Presentation of Issues in Cash Flow Analysis

Presented By: Submitted To:

Group D Dr.Devendra Singh

PGDM/A

Cash flow statement

• In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.

• Essentially, the cash flow statement is concerned with the flow of cash in and cash out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet.

• As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7

(IAS 7), is the International Accounting Standard that deals with cash flow statements.

People and groups interested in cash flow statements include:

• Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses

• Potential lenders or creditors, who want a clear picture of a company's ability to repay

• Potential investors, who need to judge whether the company is financially sound

Contd…

• Potential employees or contractors, who need to know whether the company will be able to afford compensation

• Shareholders of the business.

The cash flow statement is intended to• provide information on a firm's liquidity

and solvency and its ability to change cash flows in future circumstances

• provide additional information for evaluating changes in assets, liabilities and equity

• improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods

• indicate the amount, timing and probability of future cash flows

• The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.

Overview of the Statement of Cash Flows

The statement of cash flows …

(a) explains the reasons for a change in cash.

(b) classifies the reasons for the change as an operating, investing or financing activity.

(c) reconciles net income with cash flow from operations.

3 CLASSIFICATIONS OF CASH FLOW

OPERATION

INVESTING

FINANCING

Define the Three Classifications of Cash Flows

1.Operations – cash flows related to production,selling goods and services; that is, the principle business of the firm.

2. Investing – cash flows related to the acquisition or sale of noncurrent assets.

3. Financing – long term and short term cash flows related to liabilities and owners’ equity; dividends are a financing cash outflow.

operating cash flows include

• Receipts from the sale of goods or services• Receipts for the sale of loans, debt or equity

instruments in a trading portfolio• Interest received on loans• Dividends received on equity securities• Payments to suppliers for goods and services• Payments to employees or on behalf of

employees• Interest payments (alternatively, this can be

reported under financing activities in IAS 7, and US GAAP)

Examples of Investing activities are

• Purchase of an asset (assets can be land, building, equipment, marketable securities, etc.)

• Loans made to suppliers or customers

Financing activities include

• Proceeds from issuing short-term or long-term debt

• Payments of dividends• Payments for repurchase of company shares• Repayment of debt principal, including capital

leases• For non-profit organizations, receipts of donor-

restricted cash that is limited to long-term purposes

Components of the Statement of Cash Flows

Operation

Investing

financing

Cash received fromsale of goodsand services

Cash received fromsale of goodsand services

Cash paid foroperating goods

and services

Cash paid foroperating goods

and servicescash flow

from operations

cash flowfrom operations- =

Cash received fromsales of investments

and PP&E

Cash received fromsales of investments

and PP&E

Cash paid for ac-quisition of invest-ments and PP&E

Cash paid for ac-quisition of invest-ments and PP&E

cash flowfrom investing

cash flowfrom investing- =

Cash received fromissue of debt or

capital stock

Cash received fromissue of debt or

capital stock

Cash paid for dividends and

reacquisition of debt or capital stock

Cash paid for dividends and

reacquisition of debt or capital stock

cash flowfrom financing

cash flowfrom financing- =

Net change in cashfor the period

Net change in cashfor the period

=

+ -

+ -

Changes in Specific Accounts

Non-cash

assets

Liability &

Share-

Holder’s

equity

If noncash assetsare increased,

then cash was spent,so cash is an outflow,

so negative sign.

If noncash assetsare increased,

then cash was spent,so cash is an outflow,

so negative sign.

If noncash assetsare decreased,

then they provided cashso cash is an inflow,

so positive sign.

If noncash assetsare decreased,

then they provided cashso cash is an inflow,

so positive sign.

If liab. or S.E.increased, then cash

was obtained,so cash is an inflow,

so positive sign.

If liab. or S.E.increased, then cash

was obtained,so cash is an inflow,

so positive sign.

If liab. or S.E.decreased, then cash

was spent,so cash is an outflow,

so negative sign.

If liab. or S.E.decreased, then cash

was spent,so cash is an outflow,

so negative sign.

increase decrease

Preparation methods

Indirect methodDirect method

DIRECT METHOD

Cash flows from (used in) operating activities

Cash receipts from customers

27,500

  Cash paid to suppliers and employees

(20,000)

  Cash generated from operations (sum)

7,500

  Interest paid (2,000)

Income taxes paid (4,000)

  Net cash flows from operating activities (A)

1,500

Cash flows from (used in) investing activities

Proceeds from the sale of equipment

7,500

Dividends received 3,000

Net cash flows from investing activities(B)

10,500

Dividends paid (2,500)

  Net cash flows used in financing activities(C)

(2,500)

Net increase in cash and cash equivalents

(A+B+C) 9,500

Cash and cash equivalents, beginning of year

1,000

Cash and cash equivalents, end of year

10,500

Cash flows from (used in) financing activities

Indirect method

Period ending 12/31/2007 12/31/2006 12/31/2005

Net income 21,538 24,589 17,046

Citigroup Cash Flow Statement

Depreciation and amortization 2,790 2,592 2,747

Adjustments to net income 4,617 162 2,910

Decrease (increase) in accounts receivable

12,503 17,236 --

Increase (decrease) in liabilities (A/P, taxes payable)

131,622 19,822 37,856

Decrease (increase) in inventories -- -- --

Increase (decrease) in other operating activities

(173,057) (33,061) (62,963)

Net cash flow from operating activities

13 31,799(2,404)

Operating activities, cash flows provided by or used in:

Capital expenditures (4,035) (3,724) (3,011)

Investments (201,777) (71,710) (75,649)

Other cash flows from investing activities 1,606 17,009 (571)

Net cash flows from investing activities (204,206) (58,425) (79,231)

Dividends paid (9,826) (9,188) (8,375)

Sale (repurchase) of stock (5,327) (12,090) 133

Increase (decrease) in debt 101,122 26,651 21,204

Other cash flows from financing activities 120,461 27,910 70,349

    Net cash flows from financing activities 206,430 33,283 83,311

Effect of exchange rate changes 645 (1,840) 731

Net increase (decrease) in cash and cash equivalents

2,882 4,817 2,407

Investing activities, cash flows provided by or used in:

Comparison of Cash Flow to Net Income

• Net income is an accrual based concept and purports to show the long-term.

• Cash flows purport to show the short term.

• Consider the outlook for both short-term and long-term and consider that each is either good or poor.

• A strong growing firm would show both good long-term and good short-term outlooks.

Contd…

• A failing firm would show both poor long-term and poor short term outlooks.

• What about a firm with good cash flows (short-term) but poor net income (long-term)?

• What about a firm with poor cash flows (short-term) but good net) income (long-term?

Issues To Cash Flow Analysis

• Time horizon for analysis of cash flow

• Biases in cash flow statements

• Time Value Of Money

ISSUES IN CASH FLOW ANALYSIS

Time horizon for analysis of cash flow •Physical life of the plant•Technologies life of the plant•Product market life of the plant•Investment planning horizon of the firm

Biases in cash flow statements•Over statement of profitability•Understatement of profitability

Time value of money •Cost of capital

Issues To Cash Flow Analysis

• Time horizon for analysis of cash flow :

Physical life of the plantTechnologies life of the plantProduct market life of the plantInvestment planning horizon of the firm

Biases in cash flow statements

• As a cash flows have to be forecast far into the future, errors in estimation are bound to occur. Yet, given the critical importance of cash flow forecasts in projects evaluation, adequate care should be take to guard certain biases which may lead to overstatement or understatement of the true project profitability

Overstatement of profitability

Intentional overstatement

Lack of experience

Myopic euphoria

Capital rationing

Understatement of profitability

Salvage value are under estimated

Intangible benefits are ignored

The value of future option is overlooked

Time value of money

• Cost of capital

Leasing

Long term financing

Working capital policy Cost of all inputs

Depreciation policy

•

CASE STUDY

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