Cash

Flow
Analysis
 TOPIC OUTCOME (TO):
Ability to use this accounting tools or methods for
the evaluation of the company.

COURSE OUTCOMES (CO):

CO 1: Discuss the different types of financial
statement analysis.
TO CO 2: Examine critically the information provided in

CO the financial statements.

PO CO 3: Apply the various techniques and

procedures necessary to carry out a
comprehensive analysis of firms.

CO 4: Demonstrate technical and creative abilities

in using these skills and techniques in an
integrated and cohesive matter.
 PROGRAM OUTCOMES (PO):

PO 1: Able to apply knowledge and

understanding of accounting and accounting
related fields.

PO 3: Able to interpret and analyze financial and

TO non financial information.

CO PO 4: Able to assist in financial and managerial

accounting reporting for decision making
purposes.
PO
PO 8: Able to apply managerial and
entrepreneurial skills
PREVIEW OF
CHAPTER 7

Statement of
Cash Flows

Analysis
Analysis of Cash
Flows Implications of
Cash Flows
1. Statement of Cash Flows

Relevance of Cash

Reporting by
Activities

Constructing the
Cash Flow
Statement

Direct Method
Relevance of Cash
 Cash is the most liquid of assets.
 Offers both liquidity and flexibility.
 Includes in both the beginning
and the end of a company’s
operating cycle.
 Net cash flow as the end
measure of profitability.
 Cash flow analysis helps in
assessing liquidity, solvency, and
financial flexibility.
 • The nearness to cash of
Liquidity assets and liabilities.

• Ability to pay liabilities

Solvency when they mature.

Financial • Ability to react and adjust

to opportunities and
Flexibility adversities.
Strategies To Maintain A
Healthy Cash
Speed up receipt of cash

Put cash into high-interest savings a/c

Implement a proper credit policy

Longer term financing

2. Reporting by Activities
 Operating Activities
• The SCF reports cash receipts and cash payments by
operating, financing, and investing activities
• Operating activities are the earning-related activities
of a company.

Also, include the net inflows and outflows

of cash resulting from related operating
activities like:
• extending credit to customers,
• investing in inventories
• obtaining credit from suppliers.
 Operating Activities-Examples
• Cash receipts from the sale of
goods and the rendering of
services
• cash receipts from royalties,
fees, commissions and other
revenue
• cash payments to suppliers for
goods and services.
• cash payments to and on behalf
of employees.
• cash receipts and cash
payments of an insurance entity
for premiums and claims,
annuities and other policy
benefits
• cash payments or refunds of
income taxes unless they can be
specifically identified with
financing and investing activities
• cash receipts and payments
from contracts held for dealing or
trading
 Investing Activities
• Investing activities are means of acquiring and
disposing of noncash assets.

– represent the extent to which expenditures have been

made for resources intended to generate future
income and cash flows.
 Investing Activities-Examples
• Cash payments to acquire
property, plant and
equipment, intangibles and
other long-term assets.
These payments include
those relating to capitalized
development costs and self-
constructed property, plant
and equipment
• cash receipts from sales of
property, plant and
equipment, intangibles and
other long-term assets;
• cash payments to acquire
equity or debt instruments of
other entities and interests in
joint ventures (other than
payments for those
instruments considered to be
cash equivalents or those
held for dealing or trading
purposes.
• cash receipts from sales of
equity or debt instruments of
other entities and interests in
joint ventures (other than
receipts for those instruments
considered to be cash
equivalents and those held for
dealing or trading purposes
• cash advances and loans made
to other parties (other than
advances and loans made by a
financial institution
• cash receipts from the
repayment of advances and
loans made to other parties
(other than advances and loans
of a financial institution)
• cash payments for futures
contracts, forward contracts,
option contracts and swap
contracts except when the
contracts are held for dealing or
trading purposes, or the
payments are classified as
financing activities
 Financing Activities
Financing activities are means of contributing,
withdrawing, and servicing funds to support business
activities.
– Include borrowing and repaying funds with bonds and
other loans; contributions and withdrawals by owners
and their return on investment.
 Financing Activities-Examples
• cash proceeds from issuing
shares or other equity
instruments.
• cash payments to owners to
acquire or redeem the entity’s
shares
• cash proceeds from issuing
debentures, loans, notes, bonds,
mortgages and other short-term
or long-term borrowings
• cash repayments of amounts
borrowed
• cash payments by a lessee for
the reduction of the outstanding
liability relating to a finance
lease. Reporting cash flows from
operating activities 18 An entity
shall report cash flows from
operating activities using
 3. Constructing the Cash
Flow Statement
Format for Cash Flow Statement:
• Indirect Method
– Reconcile from Net income to cash from operating
activities.
• Direct Method
– Reports all cash receipts and cash payment from
operating activities.
• Both methods yield identical results-only the
presentation format differs.
Convert Indirect to Direct Method
 4. Direct Method
The direct (or inflow-outflow) method:
• Reports gross cash receipts and cash disbursements
related to operations—essentially adjusting each
income statement item from accrual to cash basis.

• Reports total amounts of cash flowing in and out of a

company from operating activities.

• Must disclose a reconciliation of net income to cash

flows from operations (the indirect method) in a
separate schedule.
Format Statement of Cash Flow
 ANALYSIS
IMPLICATIONS
OF CASH FLOWS

1. Limitation In Cash Flow

Reporting*

2. Interpreting Cash Flow and

Net Income
 1. Limitations in Cash Flow Reporting

Some limitations of the current reporting of cash flow:

– Practice does not require separate disclosure of cash flows
pertaining to either extraordinary items or discontinued
operations.
– Interest and dividends received and interest paid are classified
as operating cash flows.
– Income taxes are classified as operating cash flows.
– Removal of pretax (rather than after-tax) gains or losses on
sale of plant or investments from operating activities distorts
our analysis of both operating and investing activities.
 2. Interpreting The Statement of Cash Flows

CF from operations is:

• A broader view of operating activities.
• Encompass all earning-related activities of a company.
• Focus on the liquidity aspect of operations.
• Not a measure of profitability.
• Report information on operating, investing and financing activities.
• Serve as a check on net income, but not a substitute for net
income.
• To evaluate & project short-term liquidity and longer term.
• Exclude elements of revenues and expenses not currently
affecting cash.
Tips 1
1. Net cash flows from operating activities:
• Show a company's ability to generate income from
internal sources.
• to assess the company's ability to meet ongoing
funding requirements, contribute to long-term projects
and pay a dividend.
• Investors prefer companies that produce a net positive
cash flow from operating activities.
• High growth companies, such as technology firms,
tend to show negative cash flow from operations in
their formative years.
• Normally it's a good sign when it goes up.
Tips 2
2. Net cash flow from investing activities:
• Assess a company's ability to meet future expansion
requirements. 
• Negative or positive isn’t inherently bad or good and it
depends on the type and age of the company.
• For example, a young (high-growth) company might
have a large negative net cash flow from investing
activities as it buys assets to expand its business.
• A company that shells out significant cash on investing
activities without eventually increasing profits might be
using its cash inefficiently.
Tips 3

3. Net cash flow from financing activities:

• A positive number is  going to indicate that cash has
come into the company due to certain activities such
as receiving cash from issuing stock and receiving
cash from issuing bonds.

• A negative figure indicates when the company has

paid out capital, such as spending cash to repurchase
previously issued stock, to pay long-term debt or
making a dividend payment to shareholders. 
 Interpreting Net Income
Net income:
• Rely on estimates, deferrals, allocations, and
valuations.

• show no effect on timing of cash flows on the SOPL

(accrual basis).

• Not showing the effect on liquidity and solvency.

ANALYSIS OF
CASH FLOWS
1. Case Analysis of Cash Flows of
Campbell Soup
2. Inferences from Analysis of Cash Flows
3. Alternative Cash Flow Measures*
4. Company and Economic Condition *
5. Free Cash Flow
6. Cash Flows as Validators
 1. Case Analysis
Cash Flows of Campbell Soup

Page: 430
2. Inferences from Analysis of CF

Interpretations from analysis of cash flows include:

– Where management committed its resources?
– Where it reduced investments?
– Where additional cash was derived from?
– Where claims against the company were reduced?
– Disposition of earnings and the investment of
discretionary cash flows.
– The size, composition, pattern, and stability of
operating cash flows.
3. Alternative Cash Flow Measures

Known as EBITDA:
Net income + interest + taxes + depreciation +
amortization

To analyze a company's operating profitability

before non-operating expenses (such as interest
and "other" non-core expenses) and non-cash
charges (depreciation and amortization).
EBITDA

Calculation of EBITDA
An Illustration for XYZ Company
1. Obtain your company's SOPL, SOCF or
SOFP.
2. Subtract expenses (besides interest and
taxes) from sales income to find operating
profit.
3. Sum any expenses due to depreciation
4. Sum any expenses due to amortization
5. Calculate EBITDA via the formula EBIT +
depreciation + amortization = EBITDA.
Short-Cut To EBITDA
• EBITDA Calculator

FAR340\SLIDES NOTES
& TUTORIAL\SLIDES NO
TES\EBITDA-Calculator
Chapter 6.xlsx
 Changes In Operating Working Capital
and Economic Conditions
1. Increase receivables
due to:
– Expanding customers’
demand
– Inability to collect debts.
2. Increase in inventories
due to:
– Increase in production
– Inability to sell product.
3. Increase financial -inability to replace assets.
burden due to: -increase investment in
inventories & receivables.
Free Cash Flow

Another definition that is widely used:

FCF = NOPAT - Change in NOA

(net operating profits after tax (NOPAT) less the

increase in net operating assets (NOA))
Free Cash Flow

Positive free cash flow reflects the amount available for business
activities after allowances for financing and investing requirements
to maintain productive capacity at current levels.

Growth and financial flexibility depend on adequate free cash flow.

Recognize that the amount of capital expenditures

needed to maintain productive capacity is generally not
disclosed—instead, most use total capital expenditures,
which is disclosed, but can include outlays for expansion of
productive capacity.
 Cash Flow as Validators
• The SCF is useful in identifying misleading or erroneous
operating results or expectations.
SCF provides us with important clues on:
Feasibility of financing capital expenditures.
Cash sources in financing expansion.
Dependence on external financing.
Future dividend policies.
Ability in meeting debt service requirements.
Financial flexibility to unanticipated
needs/opportunities.
Financial practices of management.
Quality of earnings.