Chapter 4: Statement of Cash Flows “Joan and Joe: A Tale of Woe” Joe added up profits and went to see Joan, Assured of obtaining a much-needed loan. When Joe arrived, he announced with good cheer: “My firm has had an outstanding year, And now I need a loan from your bank.” Eyeing the statements, Joan’s heart sank. “Your profits are fine,” Joan said to Joe. “But where, oh where, is your company’s cash flow? I’m sorry to say: the answer is ‘no’.” --L. Fraser

Statement of Cash Flows It is possible for a company to post a healthy net income but not have cash needed to pay its employees, suppliers, and bankers. Positive net income on the income statement is ultimately insignificant unless a company can translate its earnings into cash.

Statement of Cash Flows Provides information about cash inflows and outflows during an accounting period Extremely important as an analytical tool Only source in financial statement data for learning about the generation of cash from operations

Preparing a Statement of Cash Flows Begins with a return to the balance sheet Requires a reordering of the information presented on a balance sheet Shows changes over time rather than the absolute dollar amount of the accounts at a point in time

Preparing a Statement of Cash Flows Prepared by calculating changes in all of the balance sheet accounts, including cash listing the changes in all of the accounts except cash as inflows or outflows categorizing the flows by operating, financing, or investing activities The inflows less the outflows balance to and explain the change in cash.

Four Parts of a Statement of Cash Flows Operating activities Investing activities Financing activities

Four Parts of a Statement of Cash Flows Cash and highly liquid short-term marketable securities Also called cash equivalents If a company separates marketable securities into two accounts (cash and cash equivalents and short-term investments), the short-term investments are classified as investing activities.

Four Parts of a Statement of Cash Flows Operating activities Delivering or producing goods for sale and providing services Cash effects of transactions and other events

Class Exercise Use Coors Annual report to review this section.

Four Parts of a Statement of Cash Flows Investing activities Acquiring and selling or otherwise disposing of securities that are not cash equivalents productive assets that are expected to benefit the firm for long periods of time Lending money and collecting on loans

Class Exercise Use Coors Annual report to review this section.

Four Parts of a Statement of Cash Flows Financing activities Borrowing from creditors and repaying the principal Obtaining resources from owners and providing them with a return on the investment

Class Exercise Use Coors Annual report to review this section.

Analyzing the Statement of Cash Flows The statement of cash flows is an important analytical tool for creditors, investors, and other users of financial statement data.

Analyzing the Statement of Cash Flows Statement of cash flows helps to determine a firm’s ability to generate cash flows in the future capacity to meet cash obligations future external financing needs success in productively managing investing activities effectiveness in implementing financing and investing strategies

Cash Flow from Operations It is possible for a firm to be highly profitable and not be able to pay dividends not be able to invest in new equipment not be able to service debt go bankrupt How? The problem is cash.

Cash Flow from Operations Ongoing operation depends upon its success in generating cash from operations. Firms need cash to satisfy creditors and investors. Temporary shortfalls of cash can be satisfied by borrowing or other means, but ultimately a firm must generate cash.

Analysis of the Statement of Cash Flows – Analyst Concerns Success or failure of the firm in generating cash from operations Underlying causes of the positive or negative operating cash flow Magnitude of positive or negative operating cash flow Fluctuations in cash flow from operations over time