SNU MBA Pre-term

Statement of Cash Flows and

Note Disclosure

August, 2022

Instructor: Yewon Kim

(Email: yewon_kim@snu.ac.kr)

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Statement of Cash Flows CHAPTER 5
and Note Disclosure

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Explain the purpose, content, 3. Describe additional types of
and preparation of the information provided.
statement of cash flows.
2. Prepare a classified statement
of financial position.

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 Statement of LEARNING OBJECTIVE 3
Explain the purpose, content,
Cash Flows and preparation of the statement
of cash flows.

An important element of the objective of financial

reporting is

“assessing the amounts, timing, and

uncertainty of cash flows.”

IASB requires the statement of cash flows

(also called the cash flow statement).

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 Statement of Cash Flows

Purpose of the Statement of Cash Flows

Primary Purpose: To provide relevant information about
the cash receipts and cash payments of an enterprise
during a period.

Statement provides answers to the following questions:

1. Where did the cash come from?

2. What was the cash used for?

3. What was the change in the cash balance?

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 Statement of Cash Flows

Usefulness of the Statement of Cash Flows

Provides information to help assess:
1. Entity’s ability to generate future cash flows.

2. Entity’s ability to pay dividends and meet obligations.

3. Reasons for the difference between net income and

net cash flow from operating activities.

4. Cash and non-cash investing and financing

transactions during the period.

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 Usefulness of the Statement of Cash Flows

Early Warning Signal

Case 1: Accounting Fraud at Moneual (모뉴엘)
- submitted false export documents (80-90% of its yearly sales) to
receive loans from local banks, where these loans amount to over 3.2
trillion Won, from 2009 to 2013.

(million Won)
ⓐ Operating ⓒ Diff.
Year
Income+DEP ⓑ CFO (=ⓑ-ⓐ)
2007 1,776 (9,471) (11,247)
2008 10,061 (13,486) (23,547)
2009 13,720 27,911 14,191
2010 25,600 (3,238) (28,838)
2011 39,956 12,869 (27,087)
2012 87,440 14,309 (73,131)
2013 106,328 1,540 (104,788)

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 Usefulness of the Statement of Cash Flows

Early Warning Signal

Case 1: Accounting Fraud at Moneual (모뉴엘; Korean)
2013
Ⅰ. Cash flows from operating activities (1,513,705,618)
1. Consolidated net income 60,187,511,315
2. Non-cash expenses added 43,542,183,752
3. Non-cash revenue subtracted (2,182,051,740)
4. Changes in assets and liabilities arising from
(103,061,348,945)
operating activities
Increase in account receivables
Increase in inventories
(41,305,608,788)
(63,116,441,670)
fake sale
... ...
Ⅱ. Cash flows from investing activities (44,385,783,237)
1. Cash inflow from investing activities 12,217,485,615
2. Cash outflow from investing activities (56,603,268,852)
Ⅲ. Cash flows from financing activities 59,643,882,512
1. Cash inflow from financing activities 266,434,469,845
Increase in borrowings 264,250,247,452
... ...
2. Cash outflow from financing activities (206,790,587,333)
Repayment of borrowings 188,232,303,051
... ...
Ⅳ. Effect of exchange rate changes on cash and
1,486,495
cash equivalents
Ⅴ. Net increase (decrease) in cash and cash
equivalents
13,745,880,152 good
Ⅵ. Cash, January 1, 2013 60,068,808,213
23-7 Ⅶ. Cash, December 31, 2013 73,814,688,365 signal? LO 1
 Usefulness of the Statement of Cash Flows

Early Warning Signal

Case 2: Accounting Fraud at Daewoo Shipbuilding (대우조선해양)
- intentionally overstated earnings by overestimating the progress toward
completion.
- was able to meet target performance set by the Industrial Bank (the largest
shareholder) and receive large amount of bonuses

(million Won)
ⓐ Operating ⓒ Diff.
Year
Income+DEP ⓑ CFO (=ⓑ-ⓐ)
2006 (37,338) 664,532 701,870
2007 449,363 1,851,163 1,401,800
2008 1,176,467 (319,904) (1,496,371)
2009 843,278 (1,279,590) (2,122,868)
2010 1,184,023 (133,560) (1,317,583)
2011 1,273,549 (30,955) (1,304,504)
2012 606,628 (774,698) (1,381,326)
2013 574,528 (1,268,051) (1,842,579)
2014 606,057 (523,370) (1,129,427)

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 Statement of Cash Flows

Content of the Statement of Cash Flows

Operating Investing Financing

Activities Activities Activities
Transactions that Making and Transactions
enter into the collecting loans involving liability
determination of and acquiring and equity
net income. and disposing of items.
investments and
property, plant,
and equipment.

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 ILLUSTRATION 5.19
Cash Inflows and Outflows
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 Classification of Cash Flows

Operating activities—Income statement items

Cash inflows: Illustration 13-1
Typical receipt and
payment classifications
From sale of goods or services.
From interest received and dividends received.
Cash outflows:
To suppliers for inventory.
To employees for wages.
To government for taxes.
To lenders for interest.
To others for expenses.

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 Classification of Cash Flows

Cash Flow From Operations (CFO)

A key indicator of the extent to which the operations of
the entity have generated sufficient cash flows to repay
loans, maintain the operating capability of the entity,
pay dividends, and make new investments without
recourse to external sources of financing.

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 Classification of Cash Flows

Investing activities—Changes in investments and non-

current assets Illustration 13-1
Typical receipt and
Cash inflows: payment classifications

From sale of property, plant, and equipment.

From sale of investments in debt or equity securities of
other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase investments in debt or equity securities of
other entities.
To make loans to other entities.
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 Classification of Cash Flows

Financing activities—Changes in non-current

liabilities and equity Illustration 13-1
Typical receipt and
payment classifications
Cash inflows:
From sale of ordinary shares.
From issuance of long-debt (bonds and notes).
Cash outflows:
To shareholders as dividends.
To redeem long-term debt or reacquire
ordinary shares (treasury shares).

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 Illustration 13-3
Format of statement of cash flows

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 > DO IT!
Illustration: Classify each of these transactions by type of
cash flow activity.
1. Issued 100,000 HK$50 par value ordinary
Financing
shares for HK$8,000,000 cash.
2. Borrowed HK$2,000,000 from Castle Bank,
Financing
signing a 5-year note bearing 8% interest.
3. Purchased two semi-trailer trucks for
Investing
HK$1,700,000 cash.
4. Paid employees HK$120,000 for salaries Operating
and wages.
5. Collected HK$200,000 cash for services Operating
performed.
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Product
Life
Cycle

Q. Are negative operating cash flows bad?

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 Income Statement
and the Statement of Cash Flows

Why are Net Income and Cash Flow from

Operations (CFO) Different?

Income Statement of
Statement Cash Flow

Prepared based on

Accrual Cash
Accounting Accounting
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 Income Statement
and the Statement of Cash Flows

Why are Net Income and CFO Different?

[Example 1 – Credit Sales]
Credit sales increases revenue and net income of a
company, but it does not involve cash inflows.

Credit Sales → Net Income + CFO

$1,000 +1,000 No Change

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 Income Statement
and the Statement of Cash Flows

Why are Net Income and CFO Different?

[Example 2 - Depreciation]
Depreciation is a non-cash expense that is designed
to reduce the value of the asset over its useful life.

Depreciation → Net Income + CFO

$500 -500 No Change

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 Income Statement
and the Statement of Cash Flows

Why are Net Income and CFO Different?

[Example 3 – Prepaid Expenses]
The company has made cash payments in the current
period, but expenses (as charges to the income
statement) have been deferred to future periods.

Prepaid
Expenses → Net Income + CFO

$800 No Change -800

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 Income Statement
and the Statement of Cash Flows

Why are Net Income and CFO Different?

[Example 4 – Unearned Revenue]
The company has received cash in the current period,
but revenue has been deferred to future periods.

Unearned
Revenue → Net Income + CFO

$1,200 No Change +1,200

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 Income Statement
and the Statement of Cash Flows

Accruals
Accruals refer to revenue and expenses for which the
related cash amounts have not yet been received or
paid out. (e.g., accounts receivable, depreciation)

Accruals = Net Income - CFO

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 Income Statement
and the Statement of Cash Flows

Advantages of Accrual Accounting

It provides an accurate picture of overall performance
of the company since the transactions are reflected
when they actually took place instead of when money
is exchanged.

Net Income = CFO + Accruals

Total Sales Cash Sales Credit Sales

$4,000 $3,000 $3,000
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 Income Statement
and the Statement of Cash Flows

Disadvantages of Accrual Accounting

(1) There is uncertainty about the timing and amount
of settlement of accruals.

For example,

“When will be the accounts receivable collected?”

“How much accounts receivable will be collected?”

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 Income Statement
and the Statement of Cash Flows

Disadvantages of Accrual Accounting

(2) Accruals are subject to manipulation.

Examples include
- Underestimating uncollectible receivables
- Delaying the recognition of impairment loss
- Changing depreciation method to reduce expenses

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 Income Statement
and the Statement of Cash Flows
Accounting Profit is Fake?
The illusion of ‘profit’ whilst the company was entering bankruptcy fooled thousands of
investors into thinking it was a valuable company. Let’s take a look at a summary of
Enron’s financials, leading up to its collapse in 2001.

From a ‘net profit’ perspective, Enron was crushing it. It was profitable year-on-year,
growing at 12% compounded growth. But if you look at the Net Cash Flow position, you
will see that the company was losing cash. Not only did it burn through over $3.1B of cash
over that 6 year period, it only had two years of positive cash flow!
You would think that would send alarm bells to investors. But it didn’t — because they
were too focused on looking at profits and the share price, not cash!
You can fake profit, but you can’t fake cash.
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 Preparing the Statement of Cash Flows

Order of Presentation:
Direct Method
1. Operating activities
Indirect Method
2. Investing activities

3. Financing activities

 To determine cash flow from operating

activities, a company should convert NI from an
accrual basis to cash basis.
 Conversion – Two methods
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 Preparing the Statement of Cash Flows

Determining Cash Flow from Operations

1. Direct Method: shows all operating cash receipts and
payments.

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 Preparing the Statement of Cash Flows

Determining Cash Flow from Operations

2. Indirect Method: converts net income from an accrual
basis to a cash basis by adjusting net income just for
items that do not affect cash.

 NI = Accruals + CF
→ CF = NI - Accruals

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 Preparing the Statement of Cash Flows

Determining Cash Flow from Operations

Eliminate ‘accruals’
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 Usefulness of Statement of Cash Flows

Without cash, a company will not survive.

Cash flow from Operations:

 High amount - able to generate sufficient cash
from operations to pay its bills without further
borrowing.

 Low or negative amount - may have to

► borrow or

► issue equity securities.

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 Usefulness of Statement of Cash Flows

Financial Liquidity
ILLUSTRATION 5.26

Net Cash Provided by

Current Cash Operating Activities
Debt Coverage =
Ratio Average Current Liabilities

Ratio indicates the ability to pay off current liabilities

from operations.
Ratio near 1:1 is good.

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 Usefulness of Statement of Cash Flows

Financial Flexibility
ILLUSTRATION 5.27

Net Cash Provided by

Cash Debt Operating Activities
=
Coverage
Average Total Liabilities
Ratio

Ratio indicates the ability to repay liabilities from net

cash provided by operating activities, without having to
liquidate assets employed in operations.

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 Usefulness of Statement of Cash Flows

Free Cash Flow

ILLUSTRATION 5.29

 Indicates the amount of discretionary cash flow

available
 How much cash can be extracted from a company
without causing issues to its operations
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 Usefulness of Statement of Cash Flows

Free Cash Flow

The greater the amount of free cash flow, the greater
the company’s amount of financial flexibility.

- Firm should invest in new plant assets to maintain the current

level of operations or to grow
- If investing a lot? Then negative (small) free cash flow!
(analyze carefully! Where negative FCF comes
from?)

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 Which information should I use?
Working Capital, OCF
 What does WC infer? Is higher level of WC always
good?
 Working capital management
 How the WC is associated with OCF?

Source: Investopedia

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