True or False: A statement of cash flow (SCF) documents the changes in a company s cash position over an accounting period.

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ENGM 401 & 620

ENGM 401 & 620 -- X1

X1

Fundamentals of Engineering Finance

Fall

Fall 2010

2010

Lecture 15:

Statement of Cash Flow (2)

Let all the learned say what they can, Let all the learned say what they can,

Tis

Tis ready money makes the man . ready money makes the man . --Shakespeare Shakespeare

M.G. Lipsett M.G. Lipsett

Department of Mechanical Engineering Department of Mechanical Engineering

University of Alberta University of Alberta

http://www.ualberta.ca/~mlipsett/ENGM401_620/ENGM401_620.htm

Department of Mechanical Engineering Engineering Management Group

Cash Flow Statements

• True or False: A

statement of cash flow

(SCF) documents

the changes in a company’s cash position over an

accounting period.

• Which is not a category of funds flow?

a) Operating activities. b) Financing activities. c) Investing activities. d) Diversifying activities.

• True or False: An increase in a liability is a source of funds.

Cash Flow Statements

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ENGM 401 & 620 – Fundamentals of Engineering Finance, Lecture 15: Statement of Cash Flow (2)

Statement of Cash Flow (SCF)

• To complete a statement of cash flow (SCF), two balance

sheets (start of period and end of period) and the income

statement for the intervening time period are used

– The sources and uses of funds are balanced to cash (including short term debt)

• The SCF gives a company’s Net Cash position

– the breakdown between cash and short term borrowings, if a company has both, is arbitrary

• The cash flow statement answers the question “

where did

our money come from, and where did it go

?”

• Note: the statement of cash flow used to be called a

statement of change in financial position

Statement of Cash Flow (SCF)

Structure of the Statement of Cash Flow

••

Operating Activities (OA)

:

– Net income is shown in full, not retained earnings ! – Add back in depreciation and any other non-cash charge – Add or subtract changes in non-cash working capital

••

Investing Activities (IA)

:

– Add/subtract asset acquisition cost and gain/loss on sale of shares/investments in other companies

••

Financing Activities (FA)

:

– Add/subtract equity injection or withdrawal

– Add/subtract new long term borrowing or repayment – Subtract dividends paid

• OA plus FA plus IA equals change in net cash

Structure of the Statement of Cash Flow

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Developing the Statement of Cash Flow

• Operating Activities (OA)

– Starts with what the company made in the last year (dividends come later) and also includes any changes in non-cash working capital – Non-cash working capital is the year-over-year difference in current

assets (except cash) and year-over-year difference in current liabilities, with the exception of: short term debt, and the current portion of long-term debt (which is financing)

– Cash (including “negative cash”) is excluded here because it’s what we balance everything with later as Net Cash (also called the Funds Flow) during the reporting period, where

– Net Cash = Cash - STCL

• Investing Activities (IA)

– Records net effect of purchase (or sale) of fixed assets, or intangible assets

– Shown at cost, since depreciation in the year is in operating activities – Note that a new asset purchase is a use of funds so this is typically a

negative entry

Developing the Statement of Cash Flow

Developing the Statement of Cash Flow (2)

• Financing Activities (FA)

– captures dividends paid, changes in long-term debt (either separate entries for pay-offs and new debts, or simply the netted total), and changes in share equity

– short term debts (STCL) do not appear here, because they are part of the cash that’s balanced out

– retained earnings changes are not shown explicitly (net income is shown in operating activities and dividends are here in financing activities)

– dividends are a use of funds so it’s a negative entry – current portion of long-term debt is included here too

Developing the Statement of Cash Flow (2)

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Funds Flow Illustrated

Balance Sheet 1 Balance Sheet 2 Income Statement

OA + FA + IA

Net Cash (start) Net Cash (end)

Non-Cash Sources & Uses

Net Cash (start)

Funds Flow Illustrated

Funds Flow (2)

If OA + IA + FA > 0:

positive cash flow

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Example: Cash Flow Statement

• Goodco and Badco have the same income statement for a

one year period but different balance sheets (next slide):

Retained Earnings, start 125

Net Earnings for the year 46

Less: Dividend Paid 16

Retained Earnings, end 155

Revenue 650

Warranty/ Bad Debt 6

Net Revenue 644

COGS 320

Contribution Margin 324

CM, % 49.8%

SG&A

All admin except dep. 220

Depreciation 70

Operating Income 34

Other Income 12

Net Income 46

Example: Cash Flow Statement

Example: Cash Flow Statement (2)

Year 1 Year 2 Year 1 Year 2 Assets Current Cash 9 22 9 22 Receivables 95 120 95 120 Inventory 75 88 75 88 Prepaids 40 28 40 28 Total current 219 258 219 258 Fixed Cost 700 760 700 760 Less depreciation 140 210 140 210 Net 560 550 560 550 Total assets 779 808 779 808 Liabilities Current ST Credit 51 24 51 174 Accounts Payable 30 48 30 48 Accrued Expenses 25 9 25 9 Taxes Payable 8 2 8 2 Cur. Port. of LT Debt 20 20 20 20 Total current 134 103 134 253

Long Term Debt 170 175 170 225

Shareholders' Equity

Capital Shares 350 375 350 175 Retained Earnings 125 155 125 155

Total Liabilities plus Equity 779 808 779 808

Goodco Badco

Example: Cash Flow Statement (2)

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Producing the Statement of Cash Flow

• Operating Activities plus Investing Activities plus Financing

Activities equals the change in Net Cash (also called the

Funds Flow) during the reporting period.

• Net Cash at a point in time is cash minus the amount of the

STCL (found on the balance sheet).

• The Funds Flow (the sum of OA + FA + IA) will equal the

change of the sum of cash minus the amount of the

short-term credit line from the beginning to the end of the period,

which is a good check.

Producing the Statement of Cash Flow

Example: Cash Flow Statement (3)

12

Goodco Badco

Cash Derived From Operating Activities:

Net income for the year 46 46 Depreciation & non-cash items: 70 70 Receivables -25 -25 Inventory -13 -13 Prepaids 12 12 Accounts Payable 18 18 Accrued Expenses -16 -16 Taxes Payable -6 -6 total 86 86 Cash Derived From Financing Activities:

Changes in equity 25 -175 Changes in Long Term Debt 5 55 Less Dividends Paid -16 -16 total 14 -136 Cash Used for Investing Activities:

Purchase of fixed assets -60 -60 Loss or gain on sale of shares 0 0

total -60 -60

Increase/Decrease in Cash 40 -110 Net Cash (cash minus credit line) - last year -42 -42 Net Cash (cash minus credit line) - this year -2 -152

Increase/Decrease in Cash 40 -110

Example: Cash Flow Statement (3)

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Example: Cash Flow Statements (4)

• So for

Badco

, the balance sheet for last year tells you that

the N

et Cash as of the start of the period is

• Similarly,

Net Cash at the end of the period is

• which comes from this year's balance sheet (the end of the

period).

• So the

change in net cash for Badco is

• This change in net cash from the start of the reporting

period to the end of the period is also called the

Change in

Cash Position

, or the

Funds Flow

during the reporting

period.

Example: Cash Flow Statement (4)

What We Look for in Cash Flow Statements

• Profitable? Steady profits?

• How much cash is coming from operations?

• Non cash Working Capital growing?

• Is this justified by sales (from Income Statement)?

• Dividend? Steady? What fraction of income?

• Investment relative to depreciation:

– Larger (hence growing) – About the same (stable) – Smaller (blowdown of assets)

• Financing

– Locking in or paying back long term debt?

– Issuing or buying back shares? Common or preferred?

What We Look for in Cash Flow Statements

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Operational vs. Financial Management

• All businesses require that management address two areas:

– Operational health: does our underlying business activity create value independent of how we finance the business?

– Financial health: have we raised money in a way that can sustain the business?

• The

Income Statement

is the primary source of evidence

of operational health

– Contribution Margin is a critical measure

• The

Balance Sheet

is the primary source of evidence of

financial health

– Working Capital is an important measure

• The

Statement of Cash Flow

is a link between

Income Statements

&

Balance Sheets

Operational vs. Financial Management

Summary of the Statement of Cash Flow

• The power of a cash flow statement is that this single statement shows the

funds flow in a company and breaks it down by category, making it easy to understand what’s happening in a business

• Operating Activities plus Investing Activities plus Financing Activities

equals the change in net cash (also called the Funds Flow) during the reporting period.

• Positive funds flow means the company is producing more cash from

non-cash sources than was needed for the period.

• A negative number for the change in cash position on the Statement of

Cash Flow means that more funds had to flow into the company.

• But isn’t it a good thing

to have extra cash coming in?

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