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KR edition 152-156

KR-152 : Cash flow statement I

Hi everyone,

We'll continue with the cash flow statement analysis...

We've seen that cash flows are divided into three major activities-

  • Operating activities - this denotes the cash generated from the company's normal line of business.

  • Investing activities - represents the amount of cash invested by the company; cash could be invested to purchase fixed assets; spent of equipment etc. Also included are cash flow due to loans and issue of bonds (just like banks issue bonds, companies can also issue bonds to the public). 

  • Financing activities - the cash flow resulting from due to issue of stocks or due to paying out of dividends. This section deals only with the equity part of financing (stocks; dividends etc) and not the debt financing. 

Let's consider a few parts of our whizkid's company's cash flow statement. The first section would be something as below:



Net income                                                        = $100

Additions (sources of cash)

Deprecation                                                       = 20

Increase in accounts payable                              = 5

Subtractions (uses of cash)

Increase in accounts receivable                          = (10)

Net cash provided by operating activities    = 115


That's the first part of our cash flow statement (first out of 3 parts);

As can be seen from the above statement, the cash flow statement actually continues from the income statement. Net income is the final figure dervied from the P&L statement (earnings after deducting taxes, interest, D&A). 

The idea is to basically find out how much cash the company has and this is derived by adding/subtracting amounts from the net income. If any quantity which was included in the P&L statement was a non-cash item ( i.e. it didn't create any cash or it didn't lead to the outflow of cash) then we should adjust the net income to find out the actual cash flow.

Food for thought? Why are we subtracting accounts receivable and adding accounts payable to the cash flow? (we've touched on this topic in an earlier example).

KR-153 : Cash flow statement II
We'll continue with our cash flow statement...

  • Generally financial statements will have an extra section titled "accompanying notes" or something like that. Some additional information can be found here - Example: for accounts receivable there may be a breakup of the details of accounts receivables.

                        0 - 30 days $5000 
                       30 - 60 days $3000 
                        over 60 days $4000

  • If a company tends to have a large percentage of accounts receivable in over 60 or over 90 days then investors would like to know the reasons for that - is it that the company isn't having an efficient collections system or are the company's customers in financial problems or is it normal in that particular line of business. 

  • This again highlghts the point that one shouldn't blindly make judgements based on individual values present in the financial statements. One should take into account the various parameters involved. 

  • Answer to yesterday's question you've probably figured out: we deduct accounts receivable because we haven't yet received this money (but we accounted for it in our income statement). And we deduct accounts payable because we haven't payed out this money yet.

The second part of the cash statement consists of "investments".

                                                             (dollars in thousands)

Expenditure on property and equipment    (20)
Investments sold                                          5

  • Investments sold will cover whatever cash was obtained by selling investments. This is a positive cash flow; i.e. the company is getting cash and so this is added here. 

  • Our whizkid's company might have purchased some bonds from a bank or from the government.

  • Upon maturity (after 5 years or whatever was the time frame) the bank would pay back the money to the bondholders (in this case the bondholder was the company).

Did you know that DEMAT means "dematerialzed"?

KR-154 : Cash flow statement III

Continuing with the cash flow statements "investment" part:

  • Expenditure on equipment is a cash outlay (expense). The company has to pay cash to buy equipment and this gets recorded here. In our example whizkid's firm spent 20,000 on buying equipment.

  • One doubt you would have is: "When a company buys equipment we discussed that we should divide the expense over the number of years the equipment would be used (which is deprecation). And we accounted for deprecation in our cash statement operating activities (we added it). So what are we subtracting here?"

  • Let's say that our whizkid bought computers worth $20,000 and these PCs are expected to be useful for 5 years. So according to accounting principles (GAAP accounting), the company should record 4,000 (20,000/5) as expense every year for 5 years. So in the first year income (P & L) statement the company will record only $4,000 as expense. In fact it won't be marked as expense but as deprecation = 4,000. This deprecation of 4,000 will appear in the subsequent four years also.

  • But as far as the cash flow statement is concerned we should be reporting how much cash the company actually has. And in the first year the company has spent 20,000 in cash and this should be recorded.

  • So in the cash flow statement we had a row:
    Expenditure on equipment: (20,000)
    It is negative because the company used so much cash.

What about deprecation in our cash statement?

  • If you remember we added that! We have to add it back because we subtracted deprecation from income statement. So at the end of Year 1 the company has shelled out 20,000 to buy PCs.

  • What happens in Year 2? In year 2, the company has to account for deprecation of $4000 in the income statement (deducted from total profit); and in the cash flow statement we will add back deprecation. 

  • The more you think of it the more you'll feel convinced about it!

The main point to note is that in the income statement the company records transactions when they happen in an economic sense (the company might not have got money from the customer as yet but it will be recorded as a sale) while in the cash statement we account for physical inflow/outflow of cash.

KR-155 : Cash flow statement IV

The last half of the cash flow statement is the "financing activities" section.

Cash flow from financing activities:

  • Any monetary transaction involving the owners of the company is included in this section (i.e. primarily the stockholders). 

  • It also includes transactions with creditors (i.e. borrowing or repaying of loans).

Some common points one might find in this section are:

  • Dividends paid out - this accounts for the outflow of cash for payment of dividends to the stockholders. It will be negative since dividends are always paid out. 

  • Issuance of common stock - When a firm issues new stocks then the firm raises money. In other words, issuance of new stock leads to inflow of cash and thus this is a positive quantity.

  • Increase or decrease in notes payable/bonds - this will indicate whether the firm has borrowed money from banks or whether it has paid back its loan dues. For example if this line reads "Increase in notes payable" it indicates that the company has borrowed money (borrowing money is a cash inflow and will be marked positive). On the other hand if the firm repays a loan then this would lead to a decrease in cash and thus would be marked negative.

You might wonder where all this info appears in the income statement? It doesn't!

  • The income statement (or Profit and Loss statement) only reflects what happened because of the firm's main operations. This is logical since, for example, issuance of common stock will raise money but can't be categorized as profit (in fact all it does is increase the number of owners of the company). 

  • But this information will be reflected in the balance sheet.

Did you know?

The equivalent of the SEC (US Securities and Exchange Commission) is SEBI (Securities and Exchange Board of India) in India. Their website: . One of their main tasks is to protect investors by ensuring that companies follow the defined standards and practices.

KR-156 : Cash flow statement V

We shall complete our series on financial management with this edition...

To conclude our cash statement series:

  • The sum of all cash flows will give the net cash flow.

  • A positive value indicates that the company has made more cash in this period while a negative cash flow indicates that the company has shelled out more cash that it received. 

  • Again one has to take a look at the individual records in the cash flow statement as well as past reports to comment on the financial health of the company.

  • The main point to note is that though the profit and loss statement might look rosy the cash flow statement might paint a completely different picture.

There was one more sheet that we mentioned at the start of the series

  • The statement of retained earnings: A company may not really publish a separate statement on this because this information appears clearly in the balance sheet itself. 

  • Based on the profits made a company has 2 options:
    a.) Give it back to the shareholders - DIVIDENDS
    b.) Invest the money back in the business - RETAIN the EARNINGS 

  • Two questions arise; "Why should a company pay back anything to the stockholders? Why not retain everything for developing the company?" 

  • The stockholders are the owners of the company and rightfully the money ought to go back to them. Also if a company never ever gives a dividend people may never want to hold that company's stocks and thus the price would decline.

                 Note: A company may not pay dividends regularly every quarter.

  • The second simpler question is, "Why not give everything back to the stockholders?" In the case of a new company the firm would need money for expanding its business later. It is better to retain earnings rather than borrow money later through loans or issue of new stock. Also companies would like to build up some cash reserve in case of any emergencies as well.

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