01e-Statement of Cash Flows

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Pa Polar Associates LLC 1

Statement of Cash Flows

Credit Analysis Course forKuwait Investment Authority

Citibank

George Werner

This presentation was provided to Citibank by George Werner for the Kuwait Investment Authority Seminar. It is for educational purposes only and should not beconstrued as investment advice or a recommendation with respect to any of the information presented. The content and views expressed in this presentation are

those of George Werner and are subject to change without notice. George Werner is not affiliated with Citibank.This is confidential and proprietary information and may not be copied or reproduced.


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Table of Contents

I. Statement of Cash Flows

II. Cash Flow from Operations (CFO)

III. Cash Flow from Investing and Financing

IV. Cash Flow Problem Areas


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I. Statement of Cash Flows


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Purpose

To provide relevant information about cash and cashequivalent receipts and payments during a period bycategorizing the cash movements into three distinct

activities:

Operations

Investing

Financing


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Reconcile net income and cash

Separate cash from non-cash activities

Assess ability of firm to meet cash obligations

Assess potential future cash flows

Uses


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Operating activities

Cash effects of transactions that determine net income

Investing activitiesMaking, collecting loans

Acquiring, disposing of investments

Acquiring, disposing of PP & E, other assets

Financing activities Liability, Equity transactions

Organized Into Three Activity Areas


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II. Cash Flow from Operations (CFO)


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Direct method Preferred by auditors

Lists all gross cash receipts and disbursementsrelated to operations

Gives a better measure of the size of cash flows inboth directions and gives more detail on certainaccounts indicating where a cash need might arise


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Indirect method

Usually allowed by auditors

Starts with net income and adjusts for non-cash itemsin order to convert to cash flow from operations (CFO)

Preferred by analysts who project future cash flows byfirst estimating future income levels


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Most firms use the indirect method (cheaper and less revealing)

so credit analyst has to be able to convert as well as possible While a net CFO number is of less use for analysis than

information about the components and their magnitudes, it doesprovide a better measure of performance than does net income,as it is less subject to distortion. It is not distortion free, however

Note: CFO has a financing, not profit measurement focus and isthus suited to the evaluation and projection of short term liquidity

The ability to generate cash from operations the business ofthe businessis an indicator of the firms true financial health


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In effect, the direct method presents net income as ifit were on a cash basis

Cash collected from operations

less Cash payments for expenses

equals

Cash income before taxes

less Cash tax payments

equals

Net cash provided by (used in) operations

Direct Method


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In the U.S., FASB requires a supplemental schedulewhich reconciles this statement to net income, as wellas

Cash collected from customers

Interest, dividends receivedOther cash receipts

Cash paid to employees, suppliers

Interest paid

Taxes paidOther operating cash payments


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A proxy for the direct method (which requires access tothe transaction journal) is to calculate

Sales - increase in AR

less

(COGS + increase in inventories + decrease in AP)

less

Interest paid and operating expenses (adjusted fordepreciation, amortizations, accruals and the like)

equals

Cash income before taxes

less

Cash tax payments

equals

Net cash provided by (used in (if negative)) operations

Derived Direct Method


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This is the most widely used on a global basis

Procedure:

Determine the change in cash using beginning andending balance sheets

Determine the cash flow from operations using Incomestatement and beginning and ending balance sheets

Determine the cash flows from investing, financing usingbeginning and ending balance sheets

Indirect Method


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Net income

plus

Depreciation, amortization, other non-cash

less adjustments

Increase in accounts receivable

Increase in inventory

Increase in other operating assets

Decrease in accounts payable

Decrease in other operating liabilities

equals

Net cash provided by (used in) operations


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In addition, the firm must disclose Interest paid

Income taxes paid

The cash flow from operations calculated bythe direct method and the indirect method willbe (must be) identical


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III. Cash Flow from Investing

and Financing


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Calculation

The calculation of the cash flows from investing andfrom financing then follows as

Investing

~ Changes in non-operating asset accounts

Financing

~ Changes in non-operating liability and equity accounts

Adding the three components will (must) equal the

change in cash between the beginning and endingbalance sheets


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IV. Cash Flow Problem Areas


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Cash Flow Problem Areas

Adjustments, such as depreciation, Need to be adjusted inamortizations, bond discounts or arriving at CFOpremiums, changes in deferredtaxes, change in equity inundistributed earnings, etc.

Accounts receivable and Net, if indirect method;Allowance for doubtful accounts If using direct method,

adjust only when written off

- Other working capital changese.g., dividends payable Separate changes that

result from operations from

other change Gains/losses Separate into investing

and operations


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Pensions

Adjust for difference betweenexpense and funding

Extraordinary items All taxes paid are treated asoperating use;

Extraordinary item is then treatedon a gross basis

Significant non-cash Do not appear in cash flow transactionsstatement;

Are disclosed in notes

Documents

01e-Statement of Cash Flows