To measure performance:
Cash flow to revenue = CFO / net revenue
Cash return on assets = CFO / average total assets
To measures coverage
Debt coverage = CFO / total debt
Interest coverage = [CFO + interest paid + taxes paid] / interest paid
Showing posts with label Understanding the Cash Flow Statement. Show all posts
Showing posts with label Understanding the Cash Flow Statement. Show all posts
Thursday, November 20
Disclosure Requirements
Under US GAAP, direct method must disclose the adjustments necessary to reconcile net income to cash flow from operating activities. It is not required under IFRS.
Under IFRS, interest or tax payments must be disclosed separately in the cash flow statement under either method. Under US GAAP, these items can be reported in cash flow statement or disclosed in the footnotes.
Under IFRS, interest or tax payments must be disclosed separately in the cash flow statement under either method. Under US GAAP, these items can be reported in cash flow statement or disclosed in the footnotes.
Indirect Method
This method is preferred by most firms because is shows a reconciliation from reported net income to cash provided by operations.
Steps:
1. Start with net income.
2. Add back non-cash expenses. (Such as depreciation and amortization)
3. Adjust for gains and losses on sales on assets.
4. Add back losses
5. Subtract out gains
6. Account for changes in all non-cash current assets.
7. Account for changes in all current assets and liabilities except notes payable and dividends payable.
In general, utilize the following rules:
Increase in assets = use of cash (-)
Decrease in assets = source of cash (+)
Increase in liability or capital = source of cash (+)
Decrease in liability or capital = use of cash (-)
Steps:
1. Start with net income.
2. Add back non-cash expenses. (Such as depreciation and amortization)
3. Adjust for gains and losses on sales on assets.
4. Add back losses
5. Subtract out gains
6. Account for changes in all non-cash current assets.
7. Account for changes in all current assets and liabilities except notes payable and dividends payable.
In general, utilize the following rules:
Increase in assets = use of cash (-)
Decrease in assets = source of cash (+)
Increase in liability or capital = source of cash (+)
Decrease in liability or capital = use of cash (-)
Direct method
Direct Method takes each item from income statement and convert to cash equivalent by adding or subtracting the changes in the corresponding balance sheet.
Cash Flow from Operations
Determine net cash flow by taking cash receipts from sales, adding interest and dividends, and deducting cash payments for purchases, operating expenses, interest and income taxes.
Cash Collections Receipts from Sales
= Sales + Decrease (or - increase) in Accounts Receivable
Cash payments for purchases
= cost of goods sold + increase (or - decrease) in inventory + decrease (or - increase) in accounts payable
Cash payments for operating expenses
= operating expenses + increase (or - decrease) in prepaid expenses + decrease (or - decrease) in accrued liabilities
Cash interest = interest expense - increase (or + decrease) interest payable + amortization of bond premium (or - discount)
Cash interest is the interest paid to debt holders in cash.
Cash payments for income taxes
= income taxes + decrease (or - increase) in income taxes payable
Cash payment for incometaxes is the actual cash paid in the form of taxes.
Note:
· Cash flow from investing and financing are computed the same way it was calculated under the indirect method.
Free Cash Flow (FCF)
Cash flow 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 flow = cash flow from operating activities - net capital expenditures (total capital expenditure - after-tax proceeds from sale of assets)
The FCF measure gives investors an idea of a company's ability to pay down debt, increase savings and increase shareholder value, and FCF is used for valuation purposes.
Free cash flow to the firm (FCFF)
Cash flow available to all investors including stockholders and debt holders.
Calculated from net income
FCFF = NI + non-cash charges +[Interest expense x (1-tax rate)] – net capital investment – working capital investment
Calculated from operating cash flow
FCFF = CFO +[interest expense x(1-tax rate)] – net capital expenditure
Free cash flow to equity (FCFE)
Cash flow available for distribution to the common shareholders, i.e. after all obligations have been paid.
FCFE = CFP- net capital expenditures +net borrowings
Cash Flow from Operations
Determine net cash flow by taking cash receipts from sales, adding interest and dividends, and deducting cash payments for purchases, operating expenses, interest and income taxes.
Cash Collections Receipts from Sales
= Sales + Decrease (or - increase) in Accounts Receivable
Cash payments for purchases
= cost of goods sold + increase (or - decrease) in inventory + decrease (or - increase) in accounts payable
Cash payments for operating expenses
= operating expenses + increase (or - decrease) in prepaid expenses + decrease (or - decrease) in accrued liabilities
Cash interest = interest expense - increase (or + decrease) interest payable + amortization of bond premium (or - discount)
Cash interest is the interest paid to debt holders in cash.
Cash payments for income taxes
= income taxes + decrease (or - increase) in income taxes payable
Cash payment for incometaxes is the actual cash paid in the form of taxes.
Note:
· Cash flow from investing and financing are computed the same way it was calculated under the indirect method.
Free Cash Flow (FCF)
Cash flow 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 flow = cash flow from operating activities - net capital expenditures (total capital expenditure - after-tax proceeds from sale of assets)
The FCF measure gives investors an idea of a company's ability to pay down debt, increase savings and increase shareholder value, and FCF is used for valuation purposes.
Free cash flow to the firm (FCFF)
Cash flow available to all investors including stockholders and debt holders.
Calculated from net income
FCFF = NI + non-cash charges +[Interest expense x (1-tax rate)] – net capital investment – working capital investment
Calculated from operating cash flow
FCFF = CFO +[interest expense x(1-tax rate)] – net capital expenditure
Free cash flow to equity (FCFE)
Cash flow available for distribution to the common shareholders, i.e. after all obligations have been paid.
FCFE = CFP- net capital expenditures +net borrowings
Direct vs indirect methods
Report noncash investing and financing activities
Information for the preparation of the statement of cash flows is derived from three sources:
· Comparative balance sheets
· Current income statements
· Selected transaction data (footnotes)
Some investing and financing activities do not flow through the statement of cash flow because they do not require the use of cash. Those activities must be disclosed in either a footnote or a supplemental schedule to the cash flow statements.
Examples Include:
· Conversion of debt to equity
· Conversion of preferred equity to common equity
· Acquisition of assets through capital leases
· Acquisition of long-term assets by issuing notes payable
· Acquisition of non-cash assets (patents, licenses) in exchange for shares or debt securities
· Comparative balance sheets
· Current income statements
· Selected transaction data (footnotes)
Some investing and financing activities do not flow through the statement of cash flow because they do not require the use of cash. Those activities must be disclosed in either a footnote or a supplemental schedule to the cash flow statements.
Examples Include:
· Conversion of debt to equity
· Conversion of preferred equity to common equity
· Acquisition of assets through capital leases
· Acquisition of long-term assets by issuing notes payable
· Acquisition of non-cash assets (patents, licenses) in exchange for shares or debt securities
Cash flow from financing activities (CFF)
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:
Financial Activities
· related to transactions for raising or repaying capital, include
· issue or repay debt
· issue or repurchasing stock
· paying dividend
Cash inflow (+)
· Sale of equity securities
· Issuance of debt securities
Cash outflow (-)
· Dividends to shareholders
· Redemption of long-term debt
· Redemption of capital stock
Financial Activities
· related to transactions for raising or repaying capital, include
· issue or repay debt
· issue or repurchasing stock
· paying dividend
Cash inflow (+)
· Sale of equity securities
· Issuance of debt securities
Cash outflow (-)
· Dividends to shareholders
· Redemption of long-term debt
· Redemption of capital stock
Cash Flow from Investing Activities (CFI)
Cash flow that arises from investment activities such as the acquisition or disposition of current and fixed assets.
Investing activities
related to acquire or dispose of long term assets, include
· purchase and sales of property, plant, equipment
· purchase and sales of securities issued by other firm
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
Investing activities
related to acquire or dispose of long term assets, include
· purchase and sales of property, plant, equipment
· purchase and sales of securities issued by other firm
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
Cash Flow from Operating Activities (CFO)
Cash flow that arises from normal operations such as revenues and cash operating expenses net of taxes.
Operating activities
· related to normal production and trade, include
· sales and related costs
· pay taxes
· buy short-term assets
· take long term liabilities to support ordinary business
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 expenses
Operating activities
· related to normal production and trade, include
· sales and related costs
· pay taxes
· buy short-term assets
· take long term liabilities to support ordinary business
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 expenses
Operating, Investing and Financial Activities
Under US GAAP
· Cash Flow from Operating Activities (CFO)
· Cash Flow from Investing Activities (CFI)
· Cash flow from financing activities (CFF)
Under IFRS
· Interest and dividends received may be classified either CFO or CFI
· Dividends paid to shareholders and interest paid on debt may be classified as either CFO or CFF.
· Income taxes are reported as operating activities unless the expenses can be tied to an investing or financing transaction.
· Cash Flow from Operating Activities (CFO)
· Cash Flow from Investing Activities (CFI)
· Cash flow from financing activities (CFF)
Under IFRS
· Interest and dividends received may be classified either CFO or CFI
· Dividends paid to shareholders and interest paid on debt may be classified as either CFO or CFF.
· Income taxes are reported as operating activities unless the expenses can be tied to an investing or financing transaction.
Statement of Cash Flow and Segregation of Cash Flows
Statement of Cash Flow
· Report the impact of a firm's operating, investing and financial activities on cash flows over an accounting period.
· Convert the accrual basis of accounting used in the income statement and balance sheet back to a cash basis.
Analyst will consider:
· 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
Segregation of Cash Flows
· Operating activities
· Investing activities
· Financing activities
Operating activities
+ investing activities
+ Financing activities
___________________
= change in cash balance
+ Beginning cash balance
_____________________
= Ending cash balance
· Report the impact of a firm's operating, investing and financial activities on cash flows over an accounting period.
· Convert the accrual basis of accounting used in the income statement and balance sheet back to a cash basis.
Analyst will consider:
· 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
Segregation of Cash Flows
· Operating activities
· Investing activities
· Financing activities
Operating activities
+ investing activities
+ Financing activities
___________________
= change in cash balance
+ Beginning cash balance
_____________________
= Ending cash balance
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