BULACAN POLYTECHNIC COLLEGE

McArthur Highway, Barangay Bulihan, City of Malolos, Bulacan 3000

Name of Instructor: EUGENE A. RUANO

School Term: 2nd Semester, A.Y. 2019-2020
Subject Code & Title: FMan 223-Financial Management
Date Covered: March 26, 2020-BSAIS 2B/March 27, 2020-BSAIS2A

MODULE IN FMAN 223-FINANCIAL MANAGEMENT

I. Subject Matter:

Topic Title: CASH FLOW ANALYSIS

Lesson/Discussion: Introduction, Usefulness of Statement of Cash Flows,

Financial Liquidity and Financial Flexibility, Free Cash Flow, Basic Approach to
Cash Flow Statement, Definition of Cash, Classification of Cash Flow Activities,
Content and Form of the Statement of Cash Flow, Direct and Indirect Method

Lesson Proper
Discussion of the topics on cash flow analysis (lecture/discussion)
INTRODUCTION
 Clearly, Income Statement and Statement of Financial Position are the
most common financial documents available to the public. But managers
who make financial decisions may find themselves at something of a loss
if they only have these two documents on which to base their decisions
for today and into the future.
 Financial managers and investors, however, are far more interested in
actual cash flows than they are in somewhat artificial, backward=looking
accounting profit listed on the income statement. This is very important
distinction between the accounting and finance point of view. Finance
professionals know that the firm needs cash, not accounting profit, to pay
the firm’s operations and growth, and to compensate the firm’s ultimate
owners/shareholders.
 The statement of cash flows is a financial statement that shows the firm’s
cash flows over a given period of time. It reports the amounts of cash that
the firm generated and distributed during a particular time period. The
bottom line on this statement equals the change in cash of the firm’s
statement of financial position from the previous year’s cash account
balance. It reconciles income statement items and noncash statement of
financial position items to show changes in the cash and marketable
securities of financial position items to show changes in the cash and
marketable securities account on the statement of financial position over
the particular analysis period.

USEFULNESS OF THE STAEMENT OF CASH FLOWS

 “Happiness is a positive cash flow” is certainly true. Although net income
provides a long-term measure of a company’s success or failure, cash is its
lifeblood. Without cash, a company will not survive.
 Creditors examine the cash flow statement carefully because they are concerned
about being paid.
  To provide relevant information about a company’s cash receipts and cash
payments during an accounting period that is useful in evaluating the preceding
items.
 A company’s ability to generate positive future net cash flows
 A company’s ability to meet its obligations and pay dividends
 A company’s need for external financing
 The reasons for differences between a company’s net income and associated
cash receipts and payments
 Both the cash and noncash aspects of a company’s financing and investing
transactions during the accounting period
STATEMENT OF CASH FLOWS PROVIDE THE MEANS OF MEASURING A
BUSINESS FIRM’S
 Financial Liquidity-which refers to the “measures to cash” of assets and
liabilities. The formula for this ratio is:
Net cash provided by operating activities = Current cash
Average Current Liabilities Debt Coverage Ratio
The higher the current cash debt coverage ratio, the less likely a company will
have liquidity problems. For example, a ratio near 1:11 is good, it indicates that
the company can meet all of its obligations from internally generated cash flow.
 Financial Flexibility-which refers to a company’s ability to respond and adapt to
financial adversity and unexpected needs and opportunities. The cash debt
coverage ratio provides information on financial flexibility. It indicates a
company’s ability to repay its liabilities from net cash provided by operating
activities, without having to liquidate the assets, employed in its operations. The
formula for this ratio is:
Net cash provided by operating activities = Cash Debt
Average total liabilities Coverage Ratio
The higher this ratio, the less the company will experience difficulty in meeting its
obligations as they come due. It signals whether the company can pay its debt
and survive if external sources of funds become limited or too expensive.
FREE CASH FLOW
 Is the amount of discretionary cash flow a company has. It can use this cash flow
to purchase additional investments, retire its debt, purchase treasury shares, or
simply add to its liquidity.
Example:
ABC Company
Free Cash Flow Analysis
Net cash provided by generating activities Pxxx
Capital expenditures (xxx)
Dividends (xxx)
Free cash flow Pxxx
If the free cash flow is positive, the business firm could have satisfactory financial
flexibility. Companies that have strong financial flexibility can
1. Take advantage of profitable investment even in tough terms, and
2. Be free from worry about survival in poor economic terms.
BASIC APPROACH TO A CASH FLOW STATEMENT
CASH
 Include both cash and cash equivalents
 Cash equivalents consist of short-term, highly liquid investment such as treasury
bills, SEC registered commercial papers and money market funds. They are
 made solely for the purpose of generating a return on funds that are temporarily
idle.
CLASSIFICATION OF CASH FLOW ACTIVITIES
 Operating Activities
 Key indicator of the extent to which the operations of the enterprise have
generated sufficient cash flows to repay loans, maintain the operating
capability of the enterprise, pay dividends and make new investments
without recourse to external sources of financing. It includes delivering or
producing goods for sale and providing services, and the cash effects
transactions and other events that enter into the determination of income.
Examples are
Inflows Outflows
Sales of goods Payments for purchases of
inventories
Revenue from services Payments for operating expenses
(salaries, rent, insurance, etc.)
Return on interest earnings assets Payments for purchases from
(interest) suppliers other than inventory
Return on equity securities Payments for lenders (interest)
(dividends)
Receipts from contracts held for Payments for taxes unless
dealing & trading purposes identified with financial and
Tax refunds unless identified with investing activities
financing & investing activities

 Investing Activities
 Separate disclosure of cash flows arising from investing activities is
important because the cash flows represent the extent to which
expenditures have been made for resources intended to generate future
income and cash flows. It includes acquiring and selling, or otherwise
disposing of securities that are not cash equivalents, and productive
assets that are expected to benefit the firm for long periods of time, and
lending money and collecting on loans. Examples are:
Inflows Outflows
Sales of long-lived assets such as Acquisitions of long-lived assets
property, plant and equipment, such as property, plant and
intangibles & other long-term equipment, intangibles and other
assets long-term assets
Sale of debt or equity securities of Purchases of debt or equity
other entities securities of other entities
Collection of loans (principal) to Loans (principal) to others (other
others (other than advances and than advances and loans made by
loans made by a financial a financial institution)
institution)

 Financing Activities
 The separate disclosure of cash flows arising from financing activities is
important because it is useful in predicting claims on future cash flows by
providers of capital to the enterprise. It includes borrowing from creditors
and repaying the principal, and obtaining resources from owners and
providing them with a return on the investment. Examples are:
Inflows Outflows
Proceeds from borrowing (short- Repayment of debt principal
term and long-term) Repurchase of a firm’s own shares
Proceeds from issuing the firm’s Payment of dividends
 own equity securities Acquisition of the firm’s own share

CONTENT AND FORM OF THE STATEMENT OF CASH FLOWS

The Statement of Cash Flows (SCF) for a period shall report the following:
A. Net Cash
1. Provided or used by operating activities
2. Provided or used by investing activities
3. Provided or used by financing activities
B. Net effect of those flows on cash and cash equivalents during the period in a
manner that reconciles the beginning and ending cash and cash equivalents.
Noncash investing and financing activities affecting the financial position shall be
excluded from a cash flow statement.
Illustration of Statement of Cash Flows
SUNSTAR CORPORATION
Statement of Cash Flows
For the Year Ended, December 31, 2019
Cash Flows from Operating Activities
Net income P 14,000
Add (Deduct) Adjustments for differences between net
Income and cash flows from operating activities:
Depreciation expense 8,000
Increase in salaries payable 800
Increase in accounts payable 2,600
Increase in accounts receivable ( 7,000)
Net cash provided by operating activities P 18,400

Cash Flows from Investing Activities

Payment for purchase of building P (30,000)
Payment of purchase of equipment ( 4,000)
Proceeds from sale of land, at cost 10,000
Net cash used for investing activities P (24,000)
Cash Flows from Financing Activities
Proceeds from issuance of ordinary shares P 18,000
Proceeds from issuance of bonds 12,000
Payment of dividends ( 9,000)
Payment of note payable 13,000
Net cash provided by financing activities P 8,000
Net Increase in Cash P 2,400
Cash Balance, January 1, 2019 10,900
Cash Balance, December 31, 2019 P 13,300

Investing and Financing Activities Not Affecting Cash:

Issuance of ordinary shares for land P 6,000
Acquisition of land by issuance of ordinary shares (6,000)

CALCULATING CASH FLOW FROM OPERATING ACTIVITIES

 Direct Method
 Firms are encouraged to report major classes of gross cash receipts and
gross cash payments and the net cash flow from operating activities.
Cash receipts and payments should be separately reported:
1. Cash collected from customers, including lessees, licensees and the
like
2. Interest, fees, royalties and dividends received
3. 0ther operating cash receipts if any
4. Cash paid to employees and other suppliers of goods or services
5. Interest paid
6. Income taxes paid
 7. Other operating payments if any
8. Contracts held for dealing or trading purposes
Adjustments to convert Income Statement amounts to Operating
Cash Flows (DIRECT METHOD)
Cash Flows from
Income Statement Operating Net Operating
Accounts Adjustments Activities Cash Flows
+decrease in A/R or
Sales Revenue -increase in A/R =collections from
+increase in def. rev. or customers
-decrease in def. rev.
+decrease in int. rec. or
-increase in int. rec.
Interest revenue and +amortization of =interest and
Dividend revenue premium on investment dividends collected
in bonds or
-amortization of
discount on investment
in bonds Cash Inflows from
Operating Activities
+increase in unearned
revenues
-decrease in unearned
Other revenues revenues =other operating
-gains on disposals of receipts
assets & liabilities
-investment income
(equity method)
+increase in inventory
or
Cost of Goods Sold -decrease in inventory =payments to
+decrease in AP or suppliers
-increase in AP
-depreciation, depletion
& amortization expense
+decrease in accrued
expenses or
Selling and -increase in accrued =payments of
Administrative expenses operating expenses
Expenses +increase in prepaid
expenses or
-decrease in prepaid
Cash Outflows from
expenses
Operating Activities
+decrease in interest
payable or
-increase in interest
payable
Interest Expense +amortization of =payments of interest
premium on bonds
payable or
-amortization of
discount on bonds
payable
-losses on disposals of
Other expenses assets & liabilities =other operating
-investment loss (equity payments
method)
+decrease in income
tax payable or
-income tax payable =payments of income
Income tax expense +decrease in deferred taxes
income or
-increase in deferred
income taxes payable
Direct Method Illustration
Alpha Company
Cash Flow Statement
For the Year Ended December 31, 2019
Cash flows from Operating Activities
Cash receipts from customers P xxx
Cash paid to suppliers and employees xxx
Cash generated from operations xxx
Interest paid (xxx)
Income taxes paid xxx
Net cash from operating activities P xxx
Cash flows from investing activities
 Acquisition of subsidiary X, net of cash acquired P (xxx)
Purchase of property, plant & equipment (xxx)
Proceeds from sale of equipment xxx
Interest received xxx
Dividends received xxx
Net cash used in investing activities (xxx)
Cash flows from financing activities
Proceeds from issuance of share capital P xxx
Proceeds from long-term borrowings xxx
Payment of finance lease liabilities (xxx)
Dividends paid (xxx)
Net cash used in financing activities (xxx)
Net increase in cash and cash equivalents P xxx
Cash and cash equivalents at beginning of period xxx
Cash and cash equivalents at the end of the period P xxx

 Indirect Method
 Firms that choose not to provide the major classes of operating cash
receipts and payments by the direct method shall determine and report the
same amount of net cash flow from operating activities indirectly by
adjusting net income to reconcile it to net cash flow from operating
activities
 Regardless of whether the direct and indirect method of reporting net cash
flow from operating activities is used, the reconciliation of net income to
net cash flow from operating activities shall be presented.
Illustration of Indirect Method
Net Income after Taxes
Plus
Decrease in Current Liabilities except bank loan, current maturities of long-term
debt
Depreciation, depletion, and amortization expenses
Amortization of discount on bonds payable
Amortization of premium on investment in bonds
Increase in deferred income taxes
Loss (net) on disposal of assets or liabilities
Subsidiary loss under the equity method
Interest expense
Income taxes
Minus
Increase in current assets except marketable securities, and non-trade accounts
Decrease in current liabilities except bank loan, current maturities of long-term
debt
Amortization of premium on bonds payable
Amortization of discount on investment in bonds
Decrease in deferred income taxes
Gain (net) on disposal of assets or liabilities
Subsidiary gain under the equity method
Equals
Net Cash Flow from Operations
Interest paid
Income Taxes Paid

Net Cash from Operating Activities

A. Application
 In a ¼ sheet of yellow paper, explain how depreciation generates actual cash flows
for the company.

II. Evaluation/Quiz (10 Points)

Instruction: Solve the following problems below in a ½ sheet crosswise yellow paper.
1. Luis Shop had cash flows from investing activities of P2,567.000 and cash flows
from financing activities of P3,459,000. The balance in the firm’s cash account
was P950,000 at the beginning of 2019 and P1,025,000 at the end of the year.
Calculate Luis Shop’s cash flow from operations for 2019.
2. Tiffany Corporation reported free cash flows for 2019 of P23M and investment in
operating capital of P13M. The firm listed P8M in depreciation expense and
P17M in taxes on its 2019 income statement. Calculate Tiffany Corporation’s
2019 EBIT.

III. Assignment
1. What are the free cash flows for a firm? What does it mean when a firm’s free
cash flow is negative? Answers should be in a ½ sheet crosswise yellow paper.

Prepared by:

EUGENE A. RUANO
Instructor