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DAC 511: CORPORATE

FINANCIAL REPORTING &


ANALYSIS
BY

GROUP 5
CASH FLOW ANALYSIS

INTRODUCTION
STATEMENT OF CASH FLOW
ANALYSIS IMPLICATIONS OF CASHFLOWS
ANALYSIS OF CASH FLOWS
SPECIALISED CASH FLOW RATIOS
ANALYSTICAL CASH FLOW WORKSHEET

INTRODUCTION
OBJECTIVES
Provide users of financial statements the

basis for assessing the co. ability to


generate cash and cash equivalents and
needs of the company to utilize those cash
flows.
Used to make economic decisions.
Provide historical movements in cash and
cash equivalents.

INTRODUCTION
DEFINITIONS
Cash comprises of cash on hand, and demand

deposits (including those in foreign currencies) net


of bank overdrafts.
Cash equivalents are short-term, highly liquid
investments that are readily convertible to known
amounts of cash and which are not subject to any
significant risk of changes in value.
They include short-term securities; investments that
have a short maturity of three months or less from
the specified redemption date

INTRODUCTION
DEFINITIONS, CONTD
Cash flows: Net cash flows, or simply cash flows,
refers to the current period's cash inflows less cash
outflows
Cash flows are different from accrual income
measures of performance
Cash flow measures recognize inflows when cash
is received but not necessarily earned, and they
recognize outflows when cash is paid but the
expenses not necessarily incurred

INTRODUCTION
SCOPE
Unlike the statement of financial position and the

statement of comprehensive income, which are


required by the Companies Act Cap 486
The statement of cash flows is a requirement of the
International Financial Reporting Standards (IFRSs), in
particular IAS No.7
ISA 7 requires the presentation of information about
the historical changes in cash and cash equivalents
of an entity by means of a statement of cash flows,
which classifies cash flows during the period
according to operating, investing, and financing
activities.

INTRODUCTION

Questions addressed by users of cash flow


statements
How much cash is generated from/ used in

operations?
What expenses are made with cash from ops?
How are dividends paid when confronting an
operating loss?
Whats the source for cash for debt payments?
How is increase in investments financed?
Whats the source of cash for new plant assets?
Whats the use of cash received from new
financing.

PURPOSE OF STATEMENT OF CASH FLOW


RELEVANCE OF CASH
REPORTING BY ACTIVITIES DETAILED
CONSTRUCTING THE STATEMENT OF CASH
FLOW
SPECIAL TOPICS

STATEMENT OF CASH
FLOW
PURPOSE OF STATEMENT OF CASH FLOW
Provide information about the sources and application
of cash inflows and outflows for a given accounting
period by separating them into three main business
activities

Operating
Investing
Financing

It presents the changes in cash resulting from the

business activities.
It communicates information about the financial
adaptability of an enterprise for a given period of time.

STATEMENT OF CASH
FLOW
RELEVANCE OF CASH
Cash is the most liquid of assets and offers a
company both liquidity and flexibility
It is both the beginning and the end of a company's
operating cycle
Contrast: Accrual accounting and Cash Basis
Accounting
Recognize revenue when earned and expenses when
incurred,
Recognize revenues when cash is received and expenses
when paid in cash; yet, net cash flow is the end measure of
profitability

STATEMENT OF CASH
FLOW
RELEVANCE OF CASH
It is cash, not income, that ultimately repays loans,
replaces equipment, expands facilities, and pays
dividends
Cash flow analysis helps in assessing liquidity,
solvency, and financial flexibility.
Liquidity is the nearness to cash of assets and liabilities
Solvency is the ability to pay liabilities when they
mature
Financial flexibility is the ability to react and adjust to
opportunities and adversities

STATEMENT OF CASH
FLOW
REPORTING BY ACTIVITIES
Operating activities are the main revenue-producing
activities that are not investing or financing activities.
They include:
Cash receipts from sale of goods.
Cash payments to and on behalf of employees.
Cash receipts from royalties, fees, commissions & other revenue.
Cash receipts and payments under contracts held for dealing/
trading purposes.
Cash receipts and payments of insurance premium and benefits,
annuities and other liabilities arising from policies underwritten.
Cash payments/ refunds of income taxes, unless they can
specifically be classified within the investment/financing
activities.

STATEMENT OF CASH
FLOW
REPORTING BY ACTIVITIES
Investing activities are those that represent
expenditures that have been made for resources
intended to generate future income and cash flows. E.gs
Cash advances & loans to 3rd parties.
Charges arising from loan repayment and advances to 3 rd parties
Payments for purchase of tangible fixed assets, intangible assets
& payments to capitalized development costs & work performed
by the company for its property, plant & equipment.
Payments under forward contracts, futures, options & swap
transactions except contracts held on grounds of dealing/ trading
routine.

STATEMENT OF CASH
FLOW
REPORTING BY ACTIVITIES
Financing activities are means of
contributing, withdrawing, and servicing funds
to support business activities. They include:
Cash reimbursements for funds borrowed.
Cash receipts for issuance of shares/equity
instruments.
Payments to owners for the purchase / redeem of
shares
Cash receipts from issuing debentures, loans, bonds,
mortgage ballots and other funds borrowed.

STATEMENT OF CASH
FLOW
CONSTRUCTING THE Statement of Cash

Flow
Indirect Method

Net income is adjusted for non-cash income


(expense) items and accruals to yield cash flow from
operations

Direct Method

Each income item is adjusted for its related accruals

STATEMENT OF CASH
FLOW
Indirect Method

Direct Method
Sh.

Cash flows from operating activities:


Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations
Income taxes paid
Net cash from operating activities
Cash flows from investing activities
Dividends received
Proceeds from sale of marketable securities
Purchase of marketable securities
Purchase of plant and equipment
Proceeds from sale of equipment
Net cash from investing activities
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long term borrowing
Interest paid
Dividends paid
Net cash from financing activities
Change in cash and cash equivalents
Add: Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period

Sh.

XX
(XX)
XX
(XX)
XX
XX
XX
(XX)
(XX)
XX
XX
XX
XX
(XX)
(XX)
XX
XX
XX
XX

STATEMENT OF CASH
FLOW
CONSTRUCTING THE STATEMENT OF

CASH FLOW (Indirect Method)


Consider first the net cash from operations

STATEMENT OF CASH
FLOW
CONSTRUCTING THE CASH FLOW

STATEMENT (Indirect Method)


Depreciation and amortization add-back.

STATEMENT OF CASH
FLOW
CONSTRUCTING THE CASH FLOW STATEMENT (Indirect

Method)
Adjustments for changes in balance sheet accounts can be

summarized as follows:

STATEMENT OF CASH
FLOW
CONSTRUCTING THE CASH FLOW STATEMENT (Indirect Method)

1.The company purchased a truck during the


year at a cost of $30,000 that was financed
in full by the manufacturer.
2. A truck with a cost of $10,000 and a net
book value of $2,000 was sold during the
year for $7,000. There were no other sales
of depreciable assets.
3. Dividends paid during Year 2 are $51,000

STATEMENT OF CASH
FLOW
STEPS IN CONSTRUCTING THE CASH FLOW

STATEMENT

Start with Net Income

Adjust Net Income for non-cash expenses and gains

Recognize cash inflows (outflows) from changes in current


assets and liabilities

Sum to yield net cash flows from operations

Changes in long-term assets yield net cash flows from


investing activities

Changes in long-term liabilities and equity accounts yield net


cash flows from financing activities

Sum cash flows from operations, investing, and financing


activities to yield net change in cash

Add net change in cash to the beginning cash balance to

STATEMENT OF CASH
FLOW

STATEMENT OF CASH
FLOW
SPECIAL TOPICS

Equity Method Investments


The investor records as income its percentage interest in
the income of the investee company and records
dividends received as a reduction of the investment
balance
The portion of undistributed earnings is noncash income
and should be eliminated from the Cash Flow Statement

Net Income Percentage in earnings of


investee company Net of dividends
Acquisitions of Companies with Stock
Such acquisitions are non-cash.
Changes in balance sheet accounts reflecting the
acquired company will not equal cash inflows (outflows)
reported in the Cash Flow Statement.

STATEMENT OF CASH
FLOW
SPECIAL TOPICS
Postretirement Benefit Costs
Current accounting standards require that costs of providing postretirement benefits can be recognized when the employee is still
in active service, rather than when the are actually paid.
Pension and post-retirement costs are liabilities to any company.
The excess of net postretirement benefit expense over cash
benefits paid must be added to net income in computing net cash
flows from operations
Securitization of Accounts Receivable
Securitization involves transformation of receivables into
securities (i.e. those dedicated vehicles representing the assigned
receivables).
Most common reason for securitization of receivables is to raise
cash efficiently.
Companies account for the reduction in receivables as an increase
in cash flow from operations since that relates to a current asset
Analysts should question whether they represent true
improvement in operating performance or a disguised borrowing

STATEMENT OF CASH
FLOW
DIRECT METHOD
Reports gross cash receipts and cash
disbursements related to operations
essentially adjusting each income
statement item from accrual to cash basis
Reports total amounts of cash flowing in and out of a
company from operating activities
Preferred by analysts and creditors
When companies report using the direct method, they
must disclose a reconciliation of net income to cash
flows from operations (the indirect method) in a
separate schedule

LIMITATION OF CASH FLOWS


INTEPRETING CASH FLOW NET INCOME

ANALYSIS
IMPLICATION
LIMITATION OF CASH FLOWS
Practice does not require separate disclosure of cash

flows pertaining to either extraordinary items or


discontinued operations.
Interest and dividends received and interest paid are
classified as operating cash flows
Income taxes are classified as operating cash flows
Removal of pretax (rather than after-tax) gains or losses
on sale of plant or investments from operating activities
distorts our analysis of both operating and investing
activities

ANALYSIS
IMPLICATION
INTERPRETING CASH FLOW & NET INCOME

ANALYSIS
IMPLICATION
INTERPRETING CASH FLOW & NET

INCOME
Accounting accruals determining net income rely on

estimates, deferrals, allocations, and valuationsSubjectivity


CFO effectively serve as a check on net income, but not
a substitute for net income.
CFO exclude elements of revenues and expenses not
currently affecting cash

CASE ANALYSIS
INFERENCES FROM ANALYSIS OF CASH FLOW
ALTERNATIVE CASH FLOW MEASURES
COMPANY AND ECONOMIC CONDITIONS
FREE CASH FLOW
CASH FLOWS AS VALIDATORS

ANALYSIS OF CASH
FLOW
CASE ANALYSIS OF CASH FLOWS OF

CAMPBELL SOUP

ANALYSIS OF CASH
FLOW
INFERENCES
Where management committed its resources
Where it reduced investments
Where additional cash was derived from
Where claims against the company were

reduced
Disposition of earnings and the investment of
discretionary cash flows
The size, composition, pattern, and stability of
operating cash flows

ANALYSIS OF CASH
FLOW
ALTERNATIVE CASH FLOW MEASURES
Net income plus depreciation and amortization
EBITDA (earnings before interest, taxes, depreciation, and
amortization
The using up of long-term depreciable assets is a real expense
that must not be ignored.
The add-back of depreciation expense does not generate cash.
It merely zeros out the noncash expense from net income as
discussed above
Net income plus depreciation ignores changes in working
capital accounts that comprise the remainder of net cash flows
from operating activities. Yet changes in working capital
accounts often comprise a large portion of cash flows from
operating activities

ANALYSIS OF CASH
FLOW
COMPANY AND ECONOMIC CONDITIONS
While both successful and unsuccessful companies

can experience problems with cash flows from


operations, the reasons are markedly different.
We must interpret changes in operating working

capital items in light of economic circumstances.


Inflationary conditions add to the financial burdens of

companies and challenges for analysis.

ANALYSIS OF CASH
FLOW
FREE CASH FLOW

Positive free cash flow reflects the amount available for


business activities after allowances for financing and
investing requirements to maintain productive capacity
at current levels.

ANALYSIS OF CASH
FLOW
CASH FLOW AS VALIDATORS
Cash Flow Statement provides us with important
clues on:
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.

VARIOUS RATIOS

SPECIALISED CASH FLOW


RATIO
Cash Flow Adequacy Ratio
Three year sum of cash from operations
Three year sum of capital expenditures, inventory
additions and cash dividends

Cash Reinvestment Ratio


Operating cash flow- Dividends
Goss Plant + investment +other assets+ working
capital

Operating Cash Flow Ratio


Cash flow from operations
Current liabilities

SPECIALISED CASH FLOW


RATIO
Cash Interest Coverage Ratio
Cash flow from operations + Interest paid + Taxes
paid
Interest paid

Cash Current Debt Coverage Ratio


Operating cash flowcash dividends
Current debt

Capital Expenditure Ratio


Cash flow from operations
Capital expenditures

SPECIALISED CASH FLOW


RATIO
Total Debt (Cash Flow to Debt) Ratio
Cash flow from operations
Total debt

Net Free Cash Flow Ratio


(Net income + Accrued and capitalized interest
expense + Depreciation and amortization +
Operating lease and rental expense - Declared
dividends - Capital expenditures)
(Accrued and capitalized interest expense +
Operating lease and rental expense + Current
portion of long-term debt + Current portion of
capitalized lease obligations)

SAMPLE WORKSHEET