Which of the following is an example of a noncash item on an income statement?
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In addition to their historical use, Cash Flow Statements are prepared as part of the budgeting process in order to identify the effects upon the cash facilities of the proposed activities for the period under review. A typical, simplified, statement would give the following information. Show
Cash flow statementOperating profit×Depreciation×Cash flow from operations×Fixed assets bought(×)Fixed assets sold×Loans received×Loans repaid(×)Corporate taxes paid(×)Interest paid(×)Interest received×Increases in working capital*(×)Decreases in working capital*×Dividends paid(×)Net cash inflow (outflow)×Opening cash balances×Closing cash balances× *Working capital normally includes Stocks, Trade Debtors, Prepayments, Trade Creditors, Accruals, Current taxation, etc.View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780750644525500626 Techniques of equity value definition in private equity and venture capitalStefano Caselli, Giulia Negri, in Private Equity and Venture Capital in Europe (Third Edition), 2021 22.3.3 The generation of “free” cash flowCash Flow Statements outline whether the business has created or absorbed cash flow. In case the company generated positive cash flow, the Cash Flow Statement is a useful tool to understand how this cash flow has been generated. As outlined in Table 22.3, the starting point for the Cash Flow Statement is the EBIT computed in the profit-and-loss statement. To calculate the cash flow, the EBIT is reduced by the taxes paid, decreased by the net WC, and capital expenditure (CAPEX). These last two items are calculated comparing the value of the WC and the CAPEX with the current and previous period. This value has a negative impact in that if it is greater than zero then the company has absorbed cash, for example, increasing the stock of inventory between the two comparison periods. If the company has reduced the inventory, it means the cash flow has increased, so the value of inventory reducing has a positive effect on the company's cash flow. The final cash flow includes the D&A realized during a specific period of time; it does not represent real cash movement as it is a nonmonetary cost so it has to be added back to the EBIT. This method of calculating the cash flow (free cash flow unlevered) does not contain information about the capital structure. Instead it represents the cash flow available for the financers and shareholders calculated without considering raising new debt and the repayment of the old debt. Table 22.3. Free cash flow statement. If obtaining a cash flow that includes the impact of the debt and the changes realized on the debt equity ratio is the goal, include the increase and decrease of the debt. To be more accurate, add all of the new debt raised to the free cash flow unlevered. This will show that company has new cash to spend, and the repayments of old debt are deducted because they absorb liquidity. This value is called free cash flow levered. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780323854016000199 Techniques of Equity Value DefinitionStefano Caselli, Giulia Negri, in Private Equity and Venture Capital in Europe (Second Edition), 2018 18.3.3 The Cash Flow StatementCash flow statements outline whether the business has created or absorbed cash flow. In case the company has generated positive cash flow, the cash flow statement is a useful tool to understand how this cash flow has been generated. The starting point for the cash flow statement is the EBIT computed in the profit and loss statement. To calculate the cash flow, the EBIT is reduced by the taxes paid, decreased by the net working capital (WC), and capital expenditure (CAPEX). These last two items are calculated comparing the value of the WC and the CAPEX with the current and previous period. This value has a negative impact in that if it is greater than zero then the company has absorbed cash, for example, increasing the stock of inventory between the two comparison periods. If the company has reduced the inventory, it means the cash flow has increased, so the value of inventory reducing has a positive effect on the company’s cash flow. The final cash flow includes the D&A realized during a specific period of time; it does not represent real cash movement as it is a nonmonetary cost so it has to be added back to the EBIT. This method of calculating the cash flow (free cash flow unlevered) does not contain information about the capital structure. Instead it represents the cash flow available for the financers and shareholders calculated without considering raising new debt and the repayment of the old debt. If obtaining a cash flow that includes the impact of the debt and the changes realized on the debt equity ratio is the goal, include the increase and decrease of the debt. To be more accurate, add all of the new debt raised to the free cash flow unlevered. This will show that the company has new cash to spend, and the repayments of old debt are deducted because they absorb liquidity. This value is called free cash flow levered (see Fig. 18.3).  Fig. 18.3. Free cash flow statement. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780128122549000188 Accounting and TaxEdward A. Glickman, in An Introduction to Real Estate Finance, 2014 3.4 Real Estate Cash Flow StatementCASH FLOW STATEMENTPeriod Ended xx/xx/xxxxCash Flow from Operations Net Income (source) Depreciation (source) Change in Working Capital (use) Cash Flow from Investment Long-term Assets Purchased (use) Long-term Assets Sold (source) Cash Flow from Financing Additional Borrowings (source) Debts Repaid (use) Dividends/Distributions Paid (use) Beginning Cash Balance Change in Cash Ending Cash Balance The typical cash flow statement used in GAAP reporting has three separate sections: cash flow from operations, cash flow from investment, and cash flow from financing. The sum of the cash flows recorded on these three sections equals the entity cash flow or change in the cash account during the reporting period. 3.4.1 Source of Cash versus Accrual DifferencesUnder GAAP, cash flow and net income are unlikely to be equal, as there are many transactions with economic effect in which cash does not immediately change hands. A few of these are illustrated here in the following subsections. 3.4.1.1 Cash versus Accrual RentsUnder GAAP, certain lease agreements result in accounting income that differs from the cash received in the same period. The difference results in an increase or decrease in the straight-line rent accrual account. In other cases, tenants who are late in paying their rent will cause the accounts receivable account to increase. Receipt of the tardy rents will reduce this account. 3.4.1.2 Cash versus Accrual ExpensesCertain expenses are incurred prior to the requirement for payment, resulting in an increase in accrued expenses. 3.4.1.3 DepreciationDepreciation expense represents the decline in value of physical assets that were paid for in prior periods but are being used in the current period. Depreciation affects accounting income but is not a cash cost. 3.4.1.4 Amortization of Capital CostsAmortization represents the declining value of expenditures that were incurred and paid for in prior periods but that have value for future periods. Amortization affects accounting income but is not a cash cost. 3.4.2 Cash Flow from OperationsCash flow from operations looks at the cash generated by operating the business. It may be different than the net income of the business due to many noncash transactions that are recorded on the income statement, which is based on the accrual method of accounting. 3.4.2.1 Net IncomeCash flow from operations starts with net income, the profit earned by an entity determined using the accrual method of accounting. 3.4.2.2 Depreciation and AmortizationDepreciation and amortization expenses represent the economic cost of deteriorating assets and are subtracted in calculating net income. These expenses have had no impact on cash during the current period and must therefore be added back to net income when determining cash flow. 3.4.2.3 Change in Working CapitalShort-term assets and liabilities are known as working capital accounts. Short-term assets include amounts owed to the entity from customers and vendors such as accounts receivables and prepaid expenses. Short-term liabilities include amounts that the entity owes to customers and vendors, such as accrued expenses and accounts payable. To create short-term assets, the entity has “used” cash to acquire goods or to make a loan to a vendor or customer. For example, if the entity has an accounts receivable from a tenant in place of a cash rent payment, it is equivalent to accepting a note from the tenant in place of cash. This effect can be traced through the income statement. Under GAAP, when rent is due, revenue is increased, which affects net income. This increase in net income is then reflected in cash flow from operations. The assumption is that rent results in cash for the business. However, if accounts receivable has also increased, we know that the entity did not receive cash for the rent but instead a tenant’s promise to pay. In effect, the entity has received a note rather than the cash that was expected. The increase in accounts receivable must be reflected as a decrease in cash flow from operations to cancel out the expected cash from the rent. Therefore, cash flow from operations correctly shows a net zero change in cash.
Short-term liabilities represent credit that has been extended to the entity by its vendors and suppliers. It is as if vendors have given the entity cash to purchase goods and taken back notes for that cash. For this reason, increasing a short-term liability is seen as a source of cash. The entity has traded its paper for cash. This effect can be also traced through the income statement. When an expense is recorded, net income is decreased, and this decrease is also reflected in cash flow from operations. Payment for the expense is expected to reduce cash. However, if accounts payable has increased, the entity has sourced cash by increasing a short-term liability. The increase in short-term liabilities is reflected as an increase in cash flow from operations, canceling out the expected use of cash for the expense. Cash flow from operations therefore properly shows a net zero change in cash.
In summary, an entity uses cash to generate its short-term assets and sources cash from its short-term liabilities. If an entity’s working capital is increasing, it is using cash, and if it is decreasing, it is generating cash. Entities that are using cash may need to look for external capital to fund their growth. Entities that are generating cash can invest in the business, repay debts, or pay a dividend. When the short-term assets exceed the short-term liabilities, the entity is said to have positive working capital. The opposite is true when the entity owes more than it is due. 3.4.3 Cash Flow from InvestmentsCash flow from investment is affected by sales or purchases of long-term assets. 3.4.3.1 Change in Long-term AssetsAs our real estate business grows, we invest in additional properties, related equipment, and perhaps mortgages and other securities backed by real property. These investments require us to use our cash. Selling these assets provides us with liquidity and is a source of cash. As previously mentioned, depreciation lowers the amount of long-term assets shown on the balance sheet but has no effect on cash from investment. In any period during which we have bought more property than we have sold, we have used cash. 3.4.3.2 Capital Expenditures and Tenant AllowancesMajor repairs that have a useful life of more than one year are considered capital expenditures and are classified as long-term assets. Tenant replacement costs including leasing commissions and tenant allowances, if they are tied to leases with a life of over one year, are also considered long-term assets. Capital expenditures and tenant costs are uses of cash that impact cash from investment. 3.4.4 Cash Flow from FinancingCash flow from financing is typically affected by borrowing or repaying long-term corporate debt or by issuing or repurchasing equity securities. 3.4.4.1 Change in Long-Term LiabilitiesWhen an entity issues debt, it exchanges a note for cash. Raising long-term liabilities is a source of cash. Later, an entity must use its cash to repay its liabilities. 3.4.4.2 Changes in EquityReal estate is a capital-intensive business, and many real estate firms frequently access the capital markets to source equity. These transactions raise or source cash for the entity. Investors typically look to real estate investments to generate income. Dividend payments, or distributions of partner’s capital, although actually generated by operations, are considered changes to the equity account and are shown as affecting cash from financing. 3.4.5 Cash Flow Metrics3.4.5.1 Funds from OperationsRather than looking at net income, which some analysts consider distorted by depreciation expense, many real estate investors are more interested in looking at cash flow from operations. Real estate investment trusts have developed a measure of cash flow from operations that is known as funds from operations (FFO). FFO is typically defined as net income plus depreciation and is reported both as an aggregate and on a per-share basis. Adjusted FFO (AFFO) or funds available for distribution (FAD) is a metric that looks to adjust FFO for the costs of annual non-revenue-generating capital expenditures, including major repairs and tenant replacement costs. Some analysts consider these costs the “true” depreciation expense because they reflect the real annual cost of keeping the asset at peak performance. 3.4.6 Coverage Ratios3.4.6.1 Fixed ChargeCredit analysts who work for debt investors like to look at the ability of an entity’s income stream to pay for its fixed charges, such as the interest and principal payments due on its long-term liabilities. The ratio is generally stated as EBITDA divided by the sum of interest expense and periodic principal amortization. The higher the fixed charge coverage ratio, the more likely it is that the entity will be able to manage its debt load. 3.4.6.2 Dividend CoverageEquity analysts look at the ability of the real estate enterprise to pay out distributions to investors. The ratio used is dividend coverage and is generally stated as FAD/dividends paid. The higher the dividend coverage ratio, the higher is the likelihood that the entity will be able to maintain or increase its dividend. 3.4.7 Cash Accounting versus Cash Flow StatementThe cash flow statement used in accrual accounting is intended to provide the same information to management as the cash method of accounting while providing the insight into the long-term profitability of the business, which is not always present in cash accounting. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780123786265000036 Review of financial statements 2: The income statement and the statement of cash flowsMarc Bertoneche, Rory Knight, in Financial Performance, 2001 2.6 The cash flow statementThe consolidated statements of cash flow for DaimlerChrysler are presented in Exhibit 2.2. The statement of cash flow is similar to the income statement in that it reports the results of transactions over a period, this being a statement of flows. The layout as a seven-statement report, is identical to the income statement and we will focus on the 1998 consolidated statement in Euros. Exhibit 2.2. DaimlerChrysler cash flow statement (annotated) (Annual Report 1998 p. 70)The cash flow statement reports and analyses transactions that have affected the cash account of the firm during the period under review. It is of critical importance for valuations which focus directly on the future cash flows of the business. An additional advantage of the cash flow statement is that it largely avoids the effects of discretionary accounting policies, this makes it more comparable across companies and can sometimes be more useful than the income statement. The cash flow statement analyses all transactions that go through the firm’s bank account and classifies them into three categories. 1Operational cash flows 2Investment cash flows 3Financial cash flows No attempt is made at assessing profitability which was the purpose of the income statement. The cash flow statement reported by DaimlerChrysler has a large number of line items that may at first obscure the information contained therein. Notice that there is no footnote column. Thus before the guided tour let us extract the essence of what is reported by examining the accounting identity (equation) that defines the cash flow statement. Cashflowfromoperations19−Investments35=Financialflows43+changeincash€16,681−€23,445=€6,808−€44 This may be better understood if displayed visually. Figure 2.2 reports that DaimlerChrysler’s cash flow statement as a ‘twin towers’ diagram which reflects the equation. On the left we report the cash inflows and on the right the cash outflows. Here it is immediately clear that investment of €23,445 far exceeded the cash flow from operations of €16,681 which therefore required a net inflow from outside financing of €6,764. [19]Cash from operations16,681[35]Less: Investments(23,445)Minimum new funding required(6,764)[43]Actual new funding6,808[44+45]Net increase in cash€(44) It turns out that DaimlerChrysler acquired new funding of €6,808, the excess of €44 went to increase the cash at the bank. Figure 2.3 further analyses the key items reported on the cash flow statement of DaimlerChrysler. It will be generally understood that once you have managed to extract the key equation above, the other items are merely providing further information which allows you to have a deeper insight into the cash transactions but also to make explicit the articulation between the income statement and cash flow statement. Figure 2.3. DaimlerChrysler cash flows 2.6.1 Operational cash flows[19]Cash provided by operating activities€16,681 The statement begins with net income of €4,820 [1] which was the last line of the income statement and goes on to reconcile this amount in some detail to the cash from operations number. These items are summarized as follows: [1]Net income4,820Non-cash items11,698Change in working capital163Cash from operations€16,681Non-cash items€11,698 This amount is made up of the following items reported on the cash flow statement. [2]Income applicable to minority interest130[5]Gain on disposal of business(296)[10]Change in financial instruments(191)[11]Gain on disposal of fixed asset/securities(368)[12]Change in trading securities251Gains on assets(604)[6]Depreciation and amortization of equipment on operating leases€1,972[7]Depreciation and amortization of fixed assets5,359Depreciation7,331[8]Change in deferred taxes1,959[9]Extraordinary item129[13]Change in accrued liabilities1,419[18]Change in other assets and liabilities1,334Accruals2,753Non-cash items€11,698 All of these items were included in net income, however, since they did not involve any cash transactions they are removed. This reflects an indirect method of establishing the net effect of those operational transactions that do affect cash. A more tedious alternative for companies would be to review all cash transactions and report those that were operational. It is quite usual for depreciation to be the most significant non-cash item. This along with deferred tax and goodwill amortization means that the firm’s accounting policies with respect to these items do not affect cash flow. Notice that minority interest and the extraordinary item also did not involve cash flows and so are removed. Since income is derived on the basis of accrual accounting all such amounts not involving cash are removed as well. Finally gains and losses on fixed assets which although involving cash flows are not operational but form part of investment flows. These are included in the accounts as proceeds or disposal of assets reported in the investment section below. Change in net working capital€163 The last element in the reconciliation of net income and cash flow is the adjustment for changes in net working capital, in this case the adjustment increases cash flow and it represents a decrease in net working capital. The amount is made up as follows: [15]Inventories, net(976)[16]Trade receivables(688)[17]Trade liabilities1,827€163 Since we saw that revenues and costs in the income statements are recognized when goods and services are invoiced there is a lag between a transaction being recognized in the income statement and it passing through the bank as cash. Transactions that are incomplete in this way cause a difference to arise between net income and cash flows. The amounts outstanding at the beginning of the year in trade receivables and payables affect cash only and the items at the end of the year affect income only. Therefore the difference between the opening and closing balances on trade receivables and payables has to be reversed out of net income to calculate actual cash flows. The amounts reported in the cash flow statements represent that part of the change in both receivables and liabilities that affect income. Other transactions affect these items that do not have impact income such as in the sale or purchase of a subsidiary and so no adjustment is necessary. Trade receivablesTrade payablesClosing balance per balance sheet7,60512,848Opening balance per balance sheet7,26512,025Change340(823)Recognized in income(688)1,827Net effect on income€(348)€1,004 The change in Inventories does however impact cash. Assume a firm purchased all goods for cash, this amount would be apportioned between cost of sales (income statement) and inventory (balance sheet), therefore income is overstated relative to cash flow. However this amount is carried forward and income is then understated as inventory is included in cost of sales when inventory is sold, therefore the change in inventory is reversed out of income to calculate cash flow. This difference between inventory and the other items of working capital is rather subtle but takes on an importance later. In summary the adjustment for receivables and payables is simply because they represent non-cash transactions included in income. Inventory on the other hand is brought to account because it is a cash flow item not included in income being reclassified as an operational flow instead of an investment flow. Most companies report on the same basis as DaimlerChrysler. The ‘Cash provided by operating activities’ reported by DaimlerChrysler has the following features. 1.It is a cash flow amount 2.It is after tax 3.It is after finance costs 4.It is after investment in net working capital The latter two features will need some further attention in order to develop a measure for valuation. 2.6.2 Investment cash flows[35]Cash used for investing activities€(23,445) This amount is analysed into three categories as follows: Net purchases of fixed assets€(13,459)Purchases(17,613)Disposals4,154Net changes in financial receivables(6,462)Other investment flows(3,524)Investment cash flows€(23,445)Net purchases of fixed assets€(13,459)[20]Purchase of fixed assets(16,756)[21]Increase in equipment on operating losses(8,296)[22]Purchase of property, plant and equipment(8,155)[23]Purchase of other fixed assets(305)[24]Proceeds from disposals of equipment on operating losses2,954[25]Proceeds from disposals of fixed assets515[26]Payment for acquisition of business(857)[27]Proceeds from disposal of business685Net purchases of fixed assets€(13,459) It may be more helpful to lay out the data in the format shown in Table 2.2. Table 2.2. Analysis of fixed asset purchases Fixed assetPurchasesProceedsNet1. Equipment on operating leases(8,296)2,954(5,342)2. Property plant and equipment(8,155)515(7,640)3. Other(305)‒(305)4. Business (Acquisitions)/disposals(857)685(172)Total€(17,613)€4,154€(13,459) Many firms report the totals on the face of the cash flow statement and the further detail in a separate note. This tabular format shows that during the year DaimlerChrysler bought and sold assets individually and as businesses. Net changes in financial receivables€(6,462) In contrast to the treatment of trade receivables DaimlerChrysler classifies changes in financial receivables as investment flows. It will be argued later that changes in trade receivables and payables could be treated in the same way. This amount is made up of the following line items from the cash flow statement. [28]Additions to receivables from financial services(81,196)[29]Repayments of receivables from financial services74,734[30]Financial receivables collected33,784[31]Proceeds from sales of finance receivables40,950Net changes in financial receivables€(6,462) This tells us that the firm invested €6,462 more than it received back from financial receivables. However, it seems that most of the proceeds are from selling on finance receivables. Other investment flows€(3,524) Other investment flows reported relate to other financial investments made up as follows: [32]Acquisition of securities (other than trading)(4,617)[33]Proceeds from sales of securities(other than trading)2,734Net acquisitions of securities(1,883)[34]Change in other cash(1,641)€(3,524) Although there is evidently some turnover in securities other than trading, these investments are not classified as operational. The securities are intended for holding in the long term and from time to time there will be some buying and selling. The change in other cash represents an increase in other cash held by the group ‒ which is logically considered to be an investment. There is a case for classifying all cash increases (decreases) as investments (divestments). 2.6.3 Financing cash flows[43]Cash provided by (used for) financing activities€6,808 This represents the total flow of cash between the firm and its borrowers and lenders during the year excluding interest payments. It is useful to categorize these between debt and equity: Net flows from the debt markets7,686[36]Change in commercial paper borrowing and short-term financial liabilities2,503[37]Additions to long-term financial liabilities9,491[38]Repayment of financial liabilities(4,126)Net flows to the equity markets(1,060)[40]Proceeds from issuance of capital stock4,076[41]Purchase of treasury stock(169)[42]Proceeds from special distribution tax refund1,487[43]Cash provided by financing activities€6,808 This section of the cash flow statement reveals that DaimlerChrysler has had to raise additional capital to fund its deficit between cash flow from operations and investments. It is shown that in addition to this deficit there was an additional net outflow to shareholders of €1,060 which required funding. This was all provided by raising additional debt finance. [36]Change in commercial paper borrowings and short-term financial liabilities€2,503 This reflects that DaimlerChrysler issued short-term debt certificates and borrowed more from banks in short-term debt thus increasing cash inflows. [37]Additional long-term financial liabilities€9,491 DaimlerChrysler issued new long-term debt for this amount which was a cash inflow. [38]Repayments of financial liabilities€(4,612) This was old debt refinanced during the year and is an outflow of cash. We will see that this net increase in debt of course increases the financial leverage of the firm which will have both financial advantages and disadvantages. [40]Proceeds from issuance of capital stock€4,076 This tells us that DaimlerChrysler raised this amount of additional cash flow by issuing more shares. [41]Purchase of treasury stock€(169) A small amount of cash was used to buy back DaimlerChrysler’s own stock. [39]Dividends paid€(6,454) The most significant cash outflow to the equity markets was the payment of a dividend to shareholders. It will be noticed that this amount exceeds current income. This implies that the dividend caused a reduction in retained earnings during the year since they were partly provided for from reserves. This is a purely legal matter since, as mentioned earlier, the retained earnings are not kept in a separate cash account for distribution. [42]Proceeds from special distribution tax refund€1,487 This amount represents a special tax refund (deduction) triggered by the payment of the special dividend. It will be noted that this amount was accrued as a reduction of tax expense on the 1997 income statement and held as an accrued liability in the 1997 balance sheet. Therefore in the 1997 cash flow statement it is recorded as a non-cash adjustment to calculate cash flow. Since it has a cash flow effect in the 1998 year it has to be accounted for – classifying it as an equity flow makes the most sense since it was entirely linked to the dividend distribution. Thus the cost of the dividend in cash flow to the firm was only €3,967. Net increase in cash€(44) This represents the surplus of finance raised and finance required and is reflected in an increased cash balance which is similar to an investment in cash. It is made up as follows: [45]Decrease in cash and cash equivalents up to 3 months353[44]Effect of foreign exchange rate changes on cash and cash equivalents up to 3 months(397)Net increase in cash;€(44)[45]Decrease in cash balance€353 This is a potentially confusing layout in the DaimlerChrysler cash flow statement since if one refers to the balance sheet it will be noted that the change in cash balance is actually €220. Opening cash per balance sheet6,809Closing cash per balance sheet6,589Decrease in cash220Difference (change in cash equivalent longer than 3 months)133Decrease in cash and cash equivalents up to 3 months€353 The difference is equal to the change in the cash equivalents longer than 3 months. Therefore the cash flow statement analyses changes in cash and cash equivalent of less than 3 months maturity. This is quite unusual and not an obviously helpful way to set out the statement. The use of a bracket for a decrease in cash on the DaimlerChrylser cash flow statement is confusing since a decrease in cash is equivalent to a disinvestment or an inflow. [44]Effect of foreign exchange rates changes on cash and cash equivalents up to 3 months€(397) Since the group holds cash balances in many currencies changes in the exchange rate against the (DM) and then the Euro will cause an apparent inflow or outflow of cash in Euro terms. This arises because the cash balances held in foreign currencies at the start of the period would have been translated into DM (and Euros) at the exchange rate at that date. The same amounts in foreign currencies held at the end of the period are translated at the year end rate of exchange to the DM (Euro). Although no cash has left the group, the amount of cash in DM (and €) terms was reduced. This is shown as a natural part of the analysis of the change in cash balance. Since the amount is an increase in cash it suggests that in aggregate the Dm worked against these currencies in which cash balances were held over the period. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780750640114500028 Rating Credit RiskMorton Glantz, Robert Kissell, in Multi-Asset Risk Modeling, 2014 Generic Points• Cash flow statements retrace all financing and investment activities of a firm for a given period of time. •Today, more and more lenders rely on the statement of cash flows as a measure of corporate performance because it “images” the probability distribution of future cash flows in relation to debt capacity. •The greater and more certain the cash flows, the greater the debt capacity of the firm. •SFAS 95 mandates segregating the borrower’s business activities into three classifications: operating, financing, and investing activities. The operating activities section may be presented using either a direct or indirect presentation. •The direct method focuses on cash and the impact of cash on the financial condition of the business. •Investing activities involve making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets—that is, assets held for or used in the production of goods or services by the enterprise. •Cash flows from unconsolidated subsidiaries include dividends from subsidiaries, advances and repayments, and the acquisition or sale of securities of subsidiaries. Noncash transactions include equity earnings, translation gains and losses, and consolidations. Prudent bankers must obtain a full disclosure concerning the project’s future cash flows since construction projects may report noncash earnings—construction accounting or equity earnings. •Investing activities involve obtaining resources from owners and providing them with a return on, and return of, their investment; borrowing money and repaying amounts borrowed or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit. •Operating activities include all transactions and other events that are not defined as investing or financing activities. Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of income. •Gross operating cash flow is often the most important line in the cash flow statement, representing net income plus all noncash charges less all noncash credits, plus or minus all nonoperating transactions. •Cash generated from nonrecurring items may artificially inflate earnings for a period, but it cannot be depended on to provide cash flow to support long-term financing. •Net income must be the predominant source of a firm’s funds in the end. •For the most part, current assets represent more than half the total assets of many businesses. With such a large, relatively volatile cash investment connected to optimizing shareholder value, current assets are deserving of financial management’s undivided attention. •Net operating cash flow denotes the cash available from gross operating cash flow to internally finance a firm’s future growth after working capital demands have been satisfied. •Sources of cash include decreases in assets, increases in liabilities, and increases in equity. Uses of cash include increases in assets, decreases in liabilities, and decreases in equity. •The control sheet shows that the change in the cash account is always equal to the difference between sources and uses of cash. •Sources and uses of cash are usually net changes, meaning the result of many different transactions. Thus, reconciliations lie at the core of cash flow analysis. •The quality, magnitude, and trend of operating cash flow must be examined carefully since it should contribute a reasonable amount to financing. These features are readily determined by the composition of the gross operating cash flow. •When depreciation expenses consistently exceed capital expenditures over time, this occurrence is an indication of a business in decline. Eventually, it will lead to a reduction in earnings and profitability. •If investment in unconsolidated subsidiaries represents a large item on the balance sheet, lenders should ask for financial statements of the unconsolidated subsidiary—or at least a full financial summary. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B978012401690300010X LBO Financial ModelDavid P. Stowell, in Investment Banks, Hedge Funds, and Private Equity (Third Edition), 2018 Determine Cash Flow Available for Debt ServiceKKR determined the cash flow available for debt service by subtracting CapEx from projected EBITDA and then making adjustments based on changes in working capital and other long-term assets and liabilities and payment of cash taxes. In addition, because KKR expected to receive cash from the future sale of stores, the projected after-tax proceeds of these sales increased cash. The result was a forecast of cash available for debt service through 2015 (see Exhibit 17.19). This amount was then reduced to reflect interest expense netted against interest income to create cash available for debt repayment. Normally, this cash is used to pay down debt and, in the case of Toys, the Exhibit suggests that the $2.3 billion of debt assumed on the date of acquisition is paid off first, and then the senior secured credit facility receives partial repayment. The end result of using available cash flow to retire debt is the reduction in total debt over time and improvement in debt/EBITDA ratios (see Exhibits 17.19 and 17.20). The gradual reduction in debt combined with the increase in EBITDA creates a growth in equity for a financial sponsor, enabling the sponsor to achieve its targeted IRR (see Exhibit 17.1). Exhibit 17.19 Cash Flow Statement ($ in Millions) Exhibit 17.20 Returns Summary ($ in Millions) The Toys’ projected cash flow statement (Exhibit 17.19) shows that there should be $347.9 million in cash available during 2006 to repay a portion of the debt assumed at the time of the acquisition.2 Payment of this debt reduces total debt from $6.712 billion in 2005 to $6.364 billion in 2006 (see Exhibit 17.20). This total debt amount continues to decrease from debt repayment through 2010, when it reaches $5.423 billion (net debt of $4.176 billion). LBO models typically assume that all excess cash is used to pay down debt. This is because the financial sponsor usually thinks that this is the best use for excess cash. However, if there is a compelling investment opportunity, or if the sponsor wants the company to pay a large dividend, this cash can be diverted, unless lenders include loan covenants that prevent or minimize dividends and other large cash payments (which they usually do). View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780128047231000177 Cash flow statementsRobert J. Kirk, in IFRS: A Quick Reference Guide, 2009 Cash and cash equivalentsThe end product of the cash flow statement or balancing figure will be the increase or decrease in cash and cash equivalents. Cash equivalents are defined in IAS 7 as ‘short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value’. An unusual feature, which is required by IAS 7, is the need to provide a separate note to the financial statements detailing out the individual components of cash and cash equivalents and requiring a reconciliation to the amounts reported in the balance sheet. If there are any cash or cash equivalent balances held by the enterprise, but are not available for use by the group then these should be disclosed, together with a commentary by the management. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9781856175456000097 Finance and AccountingBertrand C. Liang MD, PHD, MBA, in The Pragmatic MBA for Scientific and Technical Executives, 2013 The Cash Flow StatementAs the name implies, the cash flow statement identifies both the principle sources and uses of cash within a company. Like the income statement, it is defined over a period of time, and reflects the operations of a firm. As distinct from the income statement, however, the focus of this financial statement is to understand whether sufficient cash is being generated by the operations of the company to pay both its operating and capital expenses. If a company’s operations do not generate sufficient cash, starting cash (or cash generated through the sale of assets) on the balance sheet will be used. If internal cash is not sufficient, external financing (either debt or equity) is required. While there may be a number of aspects to the cash flow statement, fundamentally, the main components are related to cash obtained from operations, cash obtained from investments, and cash obtained from financing. Note that most cash flow statements are comparative, i.e., they relate the beginning of a period to an end of a period.Table 6.3 shows TechCo’s cash flow statement. Table 6.3. TechCo Cash Flow Statement for Year 20XX Cash flow from operating activities:Net income3,265Adjustments to net income to net cash from operationsDepreciation and amortization2,200Other noncash expenses200Changes in assets and liabilitiesIncrease in accounts receivable(3)Increase in inventory11Increase in accounts payable(4)Net cash provided by operations5,669Cash flows from investing:Capital expenditures(12)Sale of property, plant, equipment2Net cash provided by investing(10)Cash flows from financing activities:Increase in borrowing25Dividends paid0Exchange rate changes(6)Net cash provided from financing activities19Net increase (decrease) in cash5,678 What can be seen from the cash flow statement is the relevance of cash payments. An increase in accounts receivable (another party owes TechCo, viz. has not paid TechCo as of yet), is not a cash payment, but rather a use of cash (credit) (as opposed to the income statement, where this is considered revenue). Further, an increase in accounts payable actually increases cash (somewhat counterintuitive – however cash will ultimately decrease once a payable is actually paid). The effect of depreciation is very important – the “depreciation effect” affects both the income statement and the cash flow statement. For the income statement, it decreases the net income of the firm, and thus, decreases overall tax rates the firm will need to pay, but increases the cash flow, since depreciation per se is not cash, but “use” of assets – hence, it is not a cash charge! A related concept is that payments are either expensed (as expenses on the income statement) or capitalized (i.e., included as capital expenditures on the cash flow statement, which are then incorporated as long-term assets on the end of period balance sheet). Long-term assets are then depreciated over their useful life. This concept is of particular importance to R&D executives, as purchases of equipment are generally treated as capital expenditures and not immediately expensed. An understanding of both internal and external appearance provides insight on how to match resources to R&D strategy. While the interpretations of the balance sheet, income statement, and cash flow statement have other subtleties, the aforementioned provide the main components with which technical executives should be familiar. The following section will provide some additional ways to utilize information in these statements, based on comparative ratios meant to evaluate financial performance. View chapterPurchase book Read full chapter URL: https://www.sciencedirect.com/science/article/pii/B9780123979322000065 Target SettingCoauthored byMarika Arena, in Performance Measurement and Management for Engineers, 2015 6.1.2.1.7 Budgeted Cash Flow StatementAs mentioned previously, the budgeted cash flow statement analyzes the overall financial sustainability of the operational and investment plan. There are two methods for calculating the cash budget: •Directly, by registering future cash inflows and outflows •Indirectly, wherein economic results based on the accrual logic are adjusted in order to define cash flows for the year. In this section, we analyze the indirect method, as it is the most widely used practice. The direct method is illustrated in presenting the detailed cash budget. Table 6.6 illustrates the budgeted cash flow statement carried out with the indirect method. The starting point is EBIT, which is first adjusted by taking into account nonmonetary operational costs: depreciation and amortization. Depreciation and amortization come directly from the operating budgets that were previously defined. Table 6.6. Budgeted Cash Flow Statement EBIT+ Depreciation and amortization + Δ Net working capital= (Opening account receivable−closing account receivable) + (Closing account payable−opening account payable) + (Opening inventories−closing inventories) Δ Capital expenditures (CapEx)= Investments in fixed assets −disinvestments in fixed assets −Taxes= Free cash flow to firm (FFCF)+ Cash flows from financial revenues, net of tax− Cash flows for financial expenses, net of tax+ Cash for increase in share capital− Cash due to decrease in equity (including dividends)+ Δ Net debt=Free cash flow to equity (FCFE)The second adjustment is to add the variation of net working capital, which encompasses accounts receivable, inventory, and accounts payable. The following adjustment is to add the variation of capital expenditures: it comprehends planned acquisitions the fixed capital investments (capital budget) decrease by disinvestments and disposals of fixed assets. Subtracting expected taxes,1 the first important cash figure is determined: FFCF. As illustrated in Chapter 2, FFCF is the cash flow available for both debt and equity holders. A further step is to move from FFCF to FCFE) considering cash flows related to the financing activity, specifically: •Inflows from financial incomes are added. •Outflows for financial expenses are subtracted. •Inflows from share capital increase are added. •Outflows linked to the decrease in share capital; the main item is usually dividends paid to shareholders. •Variation in the net debt calculated referring to the difference between the budgeted year and the current one. This positively affects cash flows if they increase (e.g., new loans taken out as bank loans or bond emissions) and negatively affects cash flows if they decrease (e.g., repayment of a previous debt). It is clear that if the FCFE is positive (financial surplus), enterprises are not required to take action; if the budget highlights a cash problem (financial need), then companies are obliged to find solutions such as: •Finding more financing sources—for example, increasing debt or issuing bonds (refer to Chapter 11 for an analysis of financing strategy) What are non cash items in income statement?Examples of non-cash items include depreciation, amortization, deferred income tax, stock based compensation that is provided to employees.
Which of the following is an example of a non cash expense?A common example of noncash expense is depreciation. When the amount of depreciation is debited in the income statement, the amount of net profit is lowered yet there is no cash flow.
What are examples of non cash assets?A non-cash asset can be any item of appreciating value, like privately held stock, farm equipment, real estate or cryptocurrency. Donating assets other than cash can have various benefits and advantages. Many options can provide you with income during your lifetime, significant tax benefits — or both.
Which of the following is NOT a non cash item answer?cash sales is not a non-cash item.
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