Understanding the Statement of Cash
Flows
Chapter 4
Contents
• Understand the cash flow statement and
how it relates to other financial statements
• Direct and indirect methods of presenting
operating cash flows
• Investing and financing activities
• Disclosure of noncash transactions
• Free cash flow and analysis
Ch 4
2
Importance of cash flows
• Accrual-based accounting requires reporting
revenues when earned and expenses when
incurred – not when cash is exchanged.
• A company cannot pay employees, creditors
and others with accrual-based net income.
• Valuation models used in financial analysis
are often based on projections of future cash
flows.
Ch 4
3
Statement of Cash Flows
• Summarizes all activity in the cash accounts
of the firm via three categories:
• Operating
– Indirect format
– Direct format
• Investing
• Financing
Ch 4
4
Motorola, Inc. and Subsidiaries
Years Ended December 31 (in millions)
Net cash provided by (used for) operating activities
Net cash provided by (used for) investing activities
Net cash provided by (used for) financing activities
Effect of exchange rate change on cash and cash equivalents
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS, END OF YEAR
Ch 4
2001
1,976
2,477
(1,820)
2000
(1,164)
(4,091)
5,119
1999
2,140
(960)
788
148
(100)
(33)
2,781
3,301
6,082
(236)
3,537
3,301
1,935
1,602
3,537
5
Nokia
Cash flow summary (EURm)
2001
2000
1999
Operating
6,547
3,509
3,102
Investing
(2,679)
(2,531)
(1,359)
Financing
(1,895)
(1,034)
(574)
Ch 4
6
Operating activities
• Primarily captures
– Income statement items
– Short-term/operating assets
– Short-term/operating liabilities
• Methods of presentation
– Indirect
– Direct
Ch 4
7
Cash Flows from Operating Activities
Indirect method
• Reconciles accrual-based net income with cash
generated via operations
• Begin with accrual-basis net income
– Adjust accrual items to reflect cash basis
• Noncash items (depreciation and amortization)
• Changes in working capital (current assets, current liabilities)
• Reclassify nonoperating items
– Appear in other sections of the Statement
• Gains/losses on sales of fixed assets or debt extinguishment
Ch 4
8
Adjustments on Net Income to
Derive Operating Cash Flows
Add back noncash expenses
–
Depreciation and amortization
Add working capital decreases
–
–
Decreases in current assets
Increases in current liabilities
Subtract working capital increases
–
–
Increases in current assets
Decreases in current liabilitie
Adjust nonoperating items
(e.g., gain from sale of fixed assets)
•Accruals = Operating Income – Operating cash Flows
Ch 4
9
Motorola, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31 (in millions)
2001
OPERATING
Net earnings (loss)
(3,937)
Adjustments to reconcile net earnings (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization
2,552
Charges for reorganization of businesses and other
charges
5,998
Acquired in-process research and development charges
40
Gains on sales of investments and businesses
(1,931)
Deferred income taxes
(2,273)
Changes in assets and liabilities, net of effects of
acquisitions and dispositions:
Accounts receivable
2,445
Inventories
1,838
Other current assets
249
Accounts payable and accrued liabilities
(3,030)
Other assets and liabilities
25
Net cash provided by (used for) operating activities
1,976
Ch 4
2000
1999
1,318
891
2,527
2,371
1,483
332
(1,570)
239
1,893
67
(1,180)
(443)
(1,471)
(2,305)
(532)
(666)
(519)
(1,164)
(135)
(678)
(16)
361
(991)
2,140
10
Nokia
Consolidated Cash Flow Statements, IAS
Financial year ended December 31,
2001
2000
EURm
EURm
Cash flow from operating activities
Net profit
2,200
3,938
Adjustments, total
4,132
2,805
Net profit before change in net working capital
6,332
6,743
Change in net working capital
978
(1,377)
Cash generated from operations
7,310
5,366
Interest received
226
255
Interest paid
(155)
(115)
Other financial income and expenses
99
(454)
Income taxes paid
(933)
(1,543)
Net cash from operating activities
6,547
3,509
Ch 4
1999
EURm
2,577
1,928
4,505
(21)
4,484
189
(212)
(113)
(1,246)
3,102
11
Cash Flows from Operating Activities
Direct method
•
•
•
•
•
Cash from customers
Cash to suppliers
Cash for wages
Cash for SGA
Cash for interest…
Ch 4
12
Calculating Cash from customers
+ Beginning balance in Accounts Receivable
+ Revenues
- Ending Accounts Receivable
= Cash received from customers
Beginning A/R + Sales – Payments received = Ending A/R
Ch 4
13
Calculating Cash paid to suppliers
+ Cost of (sales) revenue
+/- Increase (decrease) in inventory
-/+ Increase (decrease) in accounts payable
= Cash paid to suppliers
The cost of what was sold adjusted for changes in inventory
and payments made.
Ch 4
14
Motorola’s Cash from Operating
Activities in Direct Method Format
Cash received from customers
32,449
Cash paid to suppliers
(22,637)
Cash paid for S, G & A
(1,998)
Cash paid for research and development
(4,318)
Cash paid for interest
(844)
Cash paid for taxes
(676)
Cash from operating activities
Ch 4
1,976
15
Nokia’s Cash from Operating
Activities in Direct Method Format
Cash received from customers
30,905
Cash paid to suppliers
(18,156)
Cash paid for S, G & A
(2,556)
Cash paid for research and development
(2,558)
Cash paid for interest
(155)
Cash paid for taxes
(933)
Cash from operating activities
Ch 4
6,547
16
Cash Flows from Investing Activities
• Typically involves noncurrent capital (longterm) assets
• Cash acquisitions of investments, property
• Cash generated upon disposal of assets
• Noncash acquisitions/disposals are reported
as Supplemental Information rather than in
the body of the Statement of Cash Flows
Ch 4
17
Motorola, Inc. and Subsidiaries
Years Ended December 31 (in millions)
2001
INVESTING
Acquisitions and investments, net
(512)
Proceeds from dispositions of investments and businesses
4,063
Capital expenditures
(1,321)
Proceeds from dispositions of property, plant and equipment
14
Sales (purchases) of short-term investments
233
Net cash provided by (used for) investing activities
2,477
Ch 4
2000
1999
(1,912)
1,433
(4,131)
174
345
(4,091)
(632)
2,556
(2,856)
468
(496)
(960)
18
Nokia
Consolidated Cash Flow Statements, IAS
Financial year ended December 31,
2001
2000
EURm
EURm
Cash flow from investing activities
Acquisition of Group companies, net of acquired
cash
(131)
(400)
Purchase of non-current available-for-sale
investments
(323)
(111)
Additions in capitalized development costs
(431)
(393)
Long-term loans made to customers
(1,129)
(776)
Proceeds from (payment of) other long-term
receivables
84
Proceeds from (payment of) short-term
receivables
(114)
378
Capital expenditures
(1,041)
(1,580)
Proceeds from disposal of share in Group
companies, net of disposed cash
4
Proceeds from sale of non-current available-forsale investments
204
75
Proceeds from sale of fixed assets
175
221
Dividends received
27
51
Net cash used in investing activities
(2,679)
(2,531)
Ch 4
1999
EURm
(178)
(37)
(271)
(171)
128
(1,302)
27
121
318
6
(1,359)
19
Cash Flows from Financing Activities
• Long-term liabilities
– Cash from borrowing
– Cash used for repayment of principle
– Under IAS cash interest payments may be here
• Equity
– Cash from stock issuance
– Cash used to purchase treasury shares
– Cash used for dividend payments
Ch 4
20
Motorola, Inc. and Subsidiaries
Years Ended December 31 (in millions)
2001
FINANCING
Net proceeds from (repayment of) commercial paper and
short-term borrowings
(5,688)
Net proceeds from issuance of debt
4,167
Repayment of debt
(305)
Issuance of preferred securities of subsidiary trust
Issuance of common stock
362
Payment of dividends
(356)
Net cash provided by (used for) financing activities
(1,820)
Ch 4
2000
3,884
1,190
(5)
383
(333)
5,119
1999
(403)
501
(47)
484
544
(291)
788
21
Nokia
Consolidated Cash Flow Statements, IAS
Financial year ended December 31,
2001
2000
EURm
EURm
Cash flow from financing activities
Proceeds from share issue
77
72
Purchase of treasury shares
(21)
(160)
Capital investment by minority shareholders
4
7
Proceeds from long-term borrowings
102
Repayment of long-term borrowings
(59)
(82)
Proceeds from (repayment of) short-term
borrowings
(602)
133
Dividends paid
(1,396)
(1,004)
Net cash used in financing activities
(1,895)
(1,034)
Ch 4
1999
EURm
152
(25)
28
(6)
(126)
(597)
(574)
22
Statement of Cash Flows
Additional Disclosures
1. Cash paid for interest
2. Cash paid for taxes
• Presented at end of statement (GAAP) or
in body of statement (IAS)
• May also highlight significant noncash
transactions
Ch 4
23
Motorola, Inc. and Subsidiaries
Years Ended December 31 (in millions)
Effect of exchange rate change on cash and cash equivalents
2001
148
2000
(100)
1999
(33)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS, END OF YEAR
2,781
3,301
6,082
(236)
3,537
3,301
1,935
1,602
3,537
844
676
529
130
323
301
Supplemental Cash Flow Information
CASH PAID DURING THE YEAR FOR:
Interest
Income taxes
Ch 4
24
Nokia
Consolidated Cash Flow Statements, IAS
Financial year ended December 31,
2001
2000
Foreign exchange adjustment
(43)
80
1999
99
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
1,930
4,183
6,113
24
4,159
4,183
1,268
2,891
4,159
Change in net fair value of current Available-forsale investments
As reported on balance sheet
12
6,125
4,183
4,159
Ch 4
25
Cash analysis
• Determine and examine all sources and uses
of cash
• Determine 2 definitions of free cash flows
– To the Firm, available to both debt and equity
holders
– To Equity, available to equity holders only
– Important for valuation (present value of
expected future free cash flow)
Ch 4
26
Free Cash Flow to the Firm
Operating cash flow
Plus: Interest Paid Times (1-tax rate)
Less: Investments in Fixed Capital
Free Cash Flow to the Firm (to both debt holders
and stock holders)
Ch 4
27
Free Cash Flow to Equity
Operating cash flow
Less: Investments in Fixed Capital
Plus: New Debt Borrowing
Less: Debt Repayment
Free Cash Flow to Equity
Ch 4
28
Earnings before Interest, Taxes,
Depreciation and Amortization
EBITDA
Net income (loss)
Plus: Interest expense
Plus: Tax expense
Plus: Depreciation & Amortization expense
Free Cash Flow Estimate (to firm)
Ch 4
29
Relevance of Cash Flows and Income over a Company’s Life Cycle
+
Financing
cash flow
Inception
Free cash
flow
Operating
cash flow
Income
Growth
Maturity
Decline
Investing
cash flow
Ch 4
30
Earnings and Cash Flow, which is
more value relevant?
• If you could trade stocks based on perfect
foresight of next year’s
--earnings
--cash flow
which will help you earn higher returns?
• The power to predict future cash flows
Ch 4
31
Financial Accounting
Relevance of Accounting Numbers
Percent of Stock Price
Explained
Relation between Accounting Numbers and Stock Prices
100%
80%
Book Value
60%
Earnings
40%
Combined
20%
0%
65
70
75
80
85
90
95
Year
Ch 4
32
Accruals--The Cornerstone
Percent of Price Explained
Relation between Stock Prices and Various Income and Cash
Flow Measures for a Large Sample of Companies
70.00
60.00
57.62
44.36
50.00
40.00
33.02
32.62
30.00
20.00
10.00
1.00
0.00
NIBX
NI
OCF
FCF
NCF
NIBX = Net Income before Extraordinary Items and Discontinued Operations; NI = Net Income;
OCF = Operating Cash Flow; FCF = Free Cash Flows; NCF = Net Cash Flow (Change in Cash).
Ch 4
33
Accruals--The Cornerstone
Relation between Stock Returns and both Income and Operating
Cash Flows for Different Horizons of a Large Sample of Companies
.
45.00
40.26
Percent of Stock Returns Explained
40.00
35.00
30.00
25.00
OCF
NI
20.00
16.20
15.00
10.88
10.00
3.24
5.00
3.18
0.10
0.00
Quarter
Annual
Four-Year
Time Horizon
Source: Dechow, P
Ch 4
34