Cash flow analysis

CHAPTER 13CASH FLOW ANALYSIS

CASH FLOWA statement of cash flow is a component of financial statements summarizing the operating, investing and financing activities of an entity.

PURPOSE OF STATEMENT OF CASH FLOWS It gives us useful information in assessing

the ability of the entity to generate cash and cash equivalents

It enhances the comparability of operating performance by different entities

Users of an entity’s financial statements are interested in how the entity generates and uses cash and cash equivalents

Creditors

High Amount

Low Amount

Creditors are one of those who examine the cash flow statements because they are concerned about being paid.

CREDITORS LOOK FOR ANSWERS TO THE FOLLOWING QUESTIONS IN THE COMPANY’S CASH FLOW STATEMENTS: Is the company generating sufficient positive

cash flows from its ongoing operations to remain variable?

Will the company be able to meet its financial obligations to creditors?

What expansion activities took place and how were those financed?

Will the company be able to pay its customary dividend?

Why did cash decrease even though a net income was reported?

To what extent will the company have to borrow money in order to make needed investments?

What happened to the proceeds received from the issuance of capital stock?

INFORMATION THAT SHOULD BE ASSESS AND EVALUATE A company’s ability to generate positive

future net cash flows

A company’s ability to meet its obligations and pay dividends

A company’s need for external financing

The reasons for differences between a company’s net income and associated cash receipts and payments

The reasons for differences between a company’s net income and associated cash receipts and payments

Both the cash and noncash aspects of a company’s financing and investing transactions during the accounting period.

FINANCIAL LIQUIDITY Refers to the “measures to cash” of assets

and liabilities.

Formula:Net cash provided by operating activites = Current CashAverage current liabilities Debt Coverage Ratio

FINANCIAL FLEXIBILITY Refers to a company’s ability to respond and

adapt to financial adversity and unexpected needs and opportunities

Formula:Net cash provided by operating activites = Current CashAverage total liabilities Coverage Ratio

FREE CASH FLOW

Free cash flow represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base.