Analyzing Statements of Cash Flows

SCF can help you analyze a company's:

1. Relationship between net income and net cash flow from operations (OCF)

         If net income is positive but OCF is negative that could mean that the company is growing rapidly or a       financial mismanagement.

   

     2. Net cash flow from investing activities (ICF)

          If negative the company is making investments in plant & equipment or another company's stock (strategic reasons, venture, etc)

          If positive, company is liquidating assets, usually due to financial distress

      3. Does the company have sufficient cash to pay dividends?

          OCF should exceed dividends.

          If dividends exceed OCF:

               -Company liquidated assets to pay dividends?

               -Company issued equity or borrow to pay dividends?

          Neither situation is good.

Statement of Cash Flows

General Information that can be extracted from a statement of Cash Flow:

Was the company profitable?

Did the company generate positive cash flow?

How did the company generate its cash flow? 

To generate cash you need sales or payments on accounts receivable.

Forms of investment can also be converted into cash (bonds, stock, loans)


Examples of cash outflow would be: the purchase of stock, capital investments, payments, salaries, etc..


Tips when working with cash flows 


Cash flow from Operating Activities + Cash flow from Investing Activities + Cash flow from Financing Activities = Change in Cash account for the period!

Regardless of the section of the cash flow statement that you are preparing (operating, investing or financing)
  -If an item is a cash Inflow you add that item:
  -If an item is a cash Outflow, you subtract that item. 


Operating Activities-> Day to day operations-> usually the largest amount of cash account->production & sales of goods and services

  Asset accounts related to IS

Accounts receivable

Inventories

Liability accounts related to IS

Accounts payable

Accruals

Warning: Notes payable NOT included! Belongs to financing activities.

Investing Activities->  Buying or selling productive assets (plant & equipment) and buying or selling of financial securities.


 

Inflows:

Selling long-lived assets such as gross property, plant & equipment (i.e., fixed assets)

Selling debt or equity securities of other firms

Outflows:

Buying long-lived assets such as gross property, plant & equipment (i.e., fixed assets)

Buying debt or equity securities of other firms

Tips

Investing activities refer to changes on the lower left-hand side of balance sheet

Warning: we want changes in gross fixed assets. We don’t want the changes in net fixed assets!

But, if gross fixed assets not reported in balance sheet, ….?

 

Change in gross fixed assets = change in net fixed assets + depreciation  

Depreciation (on IS) = change in accumulated depreciation (on BS)

Cash Flows from Financing Activities

Loans from creditors (long-term, short-term) 

Repayment of principal

Sale or repurchase of stock (common or preferred) from firm’s equity holders 

Payment of dividends (selling stock is a part of the financial activities)

 

Inflows:

Proceeds from long and short term borrowing (increase in notes payable, long-term debt)

Proceeds from issuing the firm’s own equity securities (increase in common stock) 

Outflows:

Repayment of debt principal (decrease in notes payable, long-term debt)

Repurchase of firm’s own shares (decrease in common stock)

Payment of dividends

 

 

 

 

Accounting Examples

1. Suppose that a firm has total assets of $1,100,000, Long-term debt of $400,000, total Common equity of $400,000, and Preferred stock of $50,000.  The only other item recorded on the right hand side of the firm’s balance sheet is current liabilities.  Calculate the firm’s current liabilities?

2. Calculate net income based on the following information: Sales = $350.00, Cost of goods sold =
$190.00, Operating expenses = $100.00, Depreciation = $10.00, Interest expense = $20.00, Tax rate = 30%, Dividends paid = $3.00.

3. In 2005, Jason Incorporated reported Net sales of $1,432,500 and Returns and Allowances of
$28,500. What were Jason’s Gross sales in 2005?

   Gross sales = Net sales + Returns and allowances
= 1,432,500 + 28,500 = 1,461,000

First column (in order):  E, CA, CA, CL, CE 
Second column (in order):  CA, CL, FA, LTD, CA

Manipulating Financial Data

Many possible Ways:

Examples:
-By adjusting allowances for doubtful debts to affect net sales
-Switching inventory valuation methods
-Choice of depreciation method: straingt-line method smoothes earnings.
-Discretionary expenses items

Importance of Accounting

Accounting is a system of record keeping while income statements and balance sheets summarize a company's financial operations/activities over a given period.

Accounting information is essential to many parties: IRS, creditors, shareholders, firm's managers.

Example of Retained Earnings Statement

The account Balance of Retained Earnings 12/31/90 is the last years' retained earnings.(is what the company didn't pay as dividends-> goes back to the companies basket.
On the above example 50,176, is re-invested back into the company.

Balance Sheet

Is also called statement of financial position. It is also a "Stock" measure statement

It categorizes a company's resources as:

1. Assets
2. Liabilities
3. Owner's Equity

Balance Sheet Identity: 

Total Assets= Total Liabilities + Shareholders' Equity

Balance Sheet Overview

 

Assets are categorized in order of liquidity-> how fast the specific assets can be converted into cash.

Cash-> most liquid asset (frequently represented by demand deposits. The Cash account often includes highly liquid marketable securities.

The Marketable Securities account refers to the investments of the company in either treasury bongs (issued by the government) or into stock of other organizations.

Net Accounts Receivable (Net A/R)-> occurs because the company sells products/services on credit. Allowance for doubtful accounts is available for Net A/R since customers often don't pay.

Net A/R = Gross A/R – allowance for doubtful accounts

Inventories accounts are found in Accounts Receivable (A/R) of the financial statement.

Gross fixed assets: original cost of assets

Fixed Assets: equipment, buildings, vehicles, computer, etc. Permanent nature; needed for business operations. 

Reported book value= original historical cost - allowable depreciation.

The Accumulated Depreciation account refers to the depreciation accrued every year. (straight-line method and accelerated cost recovery)

Net fixed assets= gross fixed assets - accumulated depreciation

Total assets= Current assets + long-term assets

Assets(LHS of Balance Sheet) must be financed by a combination of liabilities and owner's equity (RHS of Balance Sheet)

Accrued Expenses-> Salaries

Notes Payable-> Usually sort term loans to banks-> generally refers to notes that are payable within the year.

Long-term debt refers to liabilities with maturities in excess of 1 year.

Total liabilities= current liabilities + L. T. debt

Preferred Stock (hybrid Security) Vs Common Stock-> typically preferred stockholders do not having voting rights. Usually when a company goes public for the first time and the entrepreneur has a vision for his company he issues preferred stock. Also on preferred stock a fixed amount of dividends is usually agreed.

Shareholders' equity= common stock at par+ additional paid-in capital+retained earnings

Shareholders' equity is also know as: Net Worth, Owner's Equity, book value of the firm's equity

Retained Earnings-> shows the accumulated profit a company has generated over the year. 

Cumulative total of all net income reinvested into the company.

Annual addition to retained earnings = net income – dividends paid.

Dividend per share= Dividend paid/number of shares outstanding.