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Dividends
Lenders & investors look for businesses that have good cash flow.
For lenders, it means that the business will be capable to repay a loan. For investors, the excess cash flow could be used to pay a dividend or buy back shares.
Topic 1
Operating Activites
“High Quality Earnings”
from the company's main course of business
Inflows
Direct Method
- presented by major categories of gross receipts and gross payments and the resulting net amount
Indirect (Reconciliation) Method
- begin at net income (accrual) and adjust differences in current assets/liabilities (as they relate to operating activities) to arrive at net cash provided by operating activities
- most commonly used method
- must also be presented even in using the direct method
- cash receipts from sales
- interest and dividends received
- procedes from insurance policy
- refunds from suppliers
- sales of trade securities
- awards from law suits
IFRS Differences
Classification of interest, dividends, and taxes
Other considerations
Interest paid (expense)
US GAAP: Operating vs IFRS: Operating or Financing
Dividends paid (not and IS item)
US GAAP: Financing vs IFRS: Operating or Financing
Interest received (revenue)
US GAAP: Operating vs IFRS: Operating or Financing
Dividends received (revenue)
US GAAP: Operating vs IFRS: Operating or Financing
Taxes paid (expense)
US GAAP: Operating vs IFRS: usually Operating but can be split among all classifications depending on nature of the transaction
Outflows
Cash Flow Analysis
- Special items on the Income Statement are classified under operating, investing, or financing as appropriate
- Extraordinary items
- Cumulative effect of a change in principle
- Income from discontinued operations
- Agency arrangements
- Must be presented if activity results in cash inflow/outflow even if no benefits are be received
- Hedging transactions should be classified as the same as the hedged item and disclosed
- futures contracts, swap agreements, or option contracts
- Cash flow per share = net cash flow / # of shares
- Current cash debt coverage ratio = net cash provided by operating activities / avg current liabilities
- Cash debt coverage ratio = net cash provided by operating activities / avg total liabilities
- Free cash flow (FCF) = cash flow from operations - capital spending - dividends
- (measures financial flexibility by determining discretionary cash flow)
- cash paid for operating expenses
- payment for law suit damages
- cash refunds to customers
- interest payments
- income tax payments
- cash purchase of trading securities
- payment of duties, fines, and penalties
- charitable contributions
- amortization of acquisition date fair value adjustments under either the purchase or acquisition methods
Businesses compare Cash from Operating Activities to Net Income:
If the amount is higher than Net Income, earnings are considered to be of “high quality.” If the amount is lower than Net Income, it raises questions about why income is not turning into cash.
Financing Activities
- short-term or long-term debt
- dividends paid to stockholders
- stock (common or preferred)
In the financing and investing sections, gross cash inflows should be shown separately from gross cash outflows for similar items
Investing Activites
purchasing and selling...
- fixed assets
- available-for-sale or held-to-maturity securities
- making/collecting loans
Statement of Cash Flows
Direct vs.
Indirect
Reporting & Analysis
- a difference in presentation of Operating Activities
- investing and financing sections are identical under both methods
Benefits
financial analysis
liquidity
solvency
financial flexibilitiy
- enables the assessment of future cash flows
- indicates impact on investing and financing transactions
- shows ability to
- obtain financing
- generate recurring cash earnings
- evaluates the company's ability to pay
- debt when due
- expenses for normal operations
- dividends
Cash Equivalents
GAAP defines it as...
- short-term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value...
Disclosures
- Income taxes and interest paid
- noncash investing and financing activities
- can be in narrative form in a separate schedule appended at the bottom of the statement of cash flows
- disclosed in a note to the financial statements or a supplementary schedule
Required
prepared in conformity with GAAP
Reconciliation
from beginning to ending cash
- as part of a full set of financial statements
- ASC 230, Statement of Cash Flows
- cash flow per share is prohibited as it may imply a measure of performance (ie: EPS)
- ASC 958-205 Not-for-Profit Entities: Presentation of Financial Statements
- required for NFP as well as all business enterprises
Reconciliation
- provides relavent information about cash receipts and disbursements during a period
- presenting the net effect of cash flows on the company's cash
- shows sources and uses of cash
Sample Statement
Cash Effects from...
- Operating
- Investing
- Financing
1
How can the Income Statement & Cash Flow Statement show different numbers?
Questions
Format
The Cash Flow Statement divides cash into:
- Operational Activities
- Investing Activities
- Financing Activities
- Supplemental Information
What would happen to cash flow if:
- An owner invests $10,000 of capital?
- A business purchases inventory with cash?
- A customer pays an Accounts Receivable?
- The company truck depreciates $1,200 because of heavy use?
- Land increases $50,000 in value?
Purpose
Sometimes, the Income Statement does not report the flows of cash & cash equivalents. A company requires enough cash to meet its immediate obligations. The Statement of Cash Flows reports whether a business has enough cash to remain in operation.
Cash Flow Statement
Learning Goal: Understand the role the Cash Flow Statement plays in evaluating a company’s operations.