1. Using the information provided and the statement of cash
flows for Year 5 in Exhibit 3.21, identify any signals that
Sunbeam was experiencing operating difficulties and was in
RELL RCE TT TTT
2. Using information in the statement of cash flows for Year 6,
identify indicators of the turnaround efforts and any relations
among cash flows that trouble you.
3. Using information in the statement of cash flows for Year 7,
indicate any signals that the firm might have engaged in
aggressive revenue recognition and had not yet fixed its general |
operating problems. |
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Slide 1
Chapter 3
Income Flows versus Cash Flows: Understanding the
Statement of Cash Flows
Chapter: 03
*
Chapter: 03
Statement of Cash Flow
Provides key insights into:
All sources and uses of cash during a reporting period summarized into three primary business activities.
The link between the income statement and balance sheet.
A company’s ability to generate sufficient cash to pay cu
ent obligations, repay debt, and pay dividends.
Chapter: 03
*
Chapter: 03
Statement of Cash Flow
A firm’s cash flows will differ from net income each period because:
Cash receipts from customers do not necessarily occur in the same period the firm recognizes revenues.
Cash expenditures do not necessarily occur in the same period firms recognize expenses.
Some cash inflows and outflows from investing and financing activities never flow through the income statement.
Chapter: 03
*
Chapter: 03
Primary Elements of Statement of Cash Flows
*
The Relations among the Cash Flow Activities
The three sections of the statement of cash flows follow this logical progression:
Operating activities:
Activities directly involving the production and delivery of goods and services.
Investing activities:
Cash activities of expenditures for and proceeds from dispositions of assets, such as property, equipment, investment in securities.
Financing activities:
Cash received and paid to external capital providers such as banks and shareholders.
*
Statement of Cash Flows
The sum of the subtotals for net operating, investing, and financing activities reconciles with the increase or decrease in cash and cash equivalents.
Cash equivalents include short-term, highly liquid investments which are readily convertible to cash with little risk of loss.
Examples: very short-term treasury bills, commercial paper, and money market funds.
Restricted cash is also included in cash and cash equivalents.
Interest and dividends received - Operating activities.
Note disclosure of established policy of cash equivalent classification.
*
Noncash Investing and Financing Activities
Significant investing and financing activities not affecting cash reported in separate schedule.
Examples
Acquiring an asset by incu
ing debt payable to seller.
Acquiring use of an asset by entering into a lease agreement.
Converting debt into common stock or other equity securities.
Exchanging noncash assets or liabilities for other noncash assets or liabilities.
Chapter: 03
*
Chapter: 03
Firm’s Life Cycle
Chapter: 03
*
Impact
of product life cycle on
cash flows.
Chapter: 03
Cash Flows and a Firm’s Life Cycle
Cash flows will vary over a firm’s four life cycle phases:
Introductory Stage:
Revenues low, net income may be negative
Negative cash flows from operations
Negative cash flows from investing activities
External financing (positive cash flow from financing)
Chapter: 03
*
Chapter: 03
Changes in non-cu
ent accounts will be changes from investing activities.
Cash Flows and a Firm’s Life Cycle
Growth Stage:
Increasing revenues, net income becomes positive
Increasing cash flows from operations
Continuing negative cash flows from investing activities
Decreasing positive cash flows from financing activities
Chapter: 03
*
Chapter: 03
Cash Flows and a Firm’s Life Cycle
Maturity Stage:
Peak net income, positive cash flows from operations
Cash flows from investing activities may begin to increase
Cash flows from financing activities may become negative (repayment of det, stock repurchases, etc.)
Chapter: 03
*
Chapter: 03
Product Life Cycle
Decline Stage:
Revenues decrease, net income decreases (may become negative)
Cash flows from operations decreases
Cash flows from investing activities positive (as firm divests)
Cash flows from financing activities negative
Chapter: 03
*
Chapter: 03
Cash Flows from Operating Activities
U.S. GAAP allows choice of presentation:
Direct Method
Reports transactions in logical categories that resulted in cash paid or received during the accounting period.
Indirect Method
Reconciles reported net income (accrual basis) to cash flows from operations.
Working backwards to convert that amount to a cash basis.
Adjustments for noncash effects and changes in operating assets and liabilities.
Chapter: 03
*
Chapter: 03
Noncash Effect Adjustments
The presentation of cash flows from operations under the indirect method involves two types of adjustments to net income:
Working capital – changes in cu
ent asset and cu
ent liabilities.
Noncash components of income adjustments
Chapter: 03
*
Chapter: 03
Operating Working Capital Adjustments
Increase/decrease in assets related to an income statement component.
i.e. Accounts receivable, Inventories, Prepaid Expenses
Increase/decrease in liabilities related to an income statement component.
i.e. Accounts payable, Income tax payable
Chapter: 03
*
Chapter: 03
Other Noncash Components of Income Adjustments
Other noncash components of net income must be reversed or “adjusted out” of the starting point of the statement of cash flows:
Depreciation and amortization
Defe
ed income taxes
Employee stock option expense
Gain/loss on disposition of asset
Pension cost
Impairment charges
Chapter: 03
*
Chapter: 03
Why Do Adjustments Rarely Equal the Changes in Assets and Liabilities on the Balance Sheet?
The four primary reasons that changes on the balance sheet do not match the adjustments on the statement of cash flows include:
Acquisitions and divestitures
Noncash transactions
Changes in contra accounts
Foreign cu
ency translation
Chapter: 03
*
Chapter: 03
Usefulness of the Statement of Cash
Flows for Accounting and Risk Analysis
In addition to the analysis of account quality, the statement of cash flows is useful for identifying a firm’s strategy and where a firm is in its life cycle as well as liquidity and credit risk analysis.
It helps Gauge whether reported net income reflects the underlying economics of the business.
Highlights accounting accruals, which can provide insight into the overall sustainability and quality of a firm’s reported earnings.
Chapter: 03
*
Chapter: 03