True or False: A statement of cash flow (SCF) documents the changes in a company s cash position over an accounting period.

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1 ENGM 401 & X1 Fundamentals of Engineering Finance Fall 2010 Lecture 15: Statement of Cash Flow (2) Let all the learned say what they can, Tis ready money makes the man. -Shakespeare M.G. Lipsett University of Alberta Cash Cash Flow Flow Statements Statements True or False: A statement of cash flow (SCF) documents the changes in a company s cash position over an accounting period. Which is not a category of funds flow? a) Operating activities. b) Financing activities. c) Investing activities. d) Diversifying activities. True or False: An increase in a liability is a source of funds. MG Lipsett,

2 Statement Statement of of Cash Cash Flow Flow (SCF) (SCF) To complete a statement of cash flow (SCF), two balance sheets (start of period and end of period) and the income statement for the intervening time period are used The sources and uses of funds are balanced to cash (including short term debt) The SCF gives a company s Net Cash position the breakdown between cash and short term borrowings, if a company has both, is arbitrary The cash flow statement answers the question where did our money come from, and where did it go? Note: the statement of cash flow used to be called a statement of change in financial position MG Lipsett, Structure Structure of of the the Statement Statement of of Cash Cash Flow Flow Operating Activities (OA): Net income is shown in full, not retained earnings! Add back in depreciation and any other non-cash charge Add or subtract changes in non-cash working capital Investing Activities (IA): Add/subtract asset acquisition cost and gain/loss on sale of shares/investments in other companies Financing Activities (FA): Add/subtract equity injection or withdrawal Add/subtract new long term borrowing or repayment Subtract dividends paid OA plus FA plus IA equals change in net cash MG Lipsett,

3 Developing Developing the the Statement Statement of of Cash Cash Flow Flow Operating Activities (OA) MG Lipsett, Starts with what the company made in the last year (dividends come later) and also includes any changes in non-cash working capital Non-cash working capital is the year-over-year difference in current assets (except cash) and year-over-year difference in current liabilities, with the exception of: short term debt, and the current portion of longterm debt (which is financing) Cash (including negative cash ) is excluded here because it s what we balance everything with later as Net Cash (also called the Funds Flow) during the reporting period, where Net Cash = Cash - STCL Investing Activities (IA) Records net effect of purchase (or sale) of fixed assets, or intangible assets Shown at cost, since depreciation in the year is in operating activities Note that a new asset purchase is a use of funds so this is typically a negative entry Developing Developing the the Statement Statement of of Cash Cash Flow Flow (2) (2) Financing Activities (FA) captures dividends paid, changes in long-term debt (either separate entries for pay-offs and new debts, or simply the netted total), and changes in share equity short term debts (STCL) do not appear here, because they are part of the cash that s balanced out retained earnings changes are not shown explicitly (net income is shown in operating activities and dividends are here in financing activities) dividends are a use of funds so it s a negative entry current portion of long-term debt is included here too MG Lipsett,

4 Funds Funds Flow Flow Illustrated Illustrated Balance Sheet 1 Income Statement Balance Sheet 2 Net Cash (start) OA + FA + IA Non-Cash Sources & Uses Net Cash (end) Net Cash (start) MG Lipsett, Funds Flow (2) If OA + IA + FA > 0: positive cash flow If OA + IA + FA < 0: negative cash flow MG Lipsett,

5 Example: Example: Cash Cash Flow Flow Statement Statement Goodco and Badco have the same income statement for a one year period but different balance sheets (next slide): Revenue 650 Warranty/ Bad Debt 6 Net Revenue 644 COGS 320 Contribution Margin 324 CM, % 49.8% SG&A All admin except dep. 220 Depreciation 70 Operating Income 34 Other Income 12 Net Income 46 Retained Earnings, start 125 Net Earnings for the year 46 Less: Dividend Paid 16 Retained Earnings, end 155 MG Lipsett, Example: Example: Cash Cash Flow Flow Statement Statement (2) (2) Goodco Badco Year 1 Year 2 Year 1 Year 2 Assets Current Cash Receivables Inventory Prepaids Total current Fixed Cost Less depreciation Net Total assets Liabilities Current ST Credit Accounts Payable Accrued Expenses Taxes Payable Cur. Port. of LT Debt Total current Long Term Debt Shareholders' Equity Capital Shares Retained Earnings Total Liabilities plus Equity MG Lipsett,

6 Producing Producing the the Statement Statement of of Cash Cash Flow Flow Operating Activities plus Investing Activities plus Financing Activities equals the change in Net Cash (also called the Funds Flow) during the reporting period. Net Cash at a point in time is cash minus the amount of the STCL (found on the balance sheet). The Funds Flow (the sum of OA + FA + IA) will equal the change of the sum of cash minus the amount of the shortterm credit line from the beginning to the end of the period, which is a good check. MG Lipsett, Example: Example: Cash Cash Flow Flow Statement Statement (3) (3) Goodco Badco Cash Derived From Operating Activities: Net income for the year Depreciation & non-cash items: Receivables Inventory Prepaids Accounts Payable Accrued Expenses Taxes Payable -6-6 total Cash Derived From Financing Activities: Changes in equity Changes in Long Term Debt 5 55 Less Dividends Paid total Cash Used for Investing Activities: Purchase of fixed assets Loss or gain on sale of shares 0 0 total Increase/Decrease in Cash Net Cash (cash minus credit line) - last year Net Cash (cash minus credit line) - this year Increase/Decrease in Cash MG Lipsett,

7 Example: Example: Cash Cash Flow Flow Statements Statement (4) (4) So for Badco, the balance sheet for last year tells you that the Net Cash as of the start of the period is Similarly, Net Cash at the end of the period is which comes from this year's balance sheet (the end of the period). So the change in net cash for Badco is This change in net cash from the start of the reporting period to the end of the period is also called the Change in Cash Position, or the Funds Flow during the reporting period. MG Lipsett, What What We We Look Look for for in in Cash Cash Flow Flow Statements Statements Profitable? Steady profits? How much cash is coming from operations? Non cash Working Capital growing? Is this justified by sales (from Income Statement)? Dividend? Steady? What fraction of income? Investment relative to depreciation: Larger (hence growing) About the same (stable) Smaller (blowdown of assets) Financing Locking in or paying back long term debt? Issuing or buying back shares? Common or preferred? MG Lipsett,

8 Operational Operational vs. vs. Financial Financial Management Management All businesses require that management address two areas: Operational health: does our underlying business activity create value independent of how we finance the business? Financial health: have we raised money in a way that can sustain the business? The Income Statement is the primary source of evidence of operational health Contribution Margin is a critical measure The Balance Sheet is the primary source of evidence of financial health Working Capital is an important measure The Statement of Cash Flow is a link between Income Statements & Balance Sheets MG Lipsett, Summary Summary of of the the Statement Statement of of Cash Cash Flow Flow The power of a cash flow statement is that this single statement shows the funds flow in a company and breaks it down by category, making it easy to understand what s happening in a business Operating Activities plus Investing Activities plus Financing Activities equals the change in net cash (also called the Funds Flow) during the reporting period. Positive funds flow means the company is producing more cash from noncash sources than was needed for the period. A negative number for the change in cash position on the Statement of Cash Flow means that more funds had to flow into the company. But isn t it a good thing to have extra cash coming in? MG Lipsett,