Mastering the Cash Flow Statement & Free Cash Flow

Transcription

1 Mastering the Cash & Free Cash Flow CFA Levels I & II Jonathan.bone@kaplan.co.uk Financial Reporting and Analysis LOS 27.a Compare/Classify: CFAI pg 253 Schweser pg 109 Importance of Cash Net income from accrual accounting does not tell us about the sources and uses of cash to meet liabilities and operating needs The statement of cash flows has three components under both IFRS and US GAAP: Cash provided or used by operating activities Cash provided or used by investing activities Cash provided or used in financing activities CFA LEVEL I Kaplan Financial Limited 1

2 LOS 27.c Contrast: CFAI pg 255 Schweser pg 111 Interest received Interest paid Dividends received Dividends paid Taxes paid Bank overdraft U.S. GAAP vs. IFRS U.S. GAAP (SFAS 95) CFO CFO CFO CFF CFO CFF IAS GAAP (IAS 7) CFO or CFI CFO or CFF CFO or CFI CFO or CFF CFO or CFI & CFF * * Considered part of cash and cash equivalents LOS 27.d Distinguish/Describe: CFAI pg 256 Schweser pg 112 Statement of Cash Flow: Direct vs. Indirect Method Direct vs. indirect method refers only to the calculation of CFO, the value of CFO is the same for both methods; CFI and CFF are unaffected Direct method: Identify actual cash inflows and outflows; e.g., collections from customers, amount paid to suppliers Indirect method: Begin with net income and make necessary adjustments to get operating cash flow CFA LEVEL I Kaplan Financial Limited 2

3 LOS 27.e Describe: CFAI pg 266 Schweser pg 114 Last year s balance sheet Linkages Between Statements Accounts Receivable T Account Amount B/Fwd Sales 18, , ,000 Cash collections This year s income statement 20, , ,000 Amount C/Fwd This year s balance sheet - 5 LOS 27.f Describe: CFAI pg 267 Understanding Cash s Cash Inflows and Outflows General rules regarding increases and decreases in balance sheet items over time: Increase Decrease Assets outflow inflow Liabilities & Equity inflow outflow e.g.: An increase in AR or inventory uses cash An increase in payables generates cash Adjust net income for these changes (indirect) CFA LEVEL I Kaplan Financial Limited 3

4 LOS 27.f Describe: CFAI pg 267 Ecclestone Industries Example Ecclestone Industries has the following income statement for 20X9 and balance sheets for 20X8 and 20X9. You are to construct the statement of cash flows using the indirect method. Additional information: Equipment was purchased for 50,000 Ecclestone has a tax rate of 40% LOS 27.f Describe: CFAI pg 267 Income Statement for Year to 31 December 20X9 Sales revenue 200,000 Expenses: Cost of goods sold 80,000 Salaries Depreciation 14,000 Interest 1,000 Gain from sale of PPE Pre-tax income Provision for taxes Net income 105,000 95,000 20, ,000 40,000 75,000 CFA LEVEL I Kaplan Financial Limited 4

5 LOS 27.f Describe: CFAI pg 267 Ecclestone Balance Sheet Data Balance Sheets Current assets Cash Accounts receivable Inventory Non-current assets Gross PPE Accum. Depr. 20X8 18,000 18,000 14,000 20X9 66,000 20, , ,000 (80,000) (84,000) Total Assets 252, ,000 LOS 27.f Describe: CFAI pg 267 Balance Sheets Current liabilities Accounts payable Salaries payable Interest payable Taxes payable Dividends payable Noncurrent liabilities Bonds Deferred taxes Stockholders equity Common stock Retained earnings 20X8 16,000 6,000 8,000 2,000 20,000 30, ,000 60,000 20X9 18,000 9,000 7,000 12,000 30,000 40,000 80, ,000 Total Liabilities & Equity 252, ,000 CFA LEVEL I Kaplan Financial Limited 5

6 LOS 27.g Convert: CFAI pg 302 Schweser pg 120 Direct Method CFO 1. Take each income statement item in turn e.g., sales 2. Move to the balance sheet and identify asset and liability accounts that relate to that income statement item e.g., accounts receivable 3. Calculate the change in the balance sheet item during the period (ending balance opening balance) 4. Apply the rule: Increases in an asset: deduct Increase in a liability: add Decrease in an asset: add Decrease in a liability: deduct LOS 27.g Convert: CFAI pg 302 Schweser pg 120 Direct Method CFO 5. Adjust the income statement amount by the change in the balance sheet 6. Tick off the items dealt with in both the income statement and balance sheet 7. Move to the next item on the income statement and repeat 8. Ignore depreciation/amortization and gains/losses on the disposal of assets as these are non-cash or non-cfo items CFA LEVEL I Kaplan Financial Limited 6

7 LOS 27.g Convert: CFAI pg 302 Schweser pg 120 Direct Method CFO 9. Keep moving down the income statement until all items included in net income have been addressed applying steps Total up the amounts and you have CFO LOS 27.g Convert: CFAI pg 302 Schweser pg 120 Direct Method CFO Cash Inflows Sales Less: Increase in A/R Cash collected from customers Direct cash outflows Cost of goods sold Add: Decrease in inventory Purchases Add: Increase in A/P Cash paid to suppliers 200,000 (2,000) (80,000) 4,000 (76,000) 8, ,000 (68,000) Operating expense (wages) Less: Decrease in salaries payable Cash paid to employees () (7,000) -8 CFA LEVEL I Kaplan Financial Limited 7

8 LOS 27.g Convert: CFAI pg 302 Schweser pg 120 Direct Method, cont. Cash outflows Interest Expense Add: Increase in interest payable Cash interest paid (1,000) 1,000 0 Tax Expense Add: Increase in deferred tax liab. Tax payable Add: Increase in taxes payable Cash taxes paid (40,000) (30,000) 2,000 CFO (28,000) 85,000-7 LOS 27.f Describe: CFAI pg 267 Indirect Method CFO CFO = NI + NCC - WC inv + Depreciation + Amortisation + Loss on asset disposal - Gain on asset disposal + Loss on early debt retirement - Gain on early debt retirement + Increase in DTL, decrease in DTA - Decrease in DTL, increase in DTA + Non cash expenses (provisions) Current assets excluding cash and investments Current liabilities excluding debt instruments and dividends payable = change in non-cash working capital CFA LEVEL I Kaplan Financial Limited 8

9 LOS 27.f Describe: CFAI pg 267 Indirect Method CFO (Alternative) + Dep n - Disposal gain + DTL NCC 75, , ,000 = 85,000 CFO = NI + NCC - WC inv WC = (6,000) 14,000 (20,000) 4,000 Current assets -Cash & Inv Current liabilities -Debt & divs Working Capital 20x8 20x9 50,000 96,000 (18,000) (66,000) 32,000 30,000 42,000 56,000 (2,000) (12,000) 40,000 44,000 (8,000) (14,000) -6 LOS 27.f Describe: CFAI pg 267 CFI = Calculating CFI investment in assets cash received on asset sales Net book value = Gross PPE accumulated depreciation Gain (loss) on sale = sales price net book value CFA LEVEL I Kaplan Financial Limited 9

10 LOS 27.f Describe: CFAI pg 267 Ecclestone CFI Calculating NBV of asset sold Gross Plant and Equip. Beginning PPE 282,000 Additions 50,000 PPE disposal (20,000) Ending PPE 312,000 Accumulated Depr. Begin Acc. Depr. 80,000 Depr. Expense 14,000 AD for disposal () End Acc. Depr. 84,000 NBV of disposal = 20,000 = -5 LOS 27.f Describe: CFAI pg 267 Ecclestone CFI CFI = cash additions cash received on disposal Sale Proceeds NBV of disposal Gain(loss) on sale 30,000 20,000 CFI = additions + proceeds CFI = 50, ,000 = 20,000-2 CFA LEVEL I Kaplan Financial Limited 10

11 LOS 27.f Describe: CFAI pg 267 Change in debt Computing CFF Change in common stock Cash dividends paid Net income X Dividends declared (X) Dividends declared (X) Dividends payable X in retained earnings X Cash paid (X) LOS 27.f Describe: CFAI pg 267 Ecclestone CFF Change in debt Change in common stock Cash dividends paid (20,000) (7,000) Net income Div declared in R/E 75,000 58,000 Dividends decl. Div. payable Cash div. paid (7,000) -7 CFA LEVEL I Kaplan Financial Limited 11

12 LOS 27.f Describe: CFAI pg 267 Putting the Cash Together Cash flow from operations Cash flow from investments Cash flow from financing Net increase in cash Cash balance 12/31/X8 Cash balance 12/31/X9 85,000 (20,000) 48,000 18,000 66,000-6 LOS 27.i Calculate/Interpret: CFAI pg 287 Schweser pg 126 Free Cash Flow (FCF) FCF is cash available for discretionary uses Frequently used to value firms FCFF = NI + NCC - WCInv + Int (1-T) FCInv FCFF = CFO + Int (1-T) FCInv FCFE = CFO FCInv + Net debt increase CFA LEVEL I Kaplan Financial Limited 12

13 LOS 27.i Calculate/Interpret: CFAI pg 287 Schweser pg 126 Free Cash Flow (FCF) Ecclestone FCFF = CFO + Int (1 T) FCInv 65,600 = 85, ,000 (1 0.4) 20,000 FCFE = CFO FCInv + Net debt increase 75,000 = 85,000 20,000 + FCFE = FCFF Int (1 T) + Net debt increase 75,000 = 65,600 1,000 (1 0.4) + -5 Solutions Financial Reporting and Analysis CFA LEVEL I Kaplan Financial Limited 13

14 Direct CFO Cash Inflows Sales Less: Increase in A/R Cash collected from customers Direct cash outflows Cost of goods sold Add: Decrease in inventory Purchases Add: Increase in A/P Cash paid to suppliers Operating expense (wages) Less: Decrease in salaries payable Cash paid to employees 200,000 (2,000) (80,000) 4,000 (76,000) 8,000 () (7,000) 198,000 (68,000) Direct CFO, cont. Cash outflows Interest Expense Add: Increase in interest payable Cash interest paid (1,000) 1,000 0 Tax Expense (40,000) Add: Increase in deferred tax liab. Tax payable (30,000) Add: Increase in taxes payable 2,000 Cash taxes paid CFO (28,000) 85,000 CFA LEVEL I Kaplan Financial Limited 14

15 + Dep n - Disposal gain - DTL NCC WC = (6,000) Indirect Method CFO 75, , ,000 = 85,000 CFO = NI + NCC - WC inv 14,000 (20,000) 4,000 Current assets -Cash & Inv Current liabilities -Debt & divs Working Capital 20x8 20x9 50,000 96,000 (18,000) (66,000) 32,000 30,000 42,000 56,000 (2,000) (12,000) 40,000 44,000 (8,000) (14,000) -6 Ecclestone CFI Calculating NBV of asset sold Gross Plant and Equip. Beginning PPE 282,000 Additions 50,000 PPE disposal (20,000) Ending PPE 312,000 Accumulated Depr. Begin Acc. Depr. 80,000 Depr. Expense 14,000 AD for disposal () End Acc. Depr. 84,000 NBV of disposal = 20,000 = CFA LEVEL I Kaplan Financial Limited 15

16 Ecclestone CFI CFI = cash additions cash received on disposal Sale Proceeds NBV of disposal Gain(loss) on sale 30,000 20,000 CFI = additions + proceeds CFI = 50, ,000 = 20,000 Ecclestone CFF Change in debt Change in common stock Cash dividends paid (20,000) (7,000) Net income 75,000 Dividends decl. Div declared Div. payable in R/E 58,000 Cash div. paid (7,000) CFA LEVEL I Kaplan Financial Limited 16

17 Putting the Cash Together Cash flow from operations Cash flow from investments Cash flow from financing Net increase in cash Cash balance 12/31/X8 Cash balance 12/31/X9 85,000 (20,000) 48,000 18,000 66,000 Free Cash Flow (FCF) Ecclestone FCFF = CFO + Int (1 T) FCInv 65,600 = 85, ,000 (1 0.4) 20,000 FCFE = CFO FCInv + Net debt increase 75,000 = 85,000 20,000 + FCFE = FCFF Int (1 T) + Net debt increase 75,000 = 65,600 1,000 (1 0.4) + CFA LEVEL I Kaplan Financial Limited 17