Analysis of cash flows 3 CHAPTER

Statement of cash flows (SCF) helps address questions such as:  How much cash is generated from or used in operations?  What expenditures are made with cash from operations?  How are dividends paid when confronting an operating loss?  What is the source of cash for debt payments?  How is the increase in investments financed?  What is the source of cash for new plant assets?  Why is cash lower when income increased?  What is the use of cash from new financing?

Outline 1. Statement of Cash Flows; 2. Analysis of Cash Flow Information; 3. Cash Flow Statements: An International Perspective.

1.Statement of Cash Flows 1.Statement of Cash Flows Cash Defined: refers to cash and cash equivalents. Cash equivalents: are short-term, highly liquid investments that are (1) readily convertible to known amounts of cash, and (2) near maturity (typically within 3 months) with limited risk of price changes due to interest rate shifts.

Simplified Operating Cycle of a merchandise company Products sold to customers Cash on hand 1 2 Cash paid for products 4 Customers pay for products 3

Reporting by Activities Statement of cash flows reports receipts and payments by operating, financing, and investing activities Operating activities are the earning ‑ related activities of a company. Investing activities are means of acquiring and disposing of noncash assets. Financing activities are means of contributing, withdrawing, and servicing funds to support business activities.

Reporting by Activities CFO CFFCFI EERCC NET CASH FLOW In Out

+ Income Investing cash flow Financing cash flow Operating cash flow DeclineGrowthMaturityInception

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Net Cash Flows from Operations Indirect Method -Net income is adjusted for non-cash income (expense) items and accruals to yield cash flow from operations Direct Method -Each income item is adjusted for its related accruals *Both methods yield identical results-only the presentation format differs. Preparation of cash flow statement

Direct and Indirect Method Cash Flow Statements Under the indirect method, CFO is computed by adjusting net income for all:  Noncash revenues and expenses;  Nonoperating items included in net income;  Noncash changes in operating assets and liabilities.

Net Cash Flows from Operations Indirect Method Net Income + Depreciation +/- Gains (losses) on sales of assets +/- Cash generated (used) by current assets & liabilities Net cash flows from operating activities

Depreciation Add-Back Sales - Expenses - Depreciation and amortization expense Net Income + Depreciation expense +/- Gains (losses) on sales of assets +/- Cash generated (used) by current assets and liabilities Net cash flows from operating activities Add Back

Income vs. Cash Flows Example Consider a $100 sale on account (1) In period of sale, net income is increased by $100 but no cash has been generated. Net Income100 Depreciation and amortization expense 0 Gains (losses) on sale of assets 0 Change in accounts receivable (100) Net Cash flow from operations 0  In period of collection no income is recorded. Net Income 0 Depreciation and amortization expense 0 Gains (losses) on sale of assets 0 Change in accounts receivable 100 Net Cash flow from operations100

Increase Decrease Assets(Outflow) Inflow LiabilitiesInflow (Outflow) Cash generated (used) by current assets and liabilities

Indirectly Adjustments

Directly

Reporting Formats for CFO

Preparation of cash flow statement Transactional Analysis Change in Balance Sheet Accounts Income Statement Items Cash Flow Description Cash flow from operating activities (CFO) Accounts receivable Advance from customers Inventories and accounts payable Prepaid expenses Rent payable Accrued expense Interest payable Income tax payable and deferred income taxes Net sales COGS SG&A expense Rent expense SG&A expense Interest expense Income tax expense Cash received from customers Cash paid for inputs Cash operating expense Interest paid Income tax paid

Change in Balance Sheet Accounts Income Statement Items Cash Flow Description Cash flow from investting activities (CFI) Property, plant and equipment Intangibles Investment in affiliates Short and long-term investment and gains (losses) on certain investments Assets and liabilities resulting from acquisitions and divestitures Depreciation expense Amortization expense Equity in income of affiliates Realized gains or losses on investments Capital expenditures Cash paid for and received from investments in affiliates Cash paid for and received from investments Cash paid for acquisitions or received from divestitures

Change in Balance Sheet Accounts Income Statement Items Cash Flow Description Cash flow from financing activities (CFF) Dividends payable Notes payable Short-term debt Long-term debt Bonds payable Common stock and APIC Retained earnings Dividends paid Increase or decrease in debt Increase or decrease in equity Dividends paid

2. Analysis of Cash Flow Information Relation of income and cash flow Accrual accounting can be affected by management’s choice of accounting policies and estimates. Therefore, accrual accounting by itself fails to provide adequate information about the liquidity of the firm and long-term solvency. Some of these problems can be alleviated by the use of the cash flow statement in conjunction with the income statement.

Assume two companies (A and B) each invest $50,000 in machinery yielding $45,000 per year cash flows before depreciation. Assuming a five ‑ year useful life and no salvage value for the machinery, results for the entire five-year period are: Five-Year Period Cash provided by operations ($45,000 x 5 years)$225,000 Cost of the machine$ (50,000) Income from operating machine$175,000 Average yearly net income$ 35,000 Assume two companies (A and B) each invest $50,000 in machinery yielding $45,000 per year cash flows before depreciation. Assuming a five ‑ year useful life and no salvage value for the machinery, results for the entire five-year period are: Five-Year Period Cash provided by operations ($45,000 x 5 years)$225,000 Cost of the machine$ (50,000) Income from operating machine$175,000 Average yearly net income$ 35,000 Effect of accounting policy

Company A: Company B: Straight-Line Sum-of-the-Years’- DepreciationDigits Depreciation Income before YearDepreciationDepreciationNet IncomeDepreciationNet Income 1$ 45,000$10,000$ 35,000$16,667$ 28, ,000 10,000 35,000 13,334 31, ,000 10,000 35,000 10,000 35, ,000 10,000 35,000 6,667 38, ,000 10,000 35,000 3,332 41,668 Total$225,000$50,000$175,000$50,000$175,000 Income before depreciation for these two companies is identical--this faithfully reveals identical earning power. Income after depreciation is considerably different across the years—this does not reflect changes in earning power. Company A: Company B: Straight-Line Sum-of-the-Years’- DepreciationDigits Depreciation Income before YearDepreciationDepreciationNet IncomeDepreciationNet Income 1$ 45,000$10,000$ 35,000$16,667$ 28, ,000 10,000 35,000 13,334 31, ,000 10,000 35,000 10,000 35, ,000 10,000 35,000 6,667 38, ,000 10,000 35,000 3,332 41,668 Total$225,000$50,000$175,000$50,000$175,000 Income before depreciation for these two companies is identical--this faithfully reveals identical earning power. Income after depreciation is considerably different across the years—this does not reflect changes in earning power. Two different depreciation methods

Net income plus major noncash expenses (typically depreciation and amortization) Net income plus major noncash expenses (typically depreciation and amortization) + Income Operating cash flow DeclineGrowthMaturityInception

Net Income = Accruals Operating Cash Flow ±

Cash flows from operations Deduct:Net capital expenditures required to maintain productive capacity Dividends on preferred stock and common stock (assuming a payout policy) EqualsFree cash flow (FCF) Cash flows from operations Deduct:Net capital expenditures required to maintain productive capacity Dividends on preferred stock and common stock (assuming a payout policy) EqualsFree cash flow (FCF) Free Cash Flow The cash available to the firm for discretionary uses after making all required cash outlays.

+ Free cash flow Operating cash flow DeclineGrowthMaturityInception

+ Income Investing cash flow Free cash flow Financing cash flow Operating cash flow DeclineGrowthMaturityInception

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. 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. Free Cash Flow

Analysis of cash flow trends Company: Pfizer

Cash from operations 1,580 3,282 3,076 Capital expenditure (831) (1,119) (1,490) Free cash flow 749 2,163 1, (1467) (2888) (3648) Free Cash Flow

3. Cash Flow Statements: An International Perspective. Issue US GAAP(SFAS95) IAS(IAS7) Bank overdrafts Interest and dividends received Interest paid Dividends paid Reconciliation from net income to CFO Shown as liability; changes are shown in cash flow statement CFO CFF Always required May be shown as part of cash equivalents; changes not shown in cash flow statement CFO or CFI Not required when direct method used

Summary 1. Statement of Cash Flows; 2. Analysis of Cash Flow Information; 3. Cash Flow Statements: An International Perspective.

思考题  试分析以下交易对公司现金流量的影响： （ 1 ）赊销商品一批；（ 2 ）对固定资产计 提折旧；（ 3 ）出售办公大楼；（ 4 ）债务 转为资本；（ 5 ）以商品换购设备。

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