Various Cash and Non-Cash Transactions

-

 Cash Flow Statement: Various Cash and Non-Cash Transactions

The Statement of Cash Flows (also known as the cash flow statement) is a critical financial statement that reports the cash generated and used by a business during a specific period. It links the income statement and balance sheet, showing how money moved in and out of the business.

Three Sections of the Statement of Cash Flows

  • Operating Activities:
    • Description: These are the principal revenue-generating activities of the organization, as well as other activities that are not classified as investing or financing activities.
    • Components: Cash flows from sales, purchases, and other expenses. Cash flows from current assets and current liabilities are included here.
    • Presentation:
      • Direct Method: Lists cash inflows and outflows directly (e.g., cash received from customers, cash paid to suppliers). Rarely used due to complexity.
      • Indirect Method: Adjusts net income for changes in non-cash working capital items and non-cash charges like depreciation. Commonly used due to its simplicity.
  • Investing Activities:
    • Description: These activities involve the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
    • Components: Cash flows related to the purchase and sale of property, plant, and equipment (PP&E), other non-current assets, and financial investments.
    • Capital Expenditures (CapEx): Cash spent on purchasing PP&E is called CapEx.
  • Financing Activities:
    • Description: These activities result in changes in the size and composition of the equity capital and borrowings of the entity.
    • Components: Cash flows from issuing or repurchasing shares, borrowing, and repaying bank loans. Payment of dividends is also included here.

Key Concepts and Terminology

  • Cash Flow: Inflows and outflows of cash and cash equivalents.
  • Cash Balance: Cash on hand and demand deposits (as reported on the balance sheet).
  • Cash Equivalents: Short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value (e.g., treasury bills, marketable securities).

Cash Flow Classifications

  • Operating Cash Flow (OCF):
    • Cash flows from core business operations.
    • Indirect Presentation Example:
      • Start with net income.
      • Add back non-cash expenses (depreciation, amortization).
      • Adjust for changes in working capital (accounts receivable, inventory, accounts payable).
  • Investing Cash Flow:
    • Cash flows from the acquisition and disposal of long-term assets and other investments.
    • Example: Purchase or sale of PP&E, investments in other companies.
  • Financing Cash Flow:
    • Cash flows that affect the equity and borrowings of the company.
    • Example: Issuance or repurchase of stock, dividend payments, borrowing and repaying loans.

Interest and Cash Flow

  • IFRS:
    • Companies have the option to classify interest paid and received as either operating, investing, or financing cash flows.
  • U.S. GAAP:
    • Interest paid and received must be classified as operating cash flows.

Free Cash Flow (FCF)

  • Description: Free Cash Flow is the cash available to the company after accounting for capital expenditures needed to maintain or expand its asset base.
  • Calculation: Typically calculated as Operating Cash Flow minus Capital Expenditures (CapEx).
  • Usage: Commonly used in discounted cash flow (DCF) valuation models by investment bankers and finance professionals.

Example of Cash Flow Statement

Operating Activities (Indirect Method)


Investing Activities

Financing Activities

Total Cash Flow

Analysis of Cash Flow Statement

  • Operating Activities: Indicates the company’s ability to generate cash from its core operations. A positive cash flow suggests good operational efficiency.
  • Investing Activities: Provides insights into the company’s investment strategy and long-term growth plans. Significant capital expenditures indicate expansion.
  • Financing Activities: Reflects the company’s financial structure and dividend policy. Positive cash flow from financing indicates raising capital, while negative indicates repayments and dividends.

Important Points

  • Non-Cash Transactions: Not included in the cash flow statement but disclosed in the notes (e.g., stock-based compensation, asset exchanges).
  • Reconciliation: The indirect method of presenting operating cash flows reconciles net income with cash generated from operations, highlighting non-cash expenses and changes in working capital.
  • Cash Flow Analysis: Provides a comprehensive view of the company’s liquidity, solvency, and financial flexibility, complementing the income statement and balance sheet.

By understanding these aspects of the cash flow statement, stakeholders can better assess a company’s financial health and make informed decisions.