Chapter 6: Understanding Cash Flow Statements

Transcript Chapter 6: Understanding Cash Flow Statements

CHAPTER 6 UNDERSTANDING CASH FLOW STATEMENTS

Presenter’s name Presenter’s title dd Month yyyy

OVERVIEW

APPLE, Inc.

CLASSIFICATION OF ACTIVITIES ON THE STATEMENT OF CASH FLOWS

Operating activities: Deliver or produce goods for sale and provide services. Examples: • Receive cash from customers • Pay cash to suppliers • Pay cash for operating expenses.

Investing activities: Buy or sell long-term assets and other investments. Examples: • Property, plant, and equipment (PP&E) • Other companies’ securities (that are not cash equivalents) Financing activities: Obtain or repay capital. Examples: • Borrow from creditors and repay the principal • Issue or repurchase stock • Pay dividends Copyright © 2013 CFA Institute 5

COLGATE: CASH FLOWS CLASSIFIED BY ACTIVITY

Net cash provided by operations Net cash used in investing activities Net cash used in financing activities Effect of exchange rate changes Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year

2011

2,896 (1,213) (1,242) (53)

2010

3,211 (658) (2,624) (39)

2009

COLGATE’S OPERATING CASH FLOWS

COLGATE’S INVESTING CASH FLOWS

COLGATE’S FINANCING CASH FLOWS

COMMON-SIZE STATEMENT OF CASH FLOW FOR COLGATE (ABBREVIATED)

Each line item is presented as a percentage of net revenue.

2011 2010 2009 Operating Activities Net income including noncontrolling interests Net cash provided by operations Net cash used in investing activities Net cash used in financing activities 15.3% 14.9% 15.6% 17.3% 20.6% 21.4% –7.2% –4.2% –5.5% –7.4% –16.9% –14.8% Copyright © 2013 CFA Institute 10

COLGATE’S CASH FLOWS: SUMMARY

• Overall, $323 million net increase in cash over three years, from $555 million at the beginning of 2009 to $878 million at the end of 2011. • Colgate consistently obtains its cash inflow from operating activities and uses cash in investing and financing activities —a typical profile for a mature company.

• Colgate’s operating cash flow exceeded net income in every year—a desirable profile for a mature company.

• In every year, Colgate’s cash from operations was more than enough to cover its capital expenditures. • The amount of dividends paid has steadily increased over the past three years.

• Amount of operating cash after paying for capital expenditures was more than enough to cover the dividend payments.

• In summary, Colgate’s cash flows represent a positive profile.

COLGATE’S OPERATING CASH FLOWS: INDIRECT METHOD

INDIRECT VS. DIRECT METHOD FOR PRESENTING OPERATING CASH FLOWS

Indirect method

• Begins with net income and adjusts to operating cash flows.

• Arguments for: - Clearly shows the reasons for differences between net income and operating cash flows.

- Mirrors forecasting approach that begins with forecast of income, then derives cash flows.

Direct method

• Shows each cash inflow and outflow related to receipts and disbursements.

• Arguments for: - Provides information on the specific sources of operating cash receipts and payments.

- Does not net.

INDIRECT VS. DIRECT METHOD FOR PRESENTING OPERATING CASH FLOWS

Indirect method

• IFRS permit.

• U.S. GAAP permit.

• Used by the majority of companies, whether reporting under IFRS or U.S. GAAP.

Direct method

• IFRS encourage.

• U.S. GAAP encourage, but requires a reconciliation of net income to cash flow from operating activities.

TECH DATA’S OPERATING CASH FLOWS: EXAMPLE OF DIRECT METHOD

CLASSIFICATION OF CASH FLOWS UNDER IFRS VS. U.S. GAAP

Item  Interest received    Interest paid Dividends received Dividends paid IFRS Operating or investing Operating or financing Operating or investing Operating or financing  Bank overdrafts  Taxes paid U.S. GAAP Operating Operating Operating Financing Considered part of cash equivalents Generally operating, but a portion can be allocated to investing or financing Not considered part of cash and cash equivalents; classified as financing.

PORTUGAL TELECOM’S OPERATING CASH FLOWS: ANOTHER EXAMPLE OF DIRECT METHOD

PORTUGAL TELECOM’S INVESTING CASH FLOWS

PORTUGAL TELECOM’S FINANCING CASH FLOWS

NONCASH INVESTING AND FINANCING ACTIVITIES

•

Noncash transaction:

Any transaction that does not involve an inflow or outflow of cash (e.g., exchange of one no-monetary asset for another).

• Not incorporated in the cash flow statement.

• Must be disclosed.

Cash at beginning and end of year links to the balance sheet.

PREPARATION OF THE STATEMENT OF CASH FLOWS: STEPS

• • • • •

Step 1. Determine the change in cash.

Step 2. Determine the net cash flow from operating activities.

Use both the current year's income statement and information on current assets and liabilities from the comparative balance sheets.

Step 3. Determine net cash flows from investing and financing activities.

Examine all other changes in the balance sheet accounts.

Step 4. Include summary of net increase (decrease) in cash, cash at beginning, and cash at end.

Step 5. Disclose any significant noncash transactions separately at the bottom of the statement.

EXAMPLE

A new company has the following transactions: • Sells stock for $100.

• Buys a building for $50. Its primary line of business is selling a service, so it has no COGS (cost of goods sold) and no inventory. • Makes credit sales of $100, and subsequently collects $90. • Accrues SG&A (selling, general, and administrative) expense of $40, and subsequently pays cash of $25. • Records depreciation expense of $10. Copyright © 2013 CFA Institute 24

STEP 1. DETERMINE THE CHANGE IN CASH

This step is straightforward. The information is on the comparative balance sheets. Change was $115.

Cash Accounts receivable Building Accumulated depreciation Total assets Accounts payable Common stock Retained earnings Total liabilities and equity Beginning balance 0 0 0 0 0 0 0 0 0 Ending balance 115 10 50 (10) 165 15 100 50 165 Change 115 10 50 (10) 165 15 100 50 165 Copyright © 2013 CFA Institute 25

STEP 2. DETERMINE THE NET CASH FLOW FROM OPERATING ACTIVITIES, BEGINNING WITH NET INCOME FOR THE INDIRECT METHOD

Income statement Credit sales SG&A expense Depreciation expense Net income

Net income + Depreciation expense – Change in receivables + Change in payables Cash from operating activities $ 50 +10 –10 +15 $ 65

$ 100 –40 –10 $ 50

STEP 3. DETERMINE NET CASH FLOWS FROM INVESTING AND FINANCING ACTIVITIES

Examine all other changes in the balance sheet accounts.

Cash Accounts receivable Building Accumulated depreciation Total assets Accounts payable Common stock Retained earnings Total liabilities Beginning Ending balance 0 0 balance 115 Change 115  10 10  In first step In operating 0 0 0 0 0 0

50 (10) 165 15 100 50 165 50 ?

(10)  In operating 165 15  In operating 100 50  ?

In operating* 165

*There are no dividends in this example; all changes in retained earnings are from net income

INVESTING CASH FLOWS

• Determine investing cash flows by examining changes in long-term assets. In this example, we have only PP&E.

• Beginning PP&E + Purchases – Dispositions = Ending PP&E • Ending PP&E – Beginning PP&E = Purchases – Dispositions (i.e., investing cash flows) • PP&E increased by $50, indicating cash spent acquiring PP&E.

•

We also know this from the transaction list at the beginning of the example.

FINANCING CASH FLOWS

• Determine financing cash flows by examining changes in debt and equity accounts. In this example, we have only common stock.

• Beginning stock + Issuances – Repurchases = Ending stock • Ending stock – Beginning stock = Issuances – Repurchases • Stock account increased by $100, indicating cash was raised by issuing stock.

•

We also know this from the transaction list at the beginning of the example.

STEP 3. DETERMINE NET CASH FLOWS FROM INVESTING AND FINANCING ACTIVITIES

Examine all other changes in the balance sheet accounts.

Cash Accounts receivable Building Accumulated depreciation Total assets Accounts payable Common stock Retained earnings Total liabilities Beginning Ending balance 0 0 0 0 balance 115 Change 115  10 50 (10) 10  In first step In operating 50  In investing (10)  In operating 0 0 0 0

165 15 100 50 165 165 15  100  50  In operating In financing In operating* 165

*There are no dividends in this example, so all change was net income.

INDIRECT METHOD

Company ABC Cash Flow Statement for the period ended

Operating cash flow Net income Depreciation expense Increase in accounts receivable Increase in accrued liabilities Total operating cash flow Investing cash flow Capital expenditure Financing cash flow Issue of stock Total change in cash Beginning cash balance Ending cash balance Copyright © 2013 CFA Institute 50 + 10 – 10 + 15 + 65 – 50 + 100 + 115 0 115 31

ALTERNATIVE STEP 2. DETERMINE THE NET CASH FLOW FROM OPERATING ACTIVITIES, BEGINNING WITH EACH LINE ITEM FOR THE DIRECT METHOD

Income statement Credit sales SG&A expense Depreciation expense Net income

Cash from customers Cash paid for expenses Cash from operating activities

$ 100 –40 –10 $ 50

DIRECT METHOD

Company ABC Cash Flow Statement for the period ended

Cash collected from customers Cash paid to suppliers Total operating cash flow Investing cash flow Capital expenditure Financing cash flow Issue of stock Total change in cash Beginning cash balance Ending cash balance Copyright © 2013 CFA Institute + 90 – 25 + 65 – 50 + 100 + 115 0 115 33

FREE CASH FLOW

Free Cash Flow to the Firm (FCFF):

Cash flow available to the company’s suppliers of capital (debt

and

equity).

- After all operating expenses (including taxes) have been paid.

- After all operating investments have been made for fixed capital

and

working capital.

Free Cash Flow to Equity (FCFE):

company’s common stockholders. Cash flow available to the - After all operating expenses (including taxes) have been paid.

- After borrowing costs (principal and interest) have been paid.

- After all operating investments have been made for fixed capital

and

COMPUTE FCFF

Net Income + Noncash charges – Working capital investment + Interest expense × (1 – Tax rate) – Fixed capital investments = FCFF Interest, a cash flow available to one of the capital providers, which has been deducted from net income, so it must be added back Copyright © 2013 CFA Institute 35

FCFF CAN ALSO BE COMPUTED FROM CASH FLOW FROM OPERATING ACTIVITIES

Net income + Noncash charges – Working capital investment = Cash from operating activities CFO already has added noncash items to net income and deducted working capital investment + Interest Expense × (1 – Tax rate) – Fixed capital investments = FCFF Copyright © 2013 CFA Institute 36

COMPUTE FCFE

Net Income + Noncash charges – Working capital investment – Fixed capital investment + Net new borrowing (or minus net debt repayments) = FCFE Positive FCFE means that the company has an excess of operating cash flow over amounts needed for capital expenditures and repayment of debt.

CASH FLOW PERFORMANCE RATIOS

Ratio

Cash flow to revenue Cash return on assets Cash return on equity Cash to income Cash flow per share CFO CFO CFO CFO

Calculation

÷ Net revenue ÷ Average total assets ÷ Average shareholders’ equity ÷ Operating income (CFO – Preferred dividends) ÷ Number of common shares outstanding

What It Measures

Operating cash generated per dollar of revenue Operating cash generated per dollar of asset investment Operating cash generated per dollar of owner investment Cash generating ability of operations Operating cash flow on a per-share basis Copyright © 2013 CFA Institute 38

CASH FLOW COVERAGE RATIOS

Ratio

Debt coverage

Calculation

CFO ÷ Total debt Interest coverage (CFO + Interest paid + Taxes paid) ÷ Interest paid Reinvestment CFO ÷ Cash paid for long Debt payment Dividend payment Investing and term assets CFO ÷ Cash paid for long term debt repayment CFO ÷ Dividends paid CFO ÷ Cash outflows for financing investing and financing activities

What It Measures

Financial risk and financial leverage Ability to meet interest obligations Ability to acquire assets with operating cash flows Ability to pay debts with operating cash flows Ability to pay dividends with operating cash flows Ability to acquire assets, pay debts, and make distributions to owners Copyright © 2013 CFA Institute 39

SUMMARY

• The cash flow statement provides information about a company’s

cash receipts

and

cash payments

during an accounting period. • Cash flows are categorized as operating, investing, and financing.

• Compared with U.S. GAAP, IFRS provide companies with more choices in classifying some cash flow items as operating, investing, or financing activities.

• The operating activities section of the statement of cash flows can be presented using the direct method or the indirect method.

• Two approaches to developing common-size cash flow statements are the total cash inflows/total cash outflows method and the percentage of net revenues method.

• Cash flow ratios measure a company’s profitability, performance, and financial strength.