations for a clutch of 56 top firms grew by just
3% last fiscal, the slowest growth in three years
Bajaj Auto: relatively weak demand impacted the business
resulting in a fall of 13% year-on-year in the profit before
tax. Higher inventories and provisions for advances and
liabilities led to a fall of 39% in operating cash flows.

Crompton Greaves: negative cash flow of Rs 680 crore,


the first time in a decade, as trade receivables for its
standalone operations jumped more than three times to Rs
1,080 crore. The outflow was higher due to advances
towards loss-making overseas subsidiaries.
Reliance Industries: a 20% decline in operating cash
outflow on account of lower trade payables although the
PBT was higher.
Oberoi realty: a more than four-old jump in inventories to
HUL and Asian Paints: Declines in trade payables
Rs 1,832 crore along with lower dividend income and
amounts billed to a company by suppliers for goods or
profit on sale of investments resulted in a negative cash
services provided on credit and a higher proportion of
flow of Rs 971 crore despite reporting marginal growth in
PBT paid as net taxes also weighed on the operating cash
profits (PBT). 18
flows
Cash Flows From Financing Activities

+ Net Borrowing Under Line of Credit Agreement


+ Proceeds From New Borrowings
- Repayment of Loans
- Principal Payments Under Capital Lease Obligations
- Dividends/Distributions/Withdrawals Paid
+ Proceeds From Issuance of Stock
+ Partner/Owner Capital Contributions

= Total Net Cash Provided (Used) by Financing


Activities

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Example: Calculate the Cash from financing
activities
Solution
Decription Rs.
Add :
Cash proceeds from the issue of shares 100000
Securities premium 10000
Deduct :
Interest paid on debenture -10000
Redemption of debenture -50000
Cash from financing activities 50000
Cash Flows by Investing Activities
+ Collection on Loans
+ Sale of Debt Instruments
+ Sale of Equity Instruments
+ Sale of Productive Assets
- Purchase of Productive Assets
- Purchase of Debt Instruments
- Purchase of Equity Instruments
- Purchase of equity of other company
- Payment of interest on loan
- Investment in Mutual Funds
- Investment in fixed deposits
+ Receipt of interest income
+ Receipt of dividend from other companys
equity investment
+ Proceeds from fixed deposit maturity
= Total Net Cash Provided (Used) by
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Investment Activities
Cash flow of high-debt firms turns
positive after 10 years
In the last financial year, the total cash flow from operations for the country's top 560 listed, indebted
firms exceeded their capital expenditure and investment for the first time since 2004-05. A company has
a positive free cash flow when its operations generate more cash than what is used in financing capital
expenditure and investment.
This was largely because of a sharp cut in capex and investments rather than any material
improvement in cash flow generation from operations. Cash outgo on capex and investments
declined 19 per cent to Rs 4.15 lakh crore last financial year, while operations generated cash flow
worth Rs 4.7 lakh crore in 2014-15, down 1.5 per cent, year-on-year.

Companies in the sample generated free cash flow of Rs 54,000 crore in 2014-15 but it was not
sufficient to fund all expenses such as dividend, interest and loan repayment, leading to additional
borrowing and a further deterioration in the leverage ratio. The net debt-equity ratio (debt minus
cash and equivalent on books) rose to 1.2 in 2014-15 from 1.14 in 2013-14.
A turnaround in India Inc's cash flow is the result of a process that began four years ago. The cash
burn peaked in 2011-12 when capex exceeded internal cash generation by Rs 2.04 lakh crore. The
numbers have improved every year since, due to a combination of higher internal cash generation
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and slowdown in new projects.
Indian companies' cash situation saw a marked improvement in 2013-14: These
firms generated free cash flows (net pf capital expenditure) from their operations
for the first time since the Lehman crisis of 2008
The cash outgo on account of capex and investment declined 16.4 per cent in
2013-14, as companies lowered their capacity expansion in view of an economic
slowdown. This left them with free cash flows of nearly Rs 70,000 crore, against
a similar amount of net cash outgo in 2012-13.
At its peak in 2010-11, companies' cash burn rate exceeded their internal
cash generation by Rs 1.27 lakh crore, due to a mix of low internal cash
generation and faster rise in capital expenditure.
Metal and power companies, on the other hand, faced the problem of internal
cash generation falling short of incremental capex and investment. Companies
like Tata Steel, Hindalco, JSW Steel, SAIL, Jindal Saw and Bhushan Steel
reported negative free cash flows, as internal cash generation fell short of capex
and investment last year.
The bad news, though, is that companies in sectors that are capex- and working
capital-intensive - such as construction & infrastructure, power, metals, real
estate and gems & jewellery - continue to burn more cash than they generate
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from their operations.
Cash Burn Rate

Cash burn rate is the rate at which a company uses up its cash reserves or cash balance.
Its a measure of the net-negative cash flow. Cash burn rate is a big concern for funded
start-ups. The typical pattern is to get funded, use that cash to build the business, and then
aim to get to positive cash flow before the money runs out. This is sometimes expressed
as a cash runway.
The burn rate metric for a selected period is calculated first by determining the difference
between the starting and ending cash balances for the period. That shows whether the
company lose or gain cash. Then we divide that total by the number of months in the
selected period. The result is a monthly burn rate value. Its often best to have a negative
burn rate. That means you are building your cash reserves, not using them up.
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Example
Additional Information: Ritts sold land during the year for $9,500 and purchased land
for $20,100. The company did not sell any buildings, equipment, or patents. Ritts paid
cash dividends of $33,000 during the year, and its interest expense was all paid in
cash. From its financial statements and other information, Ritts intends to prepare the
cash flow statement, using the indirect approach.
Description $ $
(A) Cash Flows from Operations:
Profit Before Tax 63500
Adjustments:
Depreciation and amortization of patents 20,600
Gain on sale of land -3,000
Income Tax paid -19,100
Interest Expenses 8,200
Decrease in accounts receivable 1,500
Increase in inventory -14,700
Increase in accounts payable and accruals 700
Increase in taxes payable 500
Cash provided by operations 58,200
(B) Cash Flows from Investing Activities:
Sale of land 9,500
Purchase of land -20,100
Purchase of buildings and equipment -82,700
Cash flows used in investing activities -93,300
(C)Cash Flows from Financing Activities:
Issuance of long-term debt 50,000
Issuance of capital stock 27,500
Dividends paid -33,000
Interest Expenses -8,200
Cash provided by financing activities 36,300

Net increase in cash (A+B+C) 1,200


Beginning cash balance 2,200
Ending cash balance 3,400
Cash Flows from Operations: $
Cash collections from customers 5,66,500
($565,000 + $1,500)

Payments to suppliers -4,89,700


($323,000 + $152,700)+ ($14,700 - $700)
Income taxes ($19,100 - $500) -18,600
Cash provided by operations 58,200
The cash collected from customers is determined by adding the decrease in accounts
receivable to the sales revenue reported in the income statement.
The cash paid to suppliers is computed by summing the cost of goods sold and operating
expenses in the income statement, adding the increase in inventory, and subtracting the
increase in accounts payable and accruals.
The cash paid for income taxes is computed by subtracting the increase in taxes payable
from the income taxes reported in the income statement.
Source:
Accounting - Text
& Cases 12E
By Anthony

31
Kidsn Caboodle
Statement of Cash Flows
Cash received from customers $155,000
Cash used in operations (146,900)
Cash flow from operations $8,100
Cash used for investments in equipment purchase (10,500)

Loan Proceeds 21,000


Cash flow from investment activity 10500
Total Cash flow (Operating activity + Investment Activity + $ 18,600
Financing Activity) 8,100+10500+0=18600

Here we are considering a


Outstanding amounts for company which is receiving
salary and bills will be not payment from a loan given to an
considered, because as per outsider. This is an investment
As per the question
question all the figures are from the company with any
there is no
directly from The Cash Book outside company, hence we are
financing activity in
considering it in Investment
this question.
Activity.
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Source:
Accounting - Text
& Cases 12E
By Anthony

33
Net loss $(11,000)
Depreciation 26,400
15,400
Accounts receivable (reduced) 17,600
Relate it with the
Accounts payable (increased) 8,800
Working Capital
Accrued salaries (increased) 3,300 Logic.
Other accruals (increased) 2,200
Cash flow from operations 47,300

Investments 0

Long-term debt (reduced) (29,700)

Change in cash 17,600


Beginning cash 4,400
Ending cash $22,000

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Impact of Product Life Cycle on Cash Flows: Strategic Finance
Introductory Phase: To support asset
purchases the company may issue stock or
debt. Expectation: cash from operations to
be negative cash from investing to be
negative. cash from financing to be
positive.
Growth Phase: The company is striving to
expand its production and sales.
Expectation: small amounts of cash to be
generated from operations. cash from
0 investing to be negative. cash from
financing to be positive
Maturity Phase: Sales and production
level-off. Expectation: Cash from
operations to exceed investing needs cash
from investing to be neutral cash from
financing to be negative
Decline Phase: Sales and production
declines Expectation: cash from
operations to decline, cash from investing
to possibly become positive, cash from
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financing to possibly become negative
Typically, large companies have a consistent negative working
capital since they have the muscle power and can demand longer
Firms with low working capital credit periods from their fragmented suppliers. They are also able
to make sales in cash or collect payments within a few days.
can be good investment bets
ET Bureau Nov 26, 2012, 08.00AM IST
The negative working capital phenomenon not only depends on
the size of the company, but also on the kind of business.
"Negative working capital is visible in companies with strong
brand and consumer franchise, which is why it is mostly seen in
the consumer sector,"
Telecom companies: Capital-intensive sector, the sector does not
require raw material, most of the capital requirements like licence
fee, spectrum cost, tower installation cost, etc, are taken care of at the
initial stage. Finally, these companies collect money from prepaid
customers in advance
Aviation industry: that has a high negative working capital because
airlines collect the money at the time of booking, months before they
spend it to transport you. "Since the sector is heavily in debt
A negative working capital need not always be a bad thing. currently, the negative working capital may not be of much
Along with the negative working capital, investors relevance,
should also check whether the company can generate FMCG sector : known for generating fast cash and may have a
free cash flow. Some capital-intensive businesses high negative working capital. This may be because their strong
that don't offer very high operating margins may brand loyalty, low inventory, generate speedy sales, high
have negative working capital. bargaining power, favourable terms from their suppliers.
Analysis of Cash Flows
The SCF is useful in identifying misleading or erroneous operating results or
expectations
Feasibility of financing capital expenditures.
Cash sources in financing expansion.
Dependence on external financing.
Future dividend policies.
Ability in meeting debt service requirements.
Financial flexibility to unanticipated needs/opportunities.
Financial practices of management.
Quality of earnings.
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Cash Flow Performance Ratios
Ratio Calculation What It Measures
Cash flow to revenue CFO Net revenue Operating cash generated per
dollar of revenue
Cash return on assets CFO Average total assets Operating cash generated per
dollar of asset investment
Cash return on equity CFO Average shareholders Operating cash generated per
equity dollar of owner investment
Cash to income CFO Operating income Cash generating ability of
operations
Cash flow per share (CFO Preferred dividends) Operating cash flow on a per-
Number of common shares share basis
outstanding

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Infosys Ltd has lagged peers on revenue and profit growth in six of the past seven years. But even when its
competitive position rapidly deteriorated, it held on to the pole position for one important metriccash flow
generation.
In the past seven years, cash flow from operations amounted to 23.3% of revenues for Infosys, compared to
19.8% in the case of Tata Consultancy Services Ltd (TCS) and 16.2% for Cognizant Technology Solutions Corp.

Cash may be king, but it is clearly no emperor. Investors far prefer strong growth accompanied by a reasonable
amount of cash generation to exceptional cash generation accompanied by sluggish growth.
Is TCS now falling into the same trap? It has closed the gap with Infosys considerably in terms of cash
generated from operations19.3% of revenues in FY16 versus 19.6% for Infosys. Besides, it has curtailed
capital expenditure. As a result, it has overtaken Infosys in free cash flow generation in the past two years. The
amount spent by TCS on capital expenditure and acquisitions accounted for just 12.5% of cash flow from
operations in the past two years, compared to 28.7% in the case of Infosys.
Another reason cash flow generation has improved in recent years is that the company has reduced its exposure
to some emerging markets such as India. Working capital needs are typically higher in these regions, and the
lower exposure has meant that overall cash generation has improved.
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Cash Flow Coverage Ratios
Ratio Calculation What It Measures
Debt coverage CFO Total debt Financial risk and financial
leverage
Interest coverage (CFO + Interest paid + Taxes paid) Ability to meet interest
Interest paid obligations
Reinvestment CFO Cash paid for long-term Ability to acquire assets with
assets operating cash flows
Debt payment CFO Cash paid for long-term debt Ability to pay debts with
repayment operating cash flows
Dividend payment CFO Dividends paid Ability to pay dividends with
operating cash flows
Investing and CFO Cash outflows for investing Ability to acquire assets, pay
financing and financing activities debts, and make distributions to
owners
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Cash Flows from Operating Activities - Indirect Method
The indirect method adjusts net income by analyzing noncash items
+ (decrease in current assets like receivables, inventory, prepaid
expenses) or increase in trade payable

- (Increase in current assets like receivables, inventory, prepaid


expenses) or decrease in trade payable

Changes in current assets and current


liabilities i.e., Change in Working Capital

Net Cash Flows from Operating


Income Activities - Indirect Method

+ Noncash expenses such as


depreciation, impairment, + Losses (Bad-debt expenses written off,
amortization. losses on sale of asset or investment )
- Gains (gain on sale of fixed asset, gain on
+ Increase in Deferred income Tax
sale of investment, interest income)
- Decrease in Deferred income Tax 41