SUMMARY REPORT – GROUP 2

Definition of Terms:
Cash Flow: Inflows and outflows of cash and cash equivalents.
Cash Balance: Cash on hand and demand deposits (cash balance on the balance sheet)
Cash Equivalents: Cash equivalents include cash held as bank deposits, short-term investments, and any
very easily cash-convertible assets – includes overdrafts and cash equivalents with short-term maturities
(less than three months).

What is the Statement of Cash Flows?

A cash flow statement is a financial statement that provides aggregate data regarding all cash inflows a
company receives from its ongoing operations and external investment sources. It also includes all cash
outflows that pay for business activities and investments during a given period.

It is one of the three key financial statements that reports the cash generated and spent during a specific
period of time (i.e., a month, quarter, or year). The statement of cash flows acts as a bridge between
the income statement and balance sheet by showing how money moved in and out of the business.

A company's financial statements offer investors and analysts a portrait of all the transactions that go
through the business, where every transaction contributes to its success. The cash flow statement is
believed to be the most intuitive of all the financial statements because it follows the cash made by the
business in three main ways—through operations, investment, and financing. The sum of these three
segments is called net cash flow.

How Cash Flow Statements Work

Every company that sells and offers its stock to the public must file financial reports and statements with
the Securities and Exchange Commission (SEC). The three main financial statements are the balance
sheet and income statement. The cash flow statement is an important document that helps open a wind
interested parties’ insight into all the transactions that go through a company.

Example:
Profitable companies can fail to adequately manage cash flow, which is why the cash flow statement is a
critical tool for companies, analysts, and investors. The cash flow statement is broken down into
three different business activities: operations, investing, and financing.

Let's consider a company that sells a product and extends credit for the sale to its customer. Even though
It recognizes that sale as revenue, the company may not receive cash until a later date. The company earns
a profit on the income statement and pays income taxes on it, but the business may bring in more or less
cash than the sales or income figures.

These three different sections of the cash flow statement can help investors determine the value of a
company's stock or the company as a whole.

The change is divided into three parts: (1) operating activities, (2) investing activities, and (3) financing
activities.
 The operating activities section explains how a company's cash (and cash equivalents) have
changed due to operations.
 It is the principal revenue-generating activities of an organization and other activities that are not
investing or financing; any cash flows from current assets and current liabilities
  Cash Flows from Operations
Operating activities are the daily activities of a company involved in producing and selling its
product, generating revenues, as well as general administrative and maintenance activities. The operating
income shown on a company's financial statements is the operating profit remaining after deducting
operating expenses from operating revenues. There is typically an operating activities section of a
company's statement of cash flows that shows inflows and outflows of cash resulting from a company's
key operating activities.

Example:
 Buying materials from suppliers and paying for labor to produce clothing
 Paying to transport the materials to the factory and the clothes from factories to warehouses
 Arranging transport from warehouses to retail stores and mail-order customers
 Paying employees to work in warehouses and retail stores
 Paying managers to oversee operations
 Paying taxes
 Paying rent on warehouse and retail facilities

Cash Flows from Operations

Net income $300,000
Depreciation ($10,000)
Accounts Payable ($20,000)
Accounts Receiveable $10,000
Net Change ($20,000)
Net Cash from Operations $280,000

 Investing activities refer to amounts spent or received in transactions involving long-term assets.
 Any cash flows from the acquisition and disposal of long-term assets and other investments not
included in cash equivalents

Investing Cash Flow

Cash flows from investing activities is a line item in the statement of cash flows, which is one of the
documents comprising a company's financial statements. This line item contains the sum total of the
changes that a company experienced during a designated reporting period in investment gains or losses, as
well as from any new investments in or sales of fixed assets.

Cash Flow from Investing Activities

This section is a summation of the investment gains or losses a company encountered in a period. It
includes purchasing or selling fixed assets, such as a plant or equipment.

Other activities include purchasing of investments, settlement collections, loaning money, or collecting on
loans you have made. This section deals with investing activities, like purchasing shares of stock, not
financing activities such as securing funding.

When you purchase assets, investments, or create new loans, you document a negative flow of cash. If
you sell them or collect on a debt, you record a positive cash flow—you brought cash in.

Example:
 Purchase of fixed assets (negative cash flow)
 Sale of fixed assets (positive cash flow)
 Purchase of investment instruments, such as stocks and bonds (negative cash flow)
  Sale of investment instruments, such as stocks and bonds (positive cash flow)
 Lending of money (negative cash flow)
 Collection of loans (positive cash flow)
 Proceeds of insurance settlements related to damaged fixed assets (positive cash flow)

Cash Flows from Investing Activities

Sale of Property $35,000
Equipment Purchase $(15,000)
Net Cash from Investment Activities $20,000

 The financing activities section reports such things as cash received through the issuance of
long-term debt, the issuance of stock, or money spent to retire long-term liabilities.
 Any cash flows that result in changes in the size and composition of the contributed equity capital
or borrowings of the entity (i.e., bonds, stock, dividends)

Financing Cash Flow

Cash Flow from Financing Activities are activities that result in changes in the size and composition of
the equity capital or borrowings of the entity. Financing cash flows typically include cash flows
associated with borrowing and repaying bank loans, and issuing and buying back shares. The payment of
a dividend is also treated as a financing cash flow.

Cash Flow from Financing Activities

This is a section that shows the financial activities not recorded in investing activities that were a result of
transactions for long-term funding or return of the funds. Activities in this section are a direct result of
receiving and making payments on loans.

The sale of company stock for financing can be recorded in this section, along with repurchase of stock,
dividend payment, debt repayments (as long as it is for a financing activity). Any payment going out are
negative cash flows, and any payments received are positive cash flows.

A positive number indicates that cash has come into the company, which boosts its asset levels. A
negative figure indicates when the company has paid out capital, such as retiring or paying off long-term
debt or making a dividend payment to shareholders.

Example:
 Receiving cash from issuing stock or spending cash to repurchase shares
 Receiving cash from issuing debt or paying down debt
 Paying cash dividends to shareholders
 Proceeds received from employees exercising stock options
 Receiving cash from issuing hybrid securities, such as convertible debt

Cash Flows from Financing Activities

Loan Payment ($10,000)
Loan Collection $5,000
Net Cash from Financing Activities ($5000)
Net Increase in Cash and Cash Equivalents $280,000
Cash and Cash at Beginning of Period $256,000
Cash and Cash at End of Period $536,000
Operating Cash Flow
Operating activities are the principal revenue-producing activities of the entity. Cash Flow from
Operationstypically include the cash flows associated with sales, purchases, and other expenses.

The company’s chief finance officer (CFO) chooses between the direct and indirect presentation of
operating cash flow:
 Direct Presentation: Operating cash flows are presented as a list of cash flows; cash in from sales,
cash out for capital expenditures, etc. Simple but rarely used method, as the indirect presentation
is more common.
 All individual instances of cash that is received or paid out are tallied up and the total is the
resulting cash flow.
 Indirect Presentation: Operating cash flows are presented as a reconciliation from profit to cash
flow:
 The accounting line items such as net income, depreciation, etc. are used to arrive at cash flow.
In financial modeling, the cash flow statement is always produced via the indirect method.

How to Prepare a Statement of Cash Flows?

The operating section of the statement of cash flows can be shown through either the direct method or the
indirect method. For either method, the investing and financing sections are identical; the only difference
is in the operating section. The direct method is a method that shows the major classes of gross cash
receipts and gross cash payments. The indirect method, on the other hand, starts with the net income and
adjusts the profit/loss by the effects of the transactions. In the end, cash flows from the operating section
will give the same result whether under the direct or indirect approach, however, the presentation will
differ.

The International Accounting Standards Board (IASB) favors the direct method of reporting because it
provides more useful information that the indirect method. However, it is believed that greater than 90%
of companies use the indirect method.

Below is a comparison of the direct method vs the indirect method.

The most commonly used format for the statement of cash flows is called the indirect method. The
general layout of an indirect method statement of cash flows is shown below, along with an explanation
of the source of the information in the statement. The sources of information appearing in the table can be
used to prepare a cash flow statement.

A less commonly-used format for the statement of cash flows is the direct method. The general layout of
the direct method statement of cash flows is shown below, along with an explanation of the source of the
information in the statement. This information can be used to prepare a cash flow statement.
What Can the Statement of Cash Flows Tell Us?
 Cash from operating activities can be compared to the company’s net income to determine the
quality of earnings. If cash from operating activities is higher than net income, earnings are said
to be of “high quality.”
 This statement is useful to investors because, under the notion that cash is king, it allows
investors to get an overall sense of the company’s cash inflows and outflows and obtain a general
understanding of its overall performance.
 If a company is funding losses from operations or financing investments by raising money (debt
or equity) it will quickly become clear on the statement of cash flows.

KeyPoints
 A cash flow statement provides data regarding all cash inflows a company receives from its
ongoing operations and external investment sources.
 The cash flow statement includes cash made by the business through operations, investment, and
financing—the sum of which is called net cash flow.
 The first section of the cash flow statement is cash flow from operations, which
includes transactions from all operational business activities.
 Cash flow from investment is the second section of the cash flow statement, and is the result of
investment gains and losses.
 Cash flow from financing is the final section, which provides an overview of cash used from debt
and equity.

Difference between direct & indirect

Direct Method
 Uses only the cash transactions, i.e cash spent and cash received to produce the cash flow
statement.
 Reconciliation is done to separate the cash flow from others.
 All non-cash transaction like depreciation are ignored.
 There’s no such preparation required
 Cash Flow Statement under direct is very accurate as there is no need for any adjustments here.
 It takes more amount of time compared to the indirect method.
 Compared to indirect method, they are only a very few companies that use this method.

Indirect Method
 Indirect method uses net income as a base and adds non-cash expense like depreciation, deducts
non-cash income like profit on sale of scraps and net adjustments between current assets &
liabilities to produce the overall cash flow statement.
 Net income is automatically converted in the form of cash flow.
 All the factors are taken into account.
 Preparations are mainly needed during conversion of net income into cash statement.
 Cash flow statement under indirect method is not very accurate as adjustments are being made.
 It takes less amount of time compared to the direct method.
Step 1: Prepare—Gather Basic Documents and Data
 Balance sheet (statement of financial position) as at the end of the current reporting period
(closing B/S) and as at the beginning of the current reporting period (opening B/S).
 Statement of comprehensive income (profit or loss statement + statement of other comprehensive
income if applicable) for the current reporting period.
 Statement of changes in equity for the current reporting period.
 Statement of cash flows for the previous reporting period—well, you can proceed further without
this, but it’s good source of potential recurring adjustments in the current period
 Major contracts that your company entered into during and before the end of the reporting period
(lease, rental, hedging, construction—all sorts of).
 Minutes from the meetings of managing bodies in your company, like board of directors’
meetings, supervisory board meetings, shareholders’ meetings, audit committee meetings, etc.
 Documents from your investment/long-term assets department to look for major purchases, sales,
exchanges and other transactions with fixed assets.

Step 2: Calculate Changes in the Balance Sheet

 First Column
Title of caption in B/S (for example, tangible non-current assets), the

 Second Column
Balance of this caption from the closing B/S

 Third Column
Balance of this caption from the opening B/S.

 Fourth Column
Calculate changes in the balance sheet over the current period.
Step 3: Put Each Change in B/S to the Statement of Cash Flows

 First Column
Titles of Individual cash flow captions.

 Second Column
Changes in the balance sheet assigned.

Step 4: Make Adjustments for Non-Cash Items from Statement of Total Comprehensive
Income

Take the profit or loss statement and statement of other comprehensive income. Then identify any
numbers where non-cash transaction might have been recorded. Typical non-cash adjustments are usually
as follows:

- Depreciation expense - A depreciation expense is the amount deducted from gross profit to
allow for a reduction in the value of something because of its age or how much it has been used.
- Interest income and expense
- Income tax expense - Income tax expense is the amount of expense that a business recognizes in
an accounting period for the government tax related to its taxable profit.
- Expense for recognition or income from derecognition of various provisions
- Revaluation of certain assets and liabilities at the end of period
 - Barter transactions - A barter transaction is the exchange of goods or services, in exchange for
other goods or services.

Step 5: Make Adjustments for Non-Cash Items from Other Information

Step five (5) is much the same as Step Four (4)

Example: Find out the company entered into new material least contract. And there is non-cash
adjustment hidden, because no one side increase in PPE was recorded that was not purchased for cash. On
the other hand, increase in loans or a lease liability was recorded, but the company have not received any
cash. We shall adjust for it, exactly the same way as described in the step five. Remember about we total
it should be always zero.

Step 6: Prepare Movements in Material Balance Sheet Items to Verify Completeness

Take the Biggest or Material items in Balance sheet and reconcile their movements between opening and
closing balance. Check whether each movement is taken into account for in cash flow statement.

Example: You might find out that movement of PPE was as follows:

- Closing balance (from closing B/S) is equal opening balance of PPE (from opening B/S) plus
cash purchases of PPE plus lease acquisitions of PPE plus PPE received as a gift minus
depreciation of PPE minus loss on sale of PPE minus cash sale of PPE.

Which items from this movement are non-cash?

- Lease acquisitions of PPE, PPE received as a gift, depreciation and loss on sale of PPE.
So for each of those non-cash items, should adjustment have made an adjustment.
- Identify another necessary adjustment in the movements.

Step 7: Add Up and Perform Final Check

 First Column
Being the headlings and titles of your Statement of cash flows
 Second Column
Being the changes in balance sheet
 Third to Tenth Column
Being individual adjustments.

Example:
Get certain number in the purchase of PPE and verify this number with accounting records or ask the
investment department whether cash payments for PPE during the period were as you calculated.

If not even close that you must have omitted something, messed up signs or made some other mistake
from vertical total of the last column, should be zero (0).