ANALYSIS OF FINANCIAL STATEMENTS CASH FLOW ANALYSIS

Prof. Priyanka Oza MMS Sem II

Definitions associated with Cash Flow

CASH: It consists of cash in hand and demand deposits with banks. CASH EQUIVALENTS: These are short term highly liquid investments that are readily convertible into known amounts of changes in value. They have short maturity, say, of three months or less CASH FLOWS: These are inflows and outflows of cash and cash-equivalents

s Usefulness of the Statement of

Cash Flows
The information may help users assess the following aspects:

The entitys ability to generate future cash flows The entitys ability to pay dividends and meet obligations The reasons as to why net income and net cash flow from operating activities differ Cash and non-cash investing and financing activities during the year

The Cash Flow Statement

The cash flow statement provides information about:

the cash receipts (cash inflows), and uses of cash (cash outflows) during the period

Inflows and outflows are reported for:

operating activities, investing activities, and financing activities during the period

Statement of Cash Flows: Concept

Operating activities
Investing activities Financing activities

inflows

Cash Pool
outflows

Operating activities Investing activities Financing activities

Direct Method: Operating Activities

Cash Flows are classified in 3 types

Operating

activities involve producing and selling goods and services. Cash inflows from operating activities include cash received from customers for sales of goods and services. Cash outflows from this include payments to suppliers for materials, to employees for services, and to government for taxes.

Direct Method: Investing Activities

Cash Flows are classified in 3 types

Investing

activities involve acquiring and disposing fixed assets, buying and selling financial securities, and disbursing and collecting loans. Cash inflows from investing activities include receipts from the sale of assets, recovery of loans, and collection of dividend and interest. Cash outflows from this includes payments for the purchase of assets and disbursement of loans

Financing Activities

Financing activities involve raising money from the lenders and shareholders, paying interest & dividend, and redeeming loans & share capital. Cash inflows from financing activities include receipts from issue of securities from loans and deposits. Cash outflows include payment of interest on various forms of borrowings, payment of dividend, retirement of borrowings & redemption of capital

Direct Method: Concept

Cash Receipts From sale of goods and services to customers
less

Cash Payments To suppliers To employees For operating exp equals For interest
Cash flow from operations

From receipts of interest and dividends

For taxes

Cash Flow Statement: Direct Method

Cash receipts from customers:
= Revenue from credit sales + Decrease in A/Rec balances - Increase in A/Rec balances

Cash Flow Statement: Direct Method

Cash payments to suppliers: = Cost of goods sold + Increase in inventory - Decrease in inventory
+ Decrease in accounts payable - Increase in accounts payable

Cash Flow Analysis

Traditional SCF Life-Cycle Phases
Each cash flow activity will increase or decease over time depending upon the life-cycle of the companys products. Here is the most common pattern for revenues, net income, and cash flows.

Analyzing Cash Flow Information

Cash flow analysis can be used to address a variety of questions regarding a firm's cash flow dynamics: How strong is the firm's internal cash flow generation?

Is the cash flow from operations positive or negative? If it is negative, why? Is it because the company is growing? Is it because its operations are unprofitable? Or is it having difficulty managing its working capital properly?

Does the company have the ability to meet its shortterm financial obligations, such as interest payments, from its operating cash flow?

Can it continue to meet these obligations without reducing its operating flexibility?

How much cash did the company invest in growth?

Are these investments consistent with its business strategy? Did the company use internal cash flow to finance growth, or did it rely on external financing?

Did the company pay dividends from internal free cash flow, or did it have to rely on external financing?

If the company had to fund its dividends from external sources, is the company's dividend policy sustainable? Equity, short-term debt, or long-term debt? Is the financing consistent with the company's overall business risk?

What type of external financing does the company rely on?

Does the company have excess cash flow after making capital investments?

Free Cash Flow

If cash flow after investing in long term assets is not positive then the firm did not generate enough cash from operations to pursue longterm growth opportunities and must rely on external financing. These firms have less flexibility than firms that can generate the necessary funds internally. Cash flow after long term investments is cash flow available to both debt and equity holders.

Free Cash Flow

Payments to debt holders include interest and principal payments. Firms with negative free cash flow after investments in long term assets must borrow additional funds to meet their interest and principal payments. They can also reduce their investments in working capital, long term investments, or issue additional equity.

Free Cash Flow

Cash flow after payments to creditors is free cash flow available to owners. Payments to equity holders include dividends and stock repurchases. If firms pay dividends despite negative cash flows available to equity holders then they are borrowing to pay dividends. This is not sustainable in the long term.