Cash flow Analysis

Chapter-2

Analysis of financial statements

Learning Objectives
Objective to prepare cash flow Scope Benefit of presenting cash flow statement Cash and cash equivalents

Analysis of financial statements

Cash Flow
The Direct Method The Indirect Method

Analysis of financial statements

Cash Flow -- Direct Method

Recommended by the FASB Most companies use the Indirect Method

Analysis of financial statements

Cash Flow -- Indirect Method - 1

Net Income
Add Non-cash income items Plus/Less

Adjustments for receivables inventories, payables, taxes

Equals

Cash Flow from Operations

5 Analysis of financial statements

Cash Flow -- Indirect Method - 2

Cash Flow from Operations
PLUS/LESS

Cash flow - Investment activities

PLUS/LESS

Cash flow - Financing activities

EQUALS

Change in cash and cash equivalents

6 Analysis of financial statements

From Profit to Cash

Net Income Cash Flow From Oper. bef. WC chgs, Inv & Int

CF from op After Wc Changes before int

+ Noncash charges +/- Chg in Working Cap

7 Analysis of financial statements

From Profit to Cash -- 2

CF Cash Flow From Operations

Free Cash Flow

+/- Interest

+/- Chg Fixed Capital

8 Analysis of financial statements

Free Cash Flow

Jensen (1988) defines free cash flow as the cash left after managers have invested in all positive NPV projects
He also asserts that managers will invest in negative NPV projects rather pay it out to shareholders

The Free cash flow used in out context is the cash flow from operations plus the net investment cash flow
9 Analysis of financial statements

Free cash Flow and Interest

You may add interest back. Depends on the purpose of the Free Cash Flow. See p. 6-3.

10

Analysis of financial statements

Free Cash Flow From Working Capital

Adjust Working Capital from operations for changes in current accounts to get Cash Flow From Operations Add the net capital investment What you get is Free Cash Flow

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Analysis of financial statements

Learning Outcomes
Direct versus indirect method Reporting cash flows on a gross basis versus a net basis Reporting futures, forward contracts, options and swaps

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Analysis of financial statements