cash flows kuku
TRANSCRIPT
The Statement of Cash Flows
The statement of cash flowsreports the entity’s cash flows
(cash receipts and cash payments)during the period.
Purpose of The Statement of
Cash Flows: Basic Concepts
Purposes of the Statement
of Cash Flows• The statement of cash flows is designed to
fulfill the following:– predict future cash flows– evaluate management decisions– determine the ability to pay dividends plus
interest and principal– show the relationship of net income to changes
in the firm’s cash
Components and Relationships Between the
Financial StatementsIt is important to understand that the income statement,
balance sheet and cash flow statement are all interrelated.
The income statement is a description of how the assets and liabilities were utilized in the stated accounting period.
The cash flow statement explains cash inflows and outflows, and will ultimately reveal the amount of cash the company has on hand; this is reported in the balance sheet as well.
We will not explain the components of the balance sheet and the income statement here since they were previously reviewed.
Statementof Retained
Earnings
12/31/x1 For the Year Ended 12/31/x2 12/31/x2(a point in time) (a period of time) (a point in time)
Statementof CashFlows
IncomeStatement
BalanceSheet
BalanceSheet
Organization of theStatement of Cash Flows
• A business may be evaluated in terms of three types of business activities:
1Operating activities2Investing activities3Financing activities
Three Sources of Information:1. Comparative balance sheets2. Current income statement3. Additional information
Preparing the Statement of Cash Flows
1. Cash Flow from Operating Activities (CFO)
• CFO is cash flow that arises from normal operations such as revenues and cash operating expenses net of taxes. This includes: Cash inflow (+) • Revenue from sale of goods and services • Interest (from debt instruments of other entities) • Dividends (from equities of other entities)
• Cash outflow (-) • Payments to suppliers • Payments to employees • Payments to government • Payments to lenders • Payments for other expense
2. Cash Flow from Investing Activities (CFI)
• CFI is cash flow that arises from investment activities such as the acquisition or disposition of current and fixed assets. This includes:
• Cash inflow (+) • Sale of property, plant and equipment • Sale of debt or equity securities (other entities) • Collection of principal on loans to other entities
• Cash outflow (-) • Purchase of property, plant and equipment • Purchase of debt or equity securities (other entities) • Lending to other entities
3. Cash flow from financing activities (CFF)
• CFF is cash flow that arises from raising (or decreasing) cash through the issuance (or retraction) of additional shares, short-term or long-term debt for the company's operations. This includes:
• Cash inflow (+) • Sale of equity securities • Issuance of debt securities
• Cash outflow (-) • Dividends to shareholders • Redemption of long-term debt • Redemption of capital stock
Illustration: Classify each of these transactions by type of cash flow activity.
Format of the Statement of Cash Flows
1. Issued 100,000 shares of $5 par value common stock for $800,000 cash.
2. Borrowed $200,000, signing a 5-year note bearing 8% interest.
3. Purchased two semi-trailer trucks for $170,000 cash.
4. Paid employees $12,000 for salaries and wages.
5. Collected $20,000 cash for services provided.
FinancingFinancingInvestingOperatingOperating
Which is an example of a cash flow from an operating activity?
a. Payment of cash to lenders for interest.b. Receipt of cash from the sale of capital
stock.c. Payment of cash dividends to the
company’s stockholders.d. None of the above.
SO 4 Prepare a statement of cash flows using the indirect method.
Review Question
Which is an example of a cash flow from an investing activity?
a. Receipt of cash from the issuance of bonds payable.
b. Payment of cash to repurchase outstanding capital stock.
c. Receipt of cash from the sale of equipment.d. Payment of cash to suppliers for inventory.
SO 4 Prepare a statement of cash flows using the indirect method.
Review Question
Format of the SCF
• FASB Statement 95 approved two methods for reporting cash flows from operating activities.
1Direct method (preferred)2Indirect method
The Direct Method
Cash Flow from Operations
Under the direct method, (net) cash flows from operating activities are determined by taking cash receipts from sales, adding interest and dividends, and deducting cash payments for purchases, operating expenses, interest and income taxes. We'll examine each of these components below:
The Direct Method
• Cash collections are the principle components of CFO. These are the actual cash received during the accounting period from customers.
They are defined as:Cash Collections Receipts from Sales = Sales + Decrease (or - increase) in Accounts Receivable
The Direct Method
• Cash payment for purchases make up the most important cash outflow component in CFO. It is the actual cash dispersed for purchases from suppliers during the accounting period. It is defined as:Cash payments for purchases = cost of goods sold + increase (or - decrease) in inventory + decrease (or - increase) in accounts payable
The Direct Method
• cash payment for operating expenses is the cash outflow related to selling general and administrative (SG&A), research and development (R&A) and other liabilities such as wage payable and accounts payable. It is defined as:
Cash payments for operating expenses = operating expenses + increase (or - decrease) in prepaid expenses + decrease (or - decrease) in accrued liabilities
The Direct Method
• Cash interest is the interest paid to debt holders in cash.It is defined as:
Cash interest = interest expense – increase (or +
decrease) interest payable + amortization of bond premium (or - discoun
The Direct Method
• Cash payment for income taxes is the actual cash paid in the form of taxes.
It is defined as: Cash payments for income taxes = income taxes + decrease (or - ncrease) in income taxes payable
Prepare SCF
1. The company purchased a truck during the year at a cost of $30,000 that was financed in full by the manufacturer.
2. A truck with a cost of $10,000 and a net book value of $2,000 was sold during the year for $7,000. There were no other sales of depreciable assets.
3. Dividends paid during Year 2 are $51,000
Statement of Cash Flows (Direct Method)
Current Assets
Add to Net Income if this account has decreased
The Indirect Method
Deduct from Net Income if this account has increased
Current Liabilities
Add to Net Income if this account has increased
The Indirect Method
Deduct from Net Income if this account has decreased
Statement of Cash Flows (Indirect Method)
CLASS WORK -SCFMenghai Pizza Dec 31, 2000Cash payment of Dividend
(35,000) Retirement of Common stock
(25,000)
Acquisition of Parahata Pizza
(14,000) Purchase of equipment
(30,000)
Cash Payment for interest
(10,000) Cash payment to suppliers
(85,000)
Cash payment for Salaries
(45,000) Cash collected from customers
250,000
Sale of equipment
38,000 Cash at Dec 31,1999
50,000
Required:Prepare SCF
CLASSWORK 1-Solution
CF FROM OACash collection from customers
250,000
Cash payment to Suppliers
(85,000)
Cash payment for Salaries
(45,000)
Cash payment for interest
(10,000)
Net cash from OA 110,000
CF from IASales of equipment 38,00
0Purchase of equipment
(30,000)
Purchase of land (14,000)
Net Cash from IA (6,000)
CF FROM FARetirement of Common stock
(25,000)
Payment of dividend
(35,000)
Net cash from FA
(60,000)
Net increase in cash
44,000
Cash at beginning of year
50,000
Cash at end of year
94,000
Menghai PizzaMenghai PizzaStatement of Cash FlowsStatement of Cash FlowsYearEnded December 31, 2000YearEnded December 31, 2000
Why Cash Flow Analysis?
• Profits and cash flows are very different things
• Profits under the accounting system are calculated on accrual basis rather than cash basis
Overview
Analysis
Budgeting
Example
Why Cash Flow Analysis?
• As an investor much better to look at both Income Statement and the Statement of Cash Flows
• As management, very important to analyze the different types of inflows/outflows
Overview
Analysis
Budgeting
Example
Types of Analysis
• Statement of CF Analysis• Free Cash Flows• Payback Period• Net Present Value• Internal Rate of Return
Overview
Analysis
Budgeting
Example
The cash flow statement will reveal the following to
analysts:
How the company obtains and spends cash Why there may be differences between net income and cash flows If the company generates enough cash from operation to sustain the business If the company generates enough cash to pay off existing debts as they mature If the company has enough cash to take advantage of new investment opportunities
Free Cash Flow (FCF)
Free cash flow (FCF) is the amount of cash that a company has left over after it has paid all of its expenses, including net capital expenditures. Net capital expenditures are what a company needs to spend annually to acquire or upgrade physical assets such as buildings and machinery to keep operating.
Free Cash Flows
Operating Income
+Depreciation
= EBITDA (Earnings before interest, taxes, Depreciation, and amortization)
-cash tax payments
= after tax cash flows from operations
Overview
Analysis
Budgeting
Example
Payback Period
• Cash flow analysis from capital budgeting perspective.
• A criteria used in capital budgeting. Defined as the number of years required to recover initial cash investment
Overview
Analysis
Budgeting
Example
Payback Period: Example1 0 0 0 0
Y e a r 1Y e a r 2Y e a r 3Y e a r 4Y e a r 5
P a y b a c k 3 . 3
5 0 0 04 0 0 05 0 0 0
It w i l l t a k e 3 y e a rs t o re c o ve r 7 0 0 0 a n d t h e . 3 o f t h e 4 t h y e a r t o re c o ve r t h e re m a in in g 3 0 0 0 . T h e re fo re t h e p a y b a c k in t h is
e x a m p le is 3 . 3 .
In i t ia l In ve s t m e n t in p ro je c t
C a s h in flo w s a ft e r - t a x1 0 0 01 0 0 0
Overview
Analysis
Budgeting
Example
Net Present Value
• In simple terms NPV is the sum of discounted cash inflows from a project- the projects initial outlay
• If NPV is > 0 accept else reject
Overview
Analysis
Budgeting
Example
NPV: ExampleI n i tia l O u tla y - 3 0 0 0 0R e q u i r e d R a te 1 2 %
N o t D is c o u n te d D is c o u n te dY e a r 1 I n f lo w 1 0 0 0 0 $ 8 , 9 2 8 .5 7Y e a r 2 I n f lo w 1 5 0 0 0 $ 1 1 ,9 5 7 .9 1Y e a r 3 I n f lo w 1 2 0 0 0 $ 8 , 5 4 1 .3 6Y e a r 4 I n f lo w 1 0 0 0 0 $ 6 , 3 5 5 .1 8Y e a r 5 I n f lo w 1 1 0 0 0 $ 6 , 2 4 1 .7 0S u m 5 8 0 0 0 $ 4 2 ,0 2 4 .7 2
N P V $ 1 2 , 0 2 4 .7 2
W e ta k e th e s u m o f th e d is c o u n te d va lu e s a n d s u b tr a c t th e in i tia l o u tla y .
Overview
Analysis
Budgeting
Example
Internal Rate of Return
• Discount rate that equates the present value of inflows with the present value of outflows. In simple terms it reflects the rate of return for a project
Overview
Analysis
Budgeting
Example
IRR: ExampleInitial Outlay -3817Year 1 Cash Inflow 1000Year 2 Cash Inflow 2000Year 3 Cash Inflow 3000
IRR 22%
Excel has a very handy function that calculates the IRR. Make sure you enter the whole range of values including the initial outlay, which is entered as a negative value.
Overview
Analysis
Budgeting
Example
What is Capital Budgeting?
• Capital budgeting is the decision making process through which firms decide which projects get the funding
• Financial plans for most firms are based on the capital budgeting analysis using cash flows
Overview
Analysis
Budgeting
Example
Comprehensive ExampleCost of new plant and Equipment 9,700,000Other Costs 300,000Total Cost 10,000,000
Total Unit Sales Year Sold1 50,0002 100,0003 100,0004 70,0005 50,000
Sales price per unit 150Variable cost 80Fixed Costs 500000Required Working Capital 100000
Depreciation 2,000,000
We just added the total cost of plant with other costs and divided it by 5 years to get a straight line decpreciation.
This example is something similar to what many firms would deal with in the real world. We will first derive Free Cash Flows and then apply the NPV and IRR techniques that we learned earlier.
Overview
Analysis
Budgeting
Example
Comprehensive Example
STEP 1
Year 0 1 2 3 4 5Units Sold 50,000 100,000 100,000 70,000 50,000Sale Price 150 150 150 150 150Sales Revenue 7500000 15000000 15000000 10500000 7500000Less: Variable Costs 4000000 8000000 8000000 5600000 4000000Less: Fixed Costs 500000 500000 500000 500000 500000EBDIT 3000000 6500000 6500000 4400000 3000000Less: Depreciation 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000EBIT 1,000,000 4,500,000 4,500,000 2,400,000 1,000,000Taxes (@ 34%) 340000 1530000 1530000 816000 340000
EBIT, TAXES and DEPRECIATION are calculated here
In this example we've calculated EBIT along with taxes that we will use to derive Operating Cash Flow on the next slide. We subtract depreciation here so we can pay less taxes. The depreciation will be added back in the next step as it is a non-cash item.
Overview
Analysis
Budgeting
Example
Comprehensive Example
STEP 2
Year 0 1 2 3 4 5EBIT 1,000,000 4,500,000 4,500,000 2,400,000 1,000,000Minus: Taxes 340000 1530000 1530000 816000 340000Plus:Depreciation 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000Operating Cash Flows 2,660,000 4,970,000 4,970,000 3,584,000 2,660,000
Operating Cash Flows
Depreciation is added back here as we move toward Free cash flows. Here Operating Cash Flows are derived.
Overview
Analysis
Budgeting
Example
Comprehensive Example
STEP 3
Year 0 1 2 3 4 5-100000 10000
Working Capital Needs
In this example we have an initial outflow of working capital that is recouped completely in the last year at the termination of the project. So in year one we subtract it and add it back in year 5.
Overview
Analysis
Budgeting
Example
Comprehensive ExampleSTEP 4
Year 0 1 2 3 4 5Operating Cash Flow 2,660,000 4,970,000 4,970,000 3,584,000 2,660,000Less: Net working capital -100000 0 0 0 0 100000Less: Initial Outlay -10,000,000
Free Cash Flow -10,100,000 2,660,000 4,970,000 4,970,000 3,584,000 2,760,000
Free Cash Flow
Finally we have the free cash flows that we can use in our NPV and IRR calculations.
Overview
Analysis
Budgeting
Example
Comprehensive Example
Now, using the date calculate the NPV and the IRR for the Project
Initial Outlay -10,100,000Cash inflows/Year 0 1 2 3 4 5
2,660,000 4,970,000 4,970,000 3,584,000 2,760,000
Depending on the answer also recommend if the project should be accepted.
Overview
Analysis
Budgeting
Example
Comprehensive Example
Year 0 1 2 3 4 5Not Discounted 2,660,000 4,970,000 4,970,000 3,584,000 2,760,000Discounted 2418181.818 4107438 3734034.6 2447920.2 1713742.9Initial Outlay -10,100,000Required Rate 10.00%
NPV 4,321,317
SOLUTION
Several ways to do so, first you can get the discounted cashflows for each year and then add all of them up along with the initial outlay. A simple way is to use the NPV function in excel. This is positive so we should go ahead with the project.
This rate depends on the firms required rate of return. Its dependent on different factors which we can't get into in this presentation. But most firms do have a given required rate of return for their projects.
Overview
Analysis
Budgeting
Example
Comprehensive Example
Year 0 1 2 3 4 5Not Discounted -10,100,000 2,660,000 4,970,000 4,970,000 3,584,000 2,760,000
IRR 26%
SOLUTION
Note that IRR is best solved for with a financial calculator or using a spreadsheet program. Here the excel function for IRR was used to come up with this value.
Overview
Analysis
Budgeting
Example
Practice ProblemCost of new plant and Equipment 1,500,000Other Costs 300,000Total Cost 1,800,000
Total Unit Sales Year Sold1 10,0002 20,0003 5,0004 60,0005 250,000
Sales price per unit 175Variable cost 85Fixed Costs 500000Required Working Capital 100000
Depreciation 360,000
We just added the total cost of plant with other costs and divided it by 5 years to get a straight line decpreciation.
This example is something similar to what many firms would deal with in the real world. We will first derive Free Cash Flows and then apply the NPV and IRR techniques that we learned earlier.
Cash Flow Ratios
Cash Flow Ratios…contd.
End of Chapter