BRIEF CASE

74376

09. 2020
Rev. 09. 2020

It´s all about cash

MBA student Aina Pernau was unable to attend last week's accounting class, and was worried about what
she missed because accounting is not her best subject. She called on Katsuji Takahata, her teammate, to
obtain the class notes and assignment.

Aina: Hi, Katsuji! Unfortunately I had to miss last week's accounting class on the statement of cash flows.
Since accounting is your strongest subject, I was wondering whether you could help me to catch up. I know
that cash flow statements are a required part of a company's full set of financial statements, but I'm under
the impression that they are a less important component of the package. Is that so? Could you give me a
rundown of the class that I missed and details of the assignment that we need to prepare for next week?

Katsuji: I'm glad to help, Aina, especially as you typically help me with the assignments for most of our other
classes. I'm familiar with cash flow statements from my work experience, so I found this week's class easy
to follow. I´m sure that I can convince you that the statement of cash flows is an important part of the
financial statement package, and that it's very useful to external users of financial statements!

Aina: I've had virtually no exposure to financial statements. Could you please remind me what the cash
flow statements contain?
Katsuji: The statement of cash flows presents the inflows and outflows of cash for a given period, all
classified into the firm's three principal areas of activity: operating, investing, and financing. By summarizing
the sources and uses of cash, the statement provides a reconciliation of the beginning and ending cash
balances for the period. To be more precise, the statement normally explains the changes in "cash and
cash equivalents", where the latter are short-term highly liquid investments, readily convertible to cash.
There is some variance in practice, but each company will define in their footnotes what they mean by "cash
and cash equivalents". As you know, a balance sheet is like a snapshot of a company's financial resources
and obligations at a point in time, while the income statement provides a summary of the firm's performance
over a stated period. Both of these statements are prepared under an accrual basis of accounting. Because
accruals involve judgment and discretion, which may vary across managers and across time, the statement
of cash flows is useful to external users because it gives us a statement that is relatively stripped of
accounting policy assumptions and estimates. Consequently, the cash flow statement facilitates
comparability across different companies by partially eliminating the effects of different accounting method
choices. Investors can see where a company's cash is coming from and to what uses it is beingput, all of
which helps them evaluate various aspects of the firm's performance, its prospects, and its financial
position. For anyone familiar with balance sheets and income statements, preparing a statement of cash
flows is not too difficult.
Aina: Do we have to prepare a statement of cash flows for this assignment?

Katsuji: No, we have to analyze the cash flow statements of four companies that come different economic
sectors: A, B, C and D. Here's an extra copy of the assignment that I picked up for you. Have a look at the
cash flow statements tonight and we can discuss them tomorrow.

The next day

This teaching note was written by Jordi Carenys (EADA Business School). It is intended to be used as the basis for class
discussion, and not to illustrate effective or ineffective handling of a management situation. The case was compiled from published
sources.

Copyright © 2019 EADA Business School. All rights reserved.

No part of this publication may be copied, stored, transmitted, reproduced, or distributed in any form or medium whatsoever
without the permission of the copyright owner.
 It´s all about cash
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Aina: Before we address that question, I would like to know more about how the cash flow statements are
prepared and what goes into each of the three areas of activity.

Katsuji: Okay, let's start with the operating section. The cash flow statement starts with accrual-based net
income (or loss), and then it adjusts this figure for all non-cash revenues and expenses (such as
depreciation) and then adds or subtracts the changes in working capital accounts. This section shows the
cash inflows and outflows associated with the company's fundamental business activities, including cash
receipts from the sale of goods or the provision of services, and the cash outflows related to the purchase
of inventory and the paying of other operating expenses. The investing section shows cash flows related to
the purchase and sale of fixed assets such as property, plant, and equipment, or the acquisition and
disposition of whole subsidiaries. This area also includes cash outflows and inflows related to investments
in financial assets. The financing section shows cash flows associated with capital market activities, such
as the issuance, redemption, or repurchase of shares, the issuance or repayment of debt, or the payment
of dividends.

Aina: 0K, now that I understand the contents of the three sections of the cash flow statement, but, how
does one go about analyzing the statements?
Katsuji: You can think of the operating section as being akin to the cash-flow motor of a company. If the
motor works well, it generates at least enough cash to cover a company's operational needs, and perhaps
beyond. It is natural for there to be year-to-year variability in operating cash flows and/or its main
components. Furthermore, different patterns are expected to be associated with, for example, early stage
versus stable and mature firms' operating cash flow generating abilities. Assessed over several years,
however, a healthy, established company's operating activities should generate positive cash flows.
Investing activities usually lead to negative cash flows since healthy companies will typically invest regularly
in fixed assets. Such investments may just replace those assets that have been used up or that have
become obsolete over time, or they may be incurred to enable the firm to expand and grow. Cash flows
fromfinancing activities may be positive or negative, and could easily vary from year to year. If cash flows
from operations are not sufficient to cover the firm's desired level of investing activities, for example, the
company will require additional financing that will be reflected as a positive cash inflow. By contrast, if
operating cash flows exceed the cash required for the firm's investments, the excess (or "free cash flow")
may be used to pay off debt, to buy back shares, or to pay out dividends, all of which would show up as
negative cash outflows within the financing section.
Aina: So for the assignment, we'll need to see whether cash flows from operations are positive, and if so
whether they are sufficient to cover investments, and then remark on what the firm did with the excess "free
cash flows" or how it made up any deficiencies?

Katsuji: Exactly! We also need to consider what happens over time. For each company, we need to examine
the trends in key line items over the years shown on their statements.

Aina: Wow, that's quite a lot to think about! How does one finally reach a conclusion about the financial
strength, liquidity situation, or performance of the company under review?

Katsuji: You need to collect as much evidence as possible and then weigh it all up in order to arrive at an
overall picture. This is obviously easier if you have a company's complete set of financial statements, but
the exercise this time is to see just how much we can extract about a company's situation from the statement
of cash flows alone. Good luck with the A, B, C and D companies, and don't miss next week's class!

Exhibits 1, 2, 3 and 4 contain the statements of cash flows for A, B, C and D respectively. These four
entities, whose real names have been disguised, come from different sectors of the economy. Each
statement provides three or four years of comparable data. Examine the statements carefully with a view
to arriving at an overall assessment of each company's financial situation.

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Company A

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Company B

Company C

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Company C

Consolidated Statements of Cash Flows

Year Ended December 31,

2018 2017 2016
Cash Flows from Operating Activities
Net Income ($1.062.582) ($2.240.578) ($773.046)
Depreciation, amortization and impairment 1.901.050 1.636.003 947.099
Other Net Income adjustments 1.201.383 1.040.524 395.979
Accounts receivable (496.732) (24.635) (216.565)
Inventory (1.023.264) (178.850) (632.867)
Other operating current assets (504.281) (1.610.110) (1.825.383)
Accounts payable and accrued liabilities 1.722.850 388.206 750.640
Other operating current liabilities 359.378 928.786 1.230.314
Net cash provided by (used in) operating activities $2.097.802 ($60.654) ($123.829)

Cash Flows from Investing Activities

Purchases of property and equipment (2.319.516) (4.081.354) (1.440.471)
Maturities of short-term marketable securities - - 16.667
Other investment activities (17.912) (114.523) 342.719
Net cash used in investing activities ($2.337.428) ($4.195.877) ($1.081.085)
Cash Flows from Financing Activities
Proceeds from issuances of common stock - 400.175 1.701.734
Net borrowing 89.144 3.385.588 1.718.190
Other financing activities 484.611 629.101 324.052
Net cash provided by financing activities $573.755 $4.414.864 $3.743.976
Effect of exchange rate changes on cash (22.700) 39.726 (6.553)
and cash equivalents and restricted cash
Net increase in cash and cash equivalents $311.429 $198.059 $2.532.509
Cash and cash equivalents, beginning of period 3.964.959 3.766.900 1.234.391
Cash and cash equivalents, end of period $4.276.388 $3.964.959 $3.766.900

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Company D

12 months 12 months 12 months 12 months

In Millions of USD ending ending ending ending
2013-12-31 2014-12-31 2015-12-31 2016-12-31
Net Income 1850 (118) (75) 16
Adjustments to reconcile net income (loss) to cash
flow from operating activities
Depreciation 193 199 145 105
Deferred Taxes 446 5 6 15
Other Non-Cash Items (2553) (58) (110) (124)
Changes in Working Capital (734) (156) (61) (25)
CASH FROM OPERATING ACTIVITIES (663) (128) (95) (13)
Capital Expenditures (39) (43) (43) (41)
Other Investing Cash Flow Items, Total 799 84 (8) 20
CASH FROM INVESTING ACTIVITIES 760 41 (51) (21)
Issuance (Retirement) of Debt, Net (-811) (4) (4) (282)
Other Financing Cash Flow Items 441 (3) 3 210
CASH FROM FINANCING ACTIVITIES (370) (7) (1) (72)
Foreign Exchange Effects (18) (38) (18) (7)
NET CHANGE IN CASH (291) (132) (165) (113)