Ignacio Lezaun

English edition
2021

Fundamentals of Finance
Contents of the course

1. The role of the Chief Financial Officer

2. Statement of cash flows
3. Working capital management I
4. Working capital management II
5. Short-term finance instruments
6. The time value of money
7. Conclusions
 UNIT
2

Unit 2:
Statement of cash flows
OBJECTIVES UNIT
2

2.1 Understand differences between net income and cash flow:

a. Revenue and collections
b. Expenses and payments

2.2 Calculating cash flow

c. Direct versus indirect method
d. Calculating cash flow activities
e. Cash flow statement
f. Exercise

2.3 Cash flow metrics and calculations

g. EBIDTA as a proxy
h. Operating cash flow
i. Free Cash Flow (FCF)
j. Free Cash Flow to Firm (FCFF)
k. Free Cash Flow to Equity (FCFE)
l. Exercise
Key Differences
UNIT
2

Income Cash
Calculated Income statement Cash flow statement

Represents Flow of goods and Monetary transactions

services

Shows us Economic viability of the Financial viability of the

company (is the company company (is the company
profitable?) sustainable?)
 UNIT
2

2.2 Calculating cash flow

Calculating cash flow: Direct method
UNIT
◼Collections minus payments 2
◼Easy to understand but requires information on all collections and
payments of the company during the time period
◼For this we have to go to the accounting of the cash or bank
statement to see all the inflows and outflows of funds
◼It provides more information than the indirect method since it
gives a breakdown of the origin of collections and payments
Calculating cash flow: Indirect method
UNIT
◼Calculations are easier to do but procedure is more difficult
2 to
understand
◼Based on the financial accounting (from the income statement of
the period for which we want to calculate the cash flows)
◼Takes the initial and final balances of said period as a
reference, then makes the appropriate adjustments and
eliminations until reaching the concept of cash
◼The following documents are required:
◼Initial balance sheet
◼Income statement for the period in question
◼Final balance sheet
Calculating cash flow: Indirect method
UNIT
◼Add and subtract the items that have involved movements of funds
2 and that
have not gone through the income statement,
For example: investments in fixed assets, entry and return of financial debt and increase in
warehouse

◼Subtract the items that have been deducted in the income statement and that
have not entailed movements of funds
For example: the deductions that have been made to the profit figure in the income statement
through the provisions for depreciations and provisions whose constitution did not suppose any
cash inflow or outflow

◼Add and subtract those items that (due to the application of the accrual
principle) add as income or subtract as expenses in the income statement
but have not been collected or paid
We refer to declared sales but those that have not been collected due to granted credit to
customers and whose balance appears on the balance sheet
Class exercise: Laserlus company

GROSS ASSETS
31/12/20
150,000.00 €
31/12/21
150,000.00 € CAPITAL
31/12/20
120,000.00 €
UNIT
31/12/21
120,000.00 €
DEPRECIATION
NON-CURRENT
-30,000.00 € -35,000.00 € RESERVES 18,000.00 € 2 21,600.00 €
ASSETS 120,000.00 € 115,000.00 € NET INCOME 6,000.00 € 7,500.00 €
INVENTORIES 18,500.00 € 5,000.00 € NET EQUITY 144,000.00 € 149,100.00 €
CUSTOMERS 38,000.00 € 20,000.00 € NON-CURRENT LIABILITIES -€ -€
CASH 24,900.00 € 33,975.00 € SUPPLIERS 15,000.00 € 4,125.00 €
CURRENT ASSETS 81,400.00 € 58,975.00 € TAXES PAYABLE 2,400.00 € € 750.00
OTHER DEBTS 40,000.00 € 20,000.00 €
CURRENT LIABILITIES 57,400.00 € € 24,875.00
TOTAL ASSETS 201,400.00 € 173,975.00 € TOTAL EQUITY + LIABILITIES 201,400.00 € 173,975.00 €

INCOME STATEMENT 2021

Sales 120,000.00 € Exercise:
Cost of materials 30,000.00 €
Direct labor cost 37,500.00 € Calculate the collections
Indirect costs 35,000.00 €
Depreciation 5,000.00 € from clients for 2021
Gross margin 12,500.00 €
General expenses 2,000.00 €
EBIT 10,500.00 €
Interests € 500.00
EBT 10,000.00 €
Tax 2,500.00 €
Net Income 7,500.00 €
 Class exercise: Laserlus company solution
Exercise: Calculate the collections from clients for 2021
UNIT
31/12/20 31/12/21 INCOME STATEMENT 2021
GROSS ASSETS 150,000.00 € 150,000.00 € Sales 2
120,000.00 €
DEPRECIATION -30,000.00 € -35,000.00 € Cost of materials 30,000.00 €
NON-CURRENT Direct labor cost 37,500.00 €
ASSETS 120,000.00 € 115,000.00 € Indirect costs 35,000.00 €
INVENTORIES 18,500.00 € 5,000.00 € Depreciation 5,000.00 €
CUSTOMERS 38,000.00 € 20,000.00 € Gross margin 12,500.00 €
CASH 24,900.00 € 33,975.00 € General expenses 2,000.00 €
CURRENT ASSETS 81,400.00 € 58,975.00 € EBIT 10,500.00 €
Interests € 500.00
EBT 10,000.00 €
Tax 2,500.00 €
TOTAL ASSETS 201,400.00 € 173,975.00 € Net Income 7,500.00 €

2021
Sales of the year 120,000.00 €

Collections in 2021 of previous year’s sales 38,000.00 €

2021 sales to be collected in the following year 20,000.00 €

Total 2021 collections from customers 120,000.00 + 38,000.00 - 20,000.00
= 138,000.00 €
Class exercise: Laserlus company solution
Exercise: Calculate the collections from clients for 2021

What about VAT?

2021 Includes VAT? Def.

(assum. 21% VAT)
Sales of the year 120,000.00 € No 120,000.00 x 21% =
145,200.00 €
Collections in 2021 of 38,000.00 € Yes 38,000.00 €
previous year’s sales
2021 sales to be collected 20,000.00 € Yes 20,000.00 €
in the following year
Total 2021 collections 120,000.00 + 145,200.00
from customers 38,000.00 - + 38,000.00 -
20,000.00 20,000.00
= 138,000.00 € = 163,200.00 €
 UNIT
2

Calculating cash flow activities

What is cash flow?
UNIT
◼ CASH FLOW= COLLECTION MINUS PAYMENTS
2
◼ Cash flow is based on financial (monetary) flow of collections and
payments

◼ It is the result of financial transactions across three activities:

1. Operating activities

2. Investing activities

3. Financing activities

(+/-) CASH FLOWS FROM OPERATING ACTIVITIES

(+/-) CASH FLOWS FROM INVESTMENT ACTIVITIES Cash flow for the period
(+/-) CASH FLOWS FROM FINANCING ACTIVITIES
Cash flow activities
UNIT
2
1. Operating activities include cash activities related to net income
e.g. cash generated from the sale of goods (revenue) and cash paid for merchandise (expense)
are operating activities because revenues and expenses are included in net income

2. Investing activities include cash activities related to noncurrent assets,

including (1) long-term investments; (2) property, plant, and equipment;
and (3) the principal amount of loans made to other entities.
e.g. cash generated from the sale of land and cash paid for an investment in another company
are included in this category
(note that interest received from loans is included in operating activities)

3. Financing activities are cash activities used to fund the company

e.g. transactions involving debt, equity, and dividends
CASH FLOW FROM OPERATING Those produced by the transactions
ACTIVITIES
A) CASH FLOW FROM OPERATING ACTIVITIES Notes Year n Year n-1
involved in determining the company's
1. Profit for the year before taxes result
2. Result adjustments UNIT
a) Depreciation of fixed assets (+) Indirect method 2
b) Valuation adjustments for impairment (+/-)

c) Variations in provisions (+) Start with the pre-tax figure

d) Imputation of subsidies (-) a) b) c) d) i) j) and k) eliminate expenses or income

e) Results from disposals and disposals of fixed assets (+/-) that do not imply a change in cash
f) Results from disposals and disposals of instruments

financial (+/-) e) and f) eliminate profit/loss from operations that

must be classified as investment or financing
g) Financial income (-)

h) Financial expenses (+) g) and h) eliminate results related to the

remuneration of financial assets and financial
i) Exchange differences (+/-)
j) Variation in fair value of financial instruments (+/-)
liabilities
k) Other income and expenses (- / +)
3. Changes in working capital
Changes in working capital
a) Inventories (+/-)
b) Debtors and other accounts receivable (+/-)
Other cash flows from operating activities:
c) Other current assets (+/-)
- Includes Corporation tax cash flows
d) Creditors and other accounts payable (+/-)
- There´s some absence of consensus regarding
e) Other current liabilities (+/-)
the rest of components (financing/investing
f) Other non-current assets and liabilities
activities?)
4. Other cash flows from operating activities
a) Payment of interest (-)
b) Collection of dividends (+)
c) Interest collection (+)
d) Payments (collections) for income tax (- / +)
5. Cash flows from operating activities
(+/- 1 +/- 2 +/- 3 +/- 4)