The Statement of Cash Flows

Cash, liquidity, and the cash flow cycle

The cash flow statement preparing a cash flow statement
Its as easy as 1,2,3

Cash and Liquidity

Cash includes highly liquid marketable securities.

These are items that can be converted to cash quickly without loss of value. ( Treasury bills, notes, negotiable CDs, and commercial paper.)

Liquidity refers to a firms ability to meet financial obligations when due, and the ability to fund investment opportunities.

A firms cash flow cycle significantly impacts its liquidity.

The Cash Flow Cycle

The movement of cash through fixed assets and inventory, into accounts receivable, and finally back to cash. Factors affecting the cash flow cycle

inventory turnover, collection period, payable period

THE CASH CONVERSION CYCLE

A/R

Cash

Sale

+ A/R Period + Inventory Period - A/P Period = Cash Conversion Period The length of time between when we pay cash for inventory and collect cash from our customers

Inventory Labor Assets, Taxes, Profits...

The Statement of Cash Flows

Focuses on the liquidity of a business, by measuring cash inflows and outflows.

Shows where money comes from and where it goes

Three components of cash flow statement: +/- Operating Cash Flows +/- Investing Cash Flows

+/- Financing Cash Flows

The Cash Flow Statement - Operating Activities - Investing Activities - Financing Activities

Cash flow from operations: Net Income Depreciation Decrease in Accounts Rec. Increase in Inventory Increase in Accounts Payable Decrease in Accruals Operating cash flow Cash flow from investing activities: Purchase Plan & Equipment Investing cash flow

1,000 500 100 (1,200) 600 (100) 900

(2,000) (2,000) 1,200 800 (500) 1,500 400 1,000 1,400

Cash flow from financing activities: Increase in Long-term Debt Sale of Common Stock Dividends Financing cash flow
Change in cash Beginning cash Ending cash

Operating Activities
Inflows:
Sale of goods Revenue from services Interest income

Outflows:
Pay wages Purchase inventory Pay other expenses Pay interest Pay taxes

Investing Activities
Inflows:
Sale of fixed assets Sale of investment securities

Outflows:
Purchase of fixed assets Purchase of investment securities

Financing Activities
Inflows:
New loans Sale of stock

Outflows:
Repayment of loans Repurchase of a firms own securities (treasury stock) Payment of dividends

Preparing a Cash Flow Statement

(Three easy steps!)

1. Calculate the change in all balance sheet accounts.

2. Identify whether the changes result in increases or decreases in cash flows.

3. Identify the source of the changes: operating, investing, or financing activities.

Note: Some changes involve multiple activities.

Use the balance sheet to explain the change in cash!

The balance sheet or accounting equation: A=L+E Since the accounting equation must remain in balance:

A = L + E
The change in cash can be written as:

cash = L + E - (non-cash assets)

The change in cash:

The change in cash can be explained in terms of all other balance sheet accounts: cash = L + E - (non-cash assets)

CASH FLOW RULES

Asset Increase = Asset Decrease = Liability Increase = Liability Decrease =

Use Source Source Use

BUILDING THE STATEMENT OF CASH FLOWS

Belfry Company Balance Sheet For the Period Ended 12/31/00

ASSETS
Cash Accts. Receivable Inventory CURRENT ASSETS Fixed Assets Plant & Equip. Accum. Depr. Net TOTAL ASSETS

12/31/99
$1,000 3,000 2,000 $6,000

12/31/00
$1,400 2,900 3,200 $7,500

LIABILITIES

12/31/99

12/31/00 $2,100 400 $2,500 $6,200 1,300 2,000 $3,300 $12,000

Accts. Payable Accruals

$1,500 500 CURRENT LIABIL. $2,000 Long-term debt Common Stock Retained Earn
TOTAL EQUITY

$5,000 500 1,500 $2,000

$4,000 (1,000) $3,000 $9,000

$6,000 (1,500) $4,500 $12,000

TOTAL LIABILITIES AND EQUITY $9,000

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The change in Retained Earnings

Beginning RE + Net Income - Dividends Ending RE $1,500 1,000 - 500 $2,000

BUILDING THE STATEMENT OF CASH FLOWS

Belfry Company Income Statement For the Period Ended 12/31/00 Sales COGS Gross Margin Expense Depreciation EBIT Interest EBT Tax Net Income $10,000 6,000 $ 4,000 $ 1,600 500 $ 1,900 400 $ 1,500 500 $ 1,000

The Cash Flow Statement - Operating Activities - Investing Activities - Financing Activities

Cash flow from operations: Net Income Depreciation Decrease in Accounts Rec. Increase in Inventory Increase in Accounts Payable Decrease in Accruals Operating cash flow Cash flow from investing activities: Purchase Plan & Equipment Investing cash flow

1,000 500 100 (1,200) 600 (100) 900

(2,000) (2,000) 1,200 800 (500) 1,500 400 1,000 1,400

Cash flow from financing activities: Increase in Long-term Debt Sale of Common Stock Dividends Financing cash flow
Change in cash Beginning cash Ending cash

CASH COVERAGE
A variation on TIE to better get at cash flow

Cash coverage =

EBIT + depreciation interest $1,900 + $500 = 6.0 $400

Cash coverage =

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FIXED CHARGE COVERAGE

A variation on TIE to include lease payments as fixed financial charges equivalent to interest

Fixed charge coverage =

EBIT + lease payments interest + lease payments

$1,900 + $700 Fixed charge coverage = = 2.4 $400 + $700

Interpretation: Failure from excessive debt is due to the inability to pay
interest (fixed) charges which depend on the amount of debt and the interest rate. Coverage ratios measure financial charges relative to available income.
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