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1、Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinFinancial Statement AnalysisK R SubramanyamJohn J Wild7-207CHAPTERCash Flow Analysis7-3A Look At This Chapter In this chapter we analyze cash flow measures for insights into all business activities, with special e
2、mphasis on operations. Attention is directed at company and business conditions when interpreting cash flows. We also consider alternative measures of cash flows.7-4Analysis Objectives Explain the relevance of cash flows in analyzing business activities Describe the reporting of cash flows by busine
3、ss activities Interpret cash flows from operating activities Analyze cash flows under alternative company and business conditions Describe alternative measures of cash flows and their usefulness7-5Statement of Cash Flows Cash is the most liquid of assets. Offers both liquidity and flexibility. Both
4、the beginning and the end of a companys operating cycle. Contrast: Accrual accounting and Cash basis accounting Financial statements analysis recognizes that accrual accounting, where companies recognize revenue when earned and expenses when incurred, differs from cash basis accounting. .Relevance o
5、f Cash7-6Statement of Cash Flows Net cash flow is the end measure of profitability. It is cash, not income, that ultimately repays loans, replace equipment, expands facilities, and pays dividends. Accordingly, analyzing a companys cash inflows and outflows, and their operating, financing, or investi
6、ng sources, is one of the most important investigative exercises. Cash flow analysis helps in assessing liquidity, solvency, and financial flexibility.Relevance of Cash7-7Statement of Cash Flows Liquidity(流动性) is the nearness to cash of assets and liabilities Solvency（偿债能力） is the ability to pay lia
7、bilities when they mature. Financial flexibility (财务灵活性) is the ability to react and adjust to opportunities and adversities.7-8Statement of Cash Flows Statement of cash flows (SCF) helps address questions such as:a How much cash is generated from or used in operations?a What expenditures are made w
8、ith cash from operations?a How are dividends paid when confronting an operating loss?a What is the source of cash for debt payments?a How is the increase in investments financed?a What is the source of cash for new plant assets?a Why is cash lower when income increased?a What is the use of cash rece
9、ived from new financing?Relevance of Cash7-9Statement of Cash Flows The SCF reports cash receipts and cash payments by operating, financing, and investing activities: Operating activities are the earning-related activities of a company. Reporting by ActivitiesBeyond revenue and expense activities re
10、presented in an income statement, they include the net inflows and outflows of cash resulting from related operating activities like extending credit to customers, investing in inventories, and obtaining credit from suppliers.7-10Statement of Cash Flows Investing activities are means of acquiring an
11、d disposing of noncash assets. Involve assets expected to generate income; lending funds and collecting the principal on these loans. Financing activities are means of contributing, withdrawing, and servicing funds to support business activities. Include borrowing and repaying funds with bonds and o
12、ther loans; contributions and withdrawals by owners and their return on investment.Reporting by Activities7-11Statement of Cash FlowsReporting by Activities7-12Statement of Cash Flows There are two acceptable methods for reporting cash flows from operations: Indirect and Direct methodsConstructing t
13、he Cash Flow Statement7-13Statement of Cash Flows Indirect Method Net income is adjusted for non-cash income (expense) items and accruals to yield cash flow from operations.The advantage: the disclosure of a reconciliation of differences between net income and operating cash flows.This can aid some
14、users that predict cash flows by first predicting income and then adjusting income for leads and lags between income and cash flows.The indirect method is most commonly employed in practice and we use it initially to illustrate preparation of the statement of cash flows.7-14Statement of Cash Flows D
15、irect Method Each income item is adjusted for its related accruals Both methods yield identical results-only the presentation format differs.7-15Statement of Cash Flows Under the accrual basis of accounting, which of the following statements is true? I. Reported net income provides a measure of oper
16、ating performanceII. Revenue is recognized when cash is received, and expenses are recognized when payment is madeIII. Cash inflows are recognized when they are received, and cash outflows are recognized when they are made A. I onlyB. III onlyC. I and IIID. I, II and III7-16 c7-17Statement of Cash F
17、lows The statement of cash flows is a blend of the income statement and the balance sheet. Net income is first adjusted for noncash income and expense items to yield cash profits which are, then, further adjusted for cash generated and used by balance sheet transactions to yield cash flows from oper
18、ations, as well as investing and financing activities.7-18Statement of Cash Flows Consider first the net cash from operations.Preparation of the SCF (Indirect method)7-19Statement of Cash Flows Depreciation and amortization add-back.Preparation of the Statement of Cash Flows7-20Statement of Cash Flo
19、ws Income v/s Cash Flows - ExampleConsider a $100 sale on account(1)In period of sale, net income is increased by $100 but no cash has been generated.Net Income100Depreciation and amortization expense 0Gains (losses) on sale of assets 0Change in accounts receivable (100)Net Cash flow from operations
20、 0In period of collection no income is recorded.Net Income 0Depreciation and amortization expense 0Gains (losses) on sale of assets 0Change in accounts receivable 100Net Cash flow from operations1007-21Statement of Cash Flows Adjustments for changes in balance sheet accounts can be summarized as fol
21、lows:Preparation of the Statement of Cash Flows7-22Statement of Cash Flows Constructing the Statement1.The company purchased a truck during the year at a cost of $30,000 that was financed in full by the manufacturer.2. A truck with a cost of $10,000 and a net book value of $2,000 was sold during the
22、 year for $7,000. There were no other sales of depreciable assets.3. Dividends paid during Year 2 are $51,0007-23Statement of Cash Flows Steps in Constructing the Statement(1) Start with Net Income(2) Adjust Net Income for non-cash expenses and gains(3) Recognize cash inflows (outflows) from changes
23、 in current assets and liabilities(4) Sum to yield net cash flows from operations(5) Changes in long-term assets yield net cash flows from investing activities(6) Changes in long-term liabilities and equity accounts yield net cash flows from financing activities(7) Sum cash flows from operations, in
24、vesting, and financing activities to yield net change in cash(8) Add net change in cash to the beginning cash balance to yield ending cash7-24Statement of Cash Flows 7-25Analysis Implications of Cash Flows Some limitations of the current reporting of cash flow: Practice does not require separate dis
25、closure of cash flows pertaining to either extraordinary items or discontinued operations. Interest and dividends received and interest paid are classified as operating cash flows. Many users consider interest paid a financing outflow, and interest and dividends received as cash inflows from investi
26、ng activities. Income taxes are classified as operating cash flows. This classification can distort analysis of the three individual activities if significant tax benefits or costs are attributed to them in a disproportionate manner.Limitations in Cash Flow Reporting7-26Analysis Implications of Cash
27、 Flows Which of the following would require an adjustment in the computation of cash flow from operations using the indirect method? I. Depreciation expenseII. Loss on sale of assetIII. Sale of services to costumers for cashIV. Utility bill received and paid in cash A. IB. I and IIC. I and IIID. IV7
28、-27Analysis Implications of Cash Flows Beginning and ending accounts receivable are $76,000 and $42,000, respectively. Sales for the period total $384,000, of which $40,000 was directly for cash. How much cash was collected from making sales and collecting accounts receivable? A. $344,000B. $418,000
29、C. $378,000D. $376,0007-28Analysis Implications of Cash Flows Beginning accounts receivable are $76,000. Sales for the period total $384,000, of which $40,000 was directly for cash. $418,000 was collected from making sales and collecting accounts receivable. What is the ending balance for accounts r
30、eceivable? A. $42,000B. $2,000C. $82,000D. $68,0007-29 BBA7-30Analysis Implications of Cash Flows 7-31Q. Linking Operating Cash Flows with Earnings Quality In reviewing the financial statements of a company, you discover that net income increased while operating cash flows decreased for the most rec
31、ent two consecutive years. Required: a. Explain how net income could increase while its operating cash flows decrease. Your answer should include three illustrative examples. b. Describe how operating cash flows can serve as one indicator of earnings quality.7-32Q. Linking Operating Cash Flows with
32、Earnings QualityA.Revenues are, in certain instances, recognized before cash is received (that is, when earned,eg. credit sale). Expenses are, in certain instances, recognized after cash is paid (that is, matched with revenues). As a result, net income can be positive when operating cash flows are n
33、egative. 7-33Q. Linking Operating Cash Flows with Earnings Quality examples: (1) If accounts receivable increase substantially during the year, this implies that revenues outpaced cash collections. (2) If a company builds up its inventory levels substantially, then cash is paid out but no expense is
34、 recognized. (3) If the company reduces its accounts payable balances substantially during the year, then cash flows can be negative when net income is positive.7-34Q. Linking Operating Cash Flows with Earnings QualityB. Operating cash flows can serve as one indicator of earnings quality because ove
35、r a number of years, cash flows should approximate earnings. If cash flows from operations are consistently lower than earnings, it is possible that the reported earnings are not of high quality. (As with any broad guideline, one must look for corroborating evidence.)7-35Analysis Implications of Cas
36、h Flows Interpreting Cash Flows and Net Income7-36Analysis Implications of Cash Flows An income statement records revenues when earned and expenses when incurred. It does not show the timing of cash inflows and outflows, nor the effect of operations on liquidity and solvency. This information is ava
37、ilable in the SCF.Cash flows from operations (CFO) is a broader view of operating activities than is net income. It is not a measure of profitability.Note: A net measure, be it net income or cash flows from operations, is of limited usefulness. The key is information about components of these net me
38、asures.Interpreting Cash Flows and Net Income7-37Analysis Implications of Cash Flows Accounting accruals determining net income rely on estimates, deferrals, allocations, and valuations. SubjectivityNote: CFO effectively serve as a check on net income, but not a substitute for net income.CFO exclude
39、 elements of revenues and expenses not currently affecting cash. Our analysis of operations and profitability should not proceed without considering these elements. Interpreting Cash Flows and Net Income7-38Analysis of Cash Flows In evaluating sources and uses of cash, the analyst should focus on qu
40、estions like:a Are asset replacements financed from internal or external funds?a What are the financing sources of expansion and business acquisitions?a Is the company dependent on external financing?a What are the companys investing demands and opportunities?a What are the requirements and types of
41、 financing?a Are managerial policies (such as dividends) highly sensitive to cash flows?7-39Analysis of Cash FlowsCase Analysis of Cash Flows of Campbell Soup7-40Analysis of Cash Flows Inferences from analysis of cash flows include: Where management committed its resources Where it reduced investmen
42、ts Where additional cash was derived from Where claims against the company were reduced Disposition of earnings and the investment of discretionary cash flows The size, composition, pattern, and stability of operating cash flowsInferences from Analysis of Cash Flows7-41Analysis of Cash Flows Free Ca
43、sh FlowA useful analytical derivative of the statement of cash flows is the computation of free cash flow7-42Analysis of Cash Flows Growth and financial flexibility depend on adequate free cash flow. Free Cash FlowPositive free cash flow reflects the amount available for business activities after al
44、lowances for financing and investing requirements to maintain productive capacity at current levels.7-43Analysis of Cash Flows The SCF is useful in identifying misleading or erroneous operating results or expectations.Cash Flow as ValidatorsSCF provides us with important clues on:Feasibility of fina
45、ncing capital expenditures.Cash sources in financing expansion.Dependence on external financing.Future dividend policies.Ability in meeting debt service requirements.Financial flexibility to unanticipated needs/opportunities.Financial practices of management.Quality of earnings.7-44Specialized Cash
46、Flow RatiosCash Flow Adequacy Ratio Measure of a companys ability to generate sufficient cash from operations to cover capital expenditures, investments in inventories, and cash dividends:Three-year sum of cash from operationsThree-year sum of expenditures, inventory additions, and cash dividendsCas
47、h Reinvestment Ratio Measure of the percentage of investment in assets representing operating cash retained and reinvested in the company for both replacing assets and growth in operations:Operating cash flow DividendsGross plant + Investment + Other assets + Working capital7-45Specialized Cash Flow
48、 Ratios The cash flow adequacy ratio A. Measures a companys ability to generate sufficient cash flow from investing to cover debt repaymentsB. Measures a companys ability to generate sufficient cash flows from operations to cover capital expenditures and debt repaymentC. Measures a companys ability to generate sufficient cash flows from operations to cover capital expenditures, inventory additions and dividendsD. Measures a companys ability to generate sufficient cash flows from operations to cover capital expenditures, debt repayment and dividends7-46 c