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The statement of cash flows reports all the cash inflows and outflows classified among operating, in

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... exchange rate changes ... in exchange rates when translating foreign currencies ... flow effect and (b) and exchange rate effect that has no current cash ... – PowerPoint PPT presentation

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Title: The statement of cash flows reports all the cash inflows and outflows classified among operating, in


1
Chapter 3
  • The statement of cash flows reports all the cash
    inflows and outflows classified among operating,
    investing and financing activities for a
    specified period.

2
Cash flow from operating activities (CFO)
  • Measures the amount of cash generated from the
    production and sales of goods and services.
  • May be negative (rapid growth or a troubled
    firm), but long-term is required to be positive
    for a firm to survive.

3
Investing cash flow (CFI)
  • Cash used to acquire assets
  • Acquire PPE, investments and other businesses
  • Sale or disposal of assets or business segments.
  • Some investment is necessary to maintain current
    operating capacity and to provide capacity for
    future growth.

4
Financing cash flow (CFF)
  • Cash flows from issuance and repurchases of
    equity
  • Payment of dividends
  • Cash flows from proceeds and repayment of debt.

5
Effect of exchange rate changes on cash
  • A fourth category applicable to firms needing to
    accumulate changes in exchange rates when
    translating foreign currencies

6
SFAS 95
  • Allows both the direct method and the indirect
    method
  • Investing and financing cash flow sections tend
    to be the same for both methods
  • Indirect method is more common, but has a
    significant drawback see pg. 76

7
Transactional analysis
  • Method to convert indirect statements to direct
    statements of cash flows.
  • See pages 78, 79 and 80 of text
  • A key point to remember is that income statement
    items tend to have an associated balance sheet
    account(s).
  • Examples Accounts receivable and sales
  • PPE and depreciation
  • Interest payable and interest expense

8
  • Discrepancies between the changes in accounts
    reported on the balance sheet and those reported
    in the cash flow statement are primarily due to
    two factors
  • 1. Acquisitions and divestitures tend to
    distort trends in cash flows from operations and
    investing cash flows. Cash outflows for the
    acquisition of operating assets and liabilities
    of the acquired firm are excluded from operating
    cash flows and included in investing cash flows.
    Upon subsequent collection or payment, the cash
    flows are included in operating cash flows.

9
  • 2. Foreign subsidiaries the assets and
    liabilities of the foreign subsidiary must be
    translated from the foreign currency to the
    reporting currency. The translated amount then
    has two components (a) a real cash flow effect
    and (b) and exchange rate effect that has no
    current cash flow effect. This translation gain
    or loss is excluded from cash flows from
    operating, investing and financing activities.

10
Free cash flow
  • FCF is the cash flow left after funding all
    positive net present value projects and has
    associated agency cost issues.
  • Our focus now is the measurement of FCF as a
    basis for valuing the company.
  • There is no single definition

11
  • A basic definition is the cash flows from
    operations less the amount of capital
    expenditures required to maintain the firms
    present productive capacity.
  • Alternative 1 Operating cash flows plus
    depreciation has the problem of using historical
    cost rather than replacement cost which may be
    quite different for long-lived assets.
  • Alternative 2 Operating cash flows less capex
    required to maintain current operations has the
    difficulty of separating replacement and
    expansion capex and whether capex is sufficient
    to maintain current operations (consider a
    distressed firm).
  • Alternative 3 Operating cash flows less capex.

12
Relationship between cash flows and net income
  • See exhibit 3-5
  • Note that cash flows from operations is the same
    for each method of accounting, but that net
    income differs.
  • Income taxes would differ based on method of
    accounting. Also note that a firms method of
    accounting for income tax purposes usually
    differs from its method of accounting for
    financial statement purposes. AMT

13
Other obfuscating issues
  • Capitalization of overhead into fixed assets
    (self-constructed asset for instance) moves the
    cash outflow to investing from operations.
  • Interest and dividends received from investments
    from other firms are operating cash flows. The
    return ON capital is separated from the return OF
    capital.
  • Interest paid is an operating cash outflow, but
    it reflects a financing decision not an operating
    decision.
  • Non-cash transactions example purchasing a
    building by assuming the mortgage does not
    require a direct outlay of cash. Disclosure is
    by footnote even though the transaction is
    equivalent to issuing debt and purchasing the
    building.
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