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Statement of Cash Flow: Lecture-8

This document discusses the usefulness and classifications of cash flows, including operating, investing, and financing cash flows. It describes the indirect and direct methods for calculating cash flows and explains why most companies use the indirect method. The document also defines free cash flow and provides an example calculation. It discusses how changes in working capital can affect a company's cash flow and the key differences between working capital and cash flow.

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Nirjon Bhowmic
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57 views11 pages

Statement of Cash Flow: Lecture-8

This document discusses the usefulness and classifications of cash flows, including operating, investing, and financing cash flows. It describes the indirect and direct methods for calculating cash flows and explains why most companies use the indirect method. The document also defines free cash flow and provides an example calculation. It discusses how changes in working capital can affect a company's cash flow and the key differences between working capital and cash flow.

Uploaded by

Nirjon Bhowmic
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Statement of Cash Flow

Lecture-8
• Usefulness of Cash Flows:
– The entity’s ability to generate future cash flows
– The entity’s ability to pay dividends and meet
obligations
– The cash investing and financing transactions during
the period
• Classifications of cash flows:
– Operating Cash Flows
• Include cash effects of transactions that create revenues and
expenses. It indicates the capacity of the company to generate
cash necessary to run the day to day activities of the business.
– Inventing Cash Flows
• Include investment related activities.
– Financing Cash Flows
• Include the source of raising funds either through share or
long term liabilities and paying dividends or repurchase of
shares.
• Cash Flow calculation method:
– Indirect Method:
• This method adjusts net income for items that do not affect
cash. A great majority of companies use this method.
Companies favor this method because of two reasons: a)
easier and less costly to prepare and b) it focuses on the
differences between NI and Net cash flow from operating
activities.
– Direct Method:
• This method shows operating cash receipts and payments. It
is prepared by adjusting cash item in the Income Statement
from the accrual basis to cash basis.
• Which one is better:
– Negative/positive Operating Cash Flow
– Negative/positive Investing Cash Flow
– Negative/positive Financing Cash Flow
• The answer depends on the position the
business.
• Indirect Cash Flow:
– Operating Cash Flow: Net Income after adjusting
all the non-cash transactions + Difference between
CA and CL
– Inventing Cash Flows: Buy or sell Fixed Asset +
Difference of investment
– Financing Cash Flows: Difference of Long Term
Liabilities + Share + Payment of Dividend
• Free Cash flow:
– Net cash provided by operating activities fails to take into
account that a company must invest in new fixed assets
just to maintain its current level of operations. Companies
must also at least maintain dividends at current levels to
satisfy investors. The measurement of free cash flow
provides additional insight regarding a company’s cash
generating ability. Free Cash Flow describes the net cash
provided by operating activities after adjustment for capital
expenditures, retirement of debt/stock and dividends.
– Free cash flow= Net cash provided by operating activities –
capital expenditures – cash dividends
• Example:
– XYZ produced and sold 10,000pc this year. It reported
USD 100,000 net cash provided by operating cash
activities. In order to maintain production at 10,000
pc, XYZ invested USD 15,000 in equipment. It choose
to pay USD 5,000 in dividends.
– How much is the free cash flow and what is
implication?
• How do changes in working capital affect a company's cash flow?
– Working Capital represents the difference between a firm’s CA and CL. For
well-run firms, managing working capital is simply a daily occurrence it
can easily handle. For other firms, the way the process is handled can
indicate financial distress.
– The impact of working capital changes are reflected in a firm’s cash flow
statement. Specifically, the operating cash flow section of the cash flow
statement details changes in its shorter-term working capital needs. A
positive working capital figure (current assets are greater than current
liabilities) means a cash inflow for the period measured. In contrast, a
negative working capital position means the firm has spent more cash out
than it brought in managing its working capital, or commitments, within a
year. Analyzing changes in working capital can be important for any
business, but is especially important for firms with seasonal or erratic
cash flow needs.
– The key difference between these two figures is that working
capital provides a snapshot of the present situation, while cash
flow is a measure of the company's ability to generate cash
over a specific period of time. Monthly or quarterly cash flows
will naturally be very different from the amount of cash
generated over a 12-month period. As a result, working capital
provides an excellent idea about how easily the company can
pay immediate liabilities, while cash flow is more of a forward-
looking measure. If the working capital is insufficient but cash
flow is satisfactory, the company could generate sufficient cash
if given enough time. If, however, creditors aren't willing to
give enough time to such a company, it could easily go
bankrupt
– Under normal circumstances, companies with high
cash flow also have high working capital. However,
several reasons can result in a divergence. Investing in
equipment or facilities, paying debt acquired a long
time ago and paying dividends to stockholders can
drain cash and working capital even if the company
has generated significant cash though regular
activities. Borrowing money and raising cash, on the
other hand, will add to the cash position as well as to
working capital, even though the company is unable to
generate much cash under ordinary circumstances

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