Cash Flow Analysis  Tax refund unless identified with financing and investing

activities
The statement of cash flows (SCF) is a valuable analytical tool for Outflows:
managers as well as investors and creditors because it answers  Payment of purchases of inventories
questions that cannot be answered by the income statement and  Payment for operating expenses (salaries, rent, insurance,
statement of financial position. Some such vital questions are: etc.)
 Is the company generating sufficient positive cash flows  Payment for purchases from suppliers other than inventory
from its operations to remain variable?  Payment for lenders (interest)*
 Will the company be able to meet its financial obligations to  Payments for taxes unless identified with financial and
creditors? investing activities
 What expansion activities took place and how were those
financed? Investing Activities – represents the extent to which
 Will the company be able to pay its customary dividend? expenditures have been made for resources intended to
 Why did cash decrease even though a net income was generate future income and cash flows.
reported? Inflows:
 To what extent will the company have to borrow money in  Sales of long-lived assets such as property, plant and
order to make needed investments? equipment; intangibles; and other long-term assets
 What happened to the proceeds received from the issuance  Sales of debt or equity securities of other entities
of capital stock?  Collection of loans (principal) to others (other than loans
The primary purpose of a cash flow statement is to provide and advances made by a financial institutions)
relevant information about a company’s cash receipts and cash Outflows:
payments during a period that is useful in evaluating the  Acquisition of long-lived assets such as property, plant and
preceding items. equipment; intangibles; and other long-term assets
 Purchases of debt or equity securities of other entities
Cash and cash equivalents  Loans (principal) to others (other than advances and loans
Cash comprises cash on hand and demand deposits made by a financial institution)
Cash equivalents are short term highly liquid investments that
are readily convertible to known amount of cash and which are Financing Activities – useful in predicting claims on future cash
subject to an insignificant risk of change in value. An instrument flows by providers of capital to the enterprise.
is considered short term if it was acquired three months before Inflows:
maturity  Proceeds from borrowing (short-term and long-term)
 Proceeds from issuing the firm’s own equity securities
Classification of cash flows Outflows:
By flow  Repayment of debt principal
 Cash inflows  Repurchase of a firm’s own shares
 Cash outflows  Payment of dividend***
By activity  Acquisition of the enterprise’s own shares
 Operating activities
 Investing activities Exemptions:
 Financing activities * The standard provides that interest paid and interest received
shall be classified as operating cash flows because they enter into
Operating Activities – key indicator of the extent to which the the determination of net income or loss.
operations of the enterprise have generated sufficient cash flows Alternatively, interest paid pay be classified as financing cash
to repay loans, maintain the operating capabilities, pay dividend flows because it is a cost of obtaining financing resources.
and make new investments without relying on external sources Alternatively, interest received may be classified as investing
of financing. cash flow because it is a return on investment.
Inflows: ** The standard provides that dividend received shall be
 Sales of goods classified as operating cash flows because it enters into the
 Revenue from services determination of net income.
 Returns on interest earnings assets (interest)* Alternatively, dividend received may be classified as investing
 Returns on equity securities (dividends)** cash flows because it is a return on investment.
 Receipts from contracts held for dealing and trading *** The standard provides that dividend paid shall be classified
purposes as financing cash flow because it is a cost of obtaining financial
resources
Alternatively, dividends paid may be classified as operating cash 1. All increases in trade noncash current assets are
flow in order to assist users to determine the ability of the entity deducted from net income
to pay dividends out of operating cash flows. 2. All decreases in trade non noncash current assets are
added to net income
The classification of interest and dividend paid and received shall 3. All increases in trade noncash current liabilities are
be classified in consistent manner prom period to period. added to net income
4. All decreases in trade noncash current liabilities are
Methods of preparing SCF deducted from net income
The standard provides that the entity shall report cash flows 5. Depreciation, amortization, and other noncash
from operating activities using either the direct or indirect expenses are added back to net income to eliminate to
method. effect they had on net income
6. Any gain on disposal of property or gain on early
Direct method shows in detail or itemizes the major classes of retirement of nontrade liabilities is deducted from net
gross cash receipts and gross cash payments. income
7. Any loss on disposal of property or gain on early
Computation of collections (from trade receivables) retirement of nontrade liabilities is added to net income
Trade accounts and notes receivable – beginning xx
Add: Sales (accrual basis) xx Free Cash Flows (FCF)
Total xx FCF are the cash available to pay the firm’s shareholders and
Less: Trade accounts and notes receivable – end xx debt holders after the firm has made the necessary working
Collections of accounts and notes receivable xx capital investment, property and equipment investment and
developed the necessary products to sustain the firm’s ongoing
Computation of payments to merchandise creditors (to trade operations.
payables) The equation to calculate FCF is
Trade accounts and notes payable – beginning xx FCF = Operating cash flow - Investment in operating asset
Add: Purchases (accrual basis) xx Where
Total xx Operating cash flow = Net income + Noncash expenses
Less: Trade accounts and notes payable – end xx Investment in operating assets = cash used or earmarked for
Payment to merchandise creditors xx
eventual equipment
replacement to sustain firm
Computation of payments for expenses (to OPEX) operation, current assets and
Expenses (accrual basis) xx spontaneous current liabilities
Add: Prepaid expense – end xx
Illustrative problem 1. Assume that in 20X1, Alam Co. had the
Accrued expense – beginning xx
following data. How much is Alam Co.’s free cash flow?
Total xx
EBIT P152,000,000
Less: Prepaid expense – beginning xx
Taxes paid 46,000,000
Accrued expense – end xx xx
Depreciation 13,000,000
Payment to merchandise creditors xx
Increase in plant and equipment 68,000,000
Increase in current assets 15,000,000
Computation of collection of other income Increase in spontaneous current liabilities 10,000,000
Income other than sales (accrual basis) xx (accrued wages, taxes and accounts payable)
Add: Differed income – end xx 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 = (152𝑀 − 46𝑀) + 13𝑀
Accrued income – beginning xx = 119𝑀
Total xx 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑠𝑠𝑒𝑡𝑠 = 68𝑀 + (15𝑀 − 10𝑀)
Less: Differed income – beginning xx = 73𝑀
Accrued income – end xx xx 𝐹𝐶𝐹 = 119𝑀 − 73𝑀
Collection of other income xx = 46𝑀
This means that the company had P46M available to pay
Indirect method presents the cash flow from operations shareholders and debt holders.
beginning with the accrual basis net income and applies a series
of adjustments to convert the income to a cash basis. Level of FCF
Positive – firm ma distribute funds to its investors
The following general guidelines are offered for the adjustment Zero – no cash available for investors
of net income to cash basic Negative – firm is experiencing operating or managerial
problems