Overview

IAS 7 Statement of Cash Flows requires an entity to

present a statement of cash flows as an integral
part of its primary financial statements.
Cash flows are classified and presented into
operating activities (either using the 'direct' or
'indirect' method), investing activities or financing
activities, with the latter two categories generally
presented on a gross basis.
 Objective of IAS 7

• The objective of IAS 7 is to require the

presentation of information about the
historical changes in cash and cash equivalents
of an entity by means of a statement of cash
flows, which classifies cash flows during the
period according to operating, investing, and
financing activities.
 Fundamental principle in IAS 7

• All entities that prepare financial statements in

conformity with IFRSs are required to present a
statement of cash flows. [IAS 7.1]
• The statement of cash flows analyses changes in
cash and cash equivalents during a period. Cash
and cash equivalents comprise cash on hand and
demand deposits, together with short-term,
highly liquid investments that are readily
convertible to a known amount of cash, and that
are subject to an insignificant risk of changes in
value.
 Fundamental principle in IAS 7

• Guidance notes indicate that an investment

normally meets the definition of a cash
equivalent when it has a maturity of three
months or less from the date of acquisition.
 Fundamental principle in IAS 7

• Equity investments are normally excluded,

unless they are in substance a cash equivalent
(e.g. preferred shares acquired within three
months of their specified redemption date).
Bankdrafts which are repayable on demand
and which form an integral part of an entity's
cash management are also included as a
component of cash and cash equivalents. [IAS
7.7-8]
 Presentation of the Statement of Cash Flows

• Cash flows must be analysed between operating,

investing and financing activities. [IAS 7.10]
• Key principles specified by IAS 7 for the
preparation of a statement of cash flows are as
follows:
• operating activities are the main revenue-
producing activities of the entity that are not
investing or financing activities, so operating cash
flows include cash received from customers and
cash paid to suppliers and employees [IAS 7.14]
 Presentation of the Statement of Cash Flows

• investing activities are the acquisition and

disposal of long-term assets and other
investments that are not considered to be
cash equivalents [IAS 7.6]
• financing activities are activities that alter the
equity capital and borrowing structure of the
entity [IAS 7.6]
 Presentation of the Statement of Cash Flows

• interest and dividends received and paid may

be classified as operating, investing, or
financing cash flows, provided that they are
classified consistently from period to period
[IAS 7.31]
• cash flows arising from taxes on income are
normally classified as operating, unless they
can be specifically identified with financing or
investing activities [IAS 7.35]
 Net Cash Flow
• Net cash flow = Net income – Noncash
revenues + Noncash charges

• Net cash flow = Net income + Depreciation

and amortization
 Presentation of the Statement of Cash Flows

for operating cash flows, the direct method of

presentation is encouraged, but the indirect
method is acceptable [IAS 7.18]

The direct method shows each major class of

gross cash receipts and gross cash payments.
• The operating cash flows section of the
statement of cash flows under the direct
method would appear something like this:
Cash receipts from customers xx,xxx

Cash paid to suppliers xx,xxx

Cash paid to employees xx,xxx

Cash paid for other operating expenses xx,xxx

Interest paid xx,xxx

Income taxes paid xx,xxx

Net cash from operating activities xx,xxx

• The indirect method adjusts accrual basis net
profit or loss for the effects of non-cash
transactions. The operating cash flows section
of the statement of cash flows under the
indirect method would appear something like
this:
Profit before interest and income taxes xx,xxx

Add back depreciation xx,xxx

Add back impairment of assets xx,xxx

Increase in receivables xx,xxx

Decrease in inventories xx,xxx

Increase in trade payables xx,xxx

Interest expense xx,xxx

Less Interest accrued but not yet paid xx,xxx

Interest paid xx,xxx

Income taxes paid xx,xxx

Net cash from operating activities xx,xxx

Net Cash Flow from Operating Activities
Net Income P14,000
Add/(Deduct) adjustment for differences between net income and
cash flows from operating activities:
depreciation expense + 8,000
Increase in salaries payable + 800
increase in accounts payable + 2,600
increase in accounts receivable -7,000
Net cash provided by operating activities P18,400
• Depreciation and amortization are noncash
expenses that were deducted when
calculating net income. They must be added
back to show the actual cash flow from
operations.
 Exercise Indirect Method
The following information is available:
• Net Income P5,000 =
• Depreciation Expense 2,500 +
• Increase in deferred tax liabilities 500 +
• Decrease in cash 3,000 -
• Increase in marketable securities 1,000 -
• Decrease in accounts receivable 2,000 +
• Increase in inventories 9,000 -
• Decrease in Accounts Payable 5,000 +
• Increase in accrued liabilities 1,000 +
• Increase in property and equipment 14,000 -
• Increase in short-term notes payable 19,000 +
• Decrease in long-term liabilities 4,000 –
• =4000
 Adjustment to convert Net Income to Net Cash Flow from Operating
Activities (INDIRECT METHOD)

Net Income After Taxes

Plus (+)
• Decrease in current assets (except cash, marketable securities and non-trade
accounts)
• Increase in current liabilities (except financing or non-operating accounts, e.g. bank
loan, current maturities of long-term debt
• Depreciation, depletion, and amortization expense
• Amortization of discounts on bonds payable
• Amortization of premium on investment in bonds
• Increase in deferred income taxes
• Loss (net) on disposal of assets or liabilities
• Subsidiary loss under the equity method
• Interest expense
• Income taxes
 Adjustment to convert Net Income to Net Cash Flow from Operating
Activities (INDIRECT METHOD)

Minus (-)
• Increase in current assets (except cash, marketable securities and non-trade
accounts)
• Decrease in current liabilities (except financing or non-operating accounts, e.g. bank
loan, current maturities of long-term debt
• Amortization of premium on bonds payable
• Amortization of discount on investment in bonds
• Decrease in deferred income taxes
• Gain (net) on disposal of assets or liabilities
• Subsidiary gain under the equity method
Equals (=)
Net Cash Flow From Operations
Interest paid
Income taxes paid
Net Cash from Operating Activities
 Required?
• What is net cash flow from operating
activities?
• What is net cash flow from investing
activities?
• What is net cash flow from financing activities
• What is the change in cash?
Financial Ratios Discussion
 Sample Exercise
For the just completed year, Twilight Corp had net income of P84,000. Balances
In the company’s current asset and current liability accounts at the beginning
And end of the year were as follows:
December 31
End of Year Beginning of Year
Current assets:
Cash P 60,000 P 80,000
Accounts Receivable 250,000 150,000
Inventory 437,000 360,000
Prepaid Expenses 12,000 14,000
Current liabilities:
Accounts payable 420,000 390,000
Accrued liabilities 8,000 12,000
The deferred income Taxes liability account on the statement of financial position
Increased by P6,000 during the year, and depreciation charges were P50,000
during the year
Using the indirect method, determine the net cash provided by operating activities
for the year.
Net income ................................................................. P84,000
Adjustments to convert net income to a cash basis:
Depreciation charges for the year ........................... P50,000
Increase in accounts receivable .............................. (60,000)
Increase in inventory .............................................. (77,000)
Decrease in prepaid expenses ................................. 2,000
Increase in accounts payable .................................. 30,000
Decrease in accrued liabilities ................................ (4,000)
Increase in deferred income taxes .......................... 6,000 (53,000)
Net cash provided by operating activities ................... P31,000
Quiz
Modifying Accounting Data
For
Managerial Decisions
 Operating Assets = Operations
Working Capital
• The cash and marketable securities, accounts
receivable, inventories, and fixed assets
necessary to operate the business.
 Non-Operating Assets
• Cash and marketable securities above the
level required for normal operations,
investments in subsidiaries, land held for
future use, and other nonessential assets.
 In millions
ASSETS 2019 2018 LIABILITIES AND SHE 2019 2018
Cash and marketable 10 80 Accounts Payable 60 30
securities
Accounts Receivable 375 315 Notes Payable 110 60
Inventories 615 415 Accruals 140 130
Total Current Assets 1,000 810 Total Current Liabilities 310 220
Net plant and equipment 1,000 870 Long-term bonds 754 580
Total Liabilities 1,064 800
Preferred Shares (400,000) 40 40
Ordinary Shares (50,000,000) 130 130
Retained earnings 766 710
_____ ____ Total Ordinary Equity 896 840
Total assets 2,000 1,680 Total Liabilities and SHE 2,000 1,680

Common Shareholders’ Equity (Net Worth) =

Assets-Liabilities-Preferred Shares
P2B – P1.064B – P40M = P896M
 Net Operating working capital
(NOWC)
• Operating working capital less accounts
payable and accruals. It is the working capital
acquired with investor-supplied funds.
=
All current assets – All current liabilities that do
not charge interest
NOWC=Cash and Marketable Securities +
Accounts receivable + inventories - Accounts
payable - accruals = 800,000
 Total Operating capital
• Current assets used in operation

Operating Working Capital = Net operating

working capital +Net fixed assets = 1,800
 Net Operating Profit After Taxes
(NOPAT)
• The profit a company would generate if it had
no debt and held no non-operating assets
=
NOPAT=EBIT(1-TAX RATE)
= P170.3M
Income Statement and Retained Earnings
2019 2018
Net Sales 3,000.0 2,850.0
Operating cost excluding depreciation and amortization 2,616.20 2,497.0
Earnings before interest, taxes, depreciation and 383.80 353.0
amortization (EBITDA)
Depreciation 100.0 90.0
Amortization 0.0 0.0
Depreciation and amortization 100.00 90.0
Earnings before interest and taxes (EBIT, or operating 283.80 263.0
income)
Less: interest 88.0 60.0
Earnings before taxes (EBT) 195.8 203.0
Taxes 78.3 81.2
Net income before dividends 117.5 121.8
Preferred dividends 4.0 4.0
Net income 113.5 117.8
 EPS=113,500/50,000 DPS=57,500/50,000

2019 2018
Net income 113.5 117.8
Ordinary share dividends 57.5 53.0
Addition to retained earnings 56.0 64.8

Per share data

Ordinary share price 23.00 26.0
Earnings per share (EPS) 2.27 2.36
Dividends per share (DPS) 1.15 1.06
Book value per share (BVPS) 17.92 16.80
Cash flow per share (CFPS) 4.27 4.16

CFPS=NI + Depreciation + Amortization/Ordinary Shares Outstanding

213.5/50
BVPS = Total SHE/Ordinary shares outstanding
2019 = =896/50
2018 = 840/50
 Net Cash Flow
• The actual net cash as opposed to accounting
net income, that a firm generates during some
specified period.
=Net Cash flow = Net income-Noncash revenues
+Noncash charges
= Net Cash flow = Net income + Depreciation
+Amortization
= P113.5 + P100
= P213.5
Operating Activities
Net income before preferred dividends 117.5
Additions (Sources of Cash)
Depreciation and amortization 100.0
Increase in accounts payable 30.0
Increase in accruals 10.0
Subtractions (Uses of Cash)
Increase in accounts receivable (60.0)
Increase in inventories (200.0)
Net cash provided by operating activities (2.5)
Long term Investing Activities
Cash used to acquire fixed assets (230.0)
Financing Activities
Increase in notes payable 50.0
Increase in bonds 174.0
Payment of common and preferred dividends (61.5)
Net cash provided by financing activities 162.5
Net decrease in cash and marketable securities (70.0)
Cash and securities at beginning of year 80.0
Accounting profit vs Net Cash Flow
 Free Cash Flow
• The cash flow actually available for
distribution to all investors (shareholders and
debtholders) after the company has made all
the investments in fixed assets, new products,
and working capital necessary to sustain
ongoing operations.
 Comparison
Free Cash Flow Net Cash Flow
• Funds available to all • Funds available to ordinary
investors shareholders
• Funds available to all • Payment to bondholders
investors after subtracting and preferred shareholders
out the investments that reduces net cash flow but
are necessary to sustain the are not deducted out of free
firm’s ongoing operations cash flow
• Thus, investments in fixed
assets and net working
capital reduces free cash
flow but are not subtracted
from net cash flow
Calculating Free Cash Flow
Income Statement and Retained Earnings
2019 2018
Net Sales 3,000.0 2,850.0
Operating cost excluding depreciation and amortization 2,616.20 2,497.0
Earnings before interest, taxes, depreciation and 383.80 353.0
amortization (EBITDA)
Depreciation 100.0 90.0
Amortization 0.0 0.0
Depreciation and amortization 100.00 90.0
Earnings before interest and taxes (EBIT, or operating 283.80 263.0
income)
Less: interest 88.0 60.0
Earnings before taxes (EBT) 195.8 203.0
Taxes 78.3 81.2
Net income before dividends 117.5 121.8
Preferred dividends 4.0 4.0
Net income 113.5 117.8
 EPS=113,500/50,000 DPS=57,500/50,000

2019 2018
Net income 113.5 117.8
Ordinary share dividends 57.5 53.0
Addition to retained earnings 56.0 64.8

Per share data

Ordinary share price 23.00 26.0
Earnings per share (EPS) 2.27 2.36
Dividends per share (DPS) 1.15 1.06
Book value per share (BVPS) 17.92 16.80
Cash flow per share (CFPS) 4.27 4.16

CFPS=NI + Depreciation + Amortization/Ordinary Shares Outstanding

213.5/50
BVPS = Total SHE/Ordinary shares outstanding
2019 = =896/50
2018 = 840/50
 Net Operating Profit After Taxes
(NOPAT)
• The profit a company would generate if it had
no debt and held no Non-Operating assets
=
NOPAT=EBIT(1-TAX RATE)
= 283.8(1-0.40)
= 283.8 (.60)
= 170.3
 Operating Cash Flow
• Equal to NOPAT plus any noncash
adjustments, calculated on an after-tax basis.

• =NOPAT + Depreciation and Amortization

=170.3 +100
= 270.3
 In millions
ASSETS 2019 2018 LIABILITIES AND SHE 2019 2018
Cash and marketable 10 80 Accounts Payable 60 30
securities
Accounts Receivable 375 315 Notes Payable 110 60
Inventories 615 415 Accruals 140 130
Total Current Assets 1,000 810 Total Current Liabilities 310 220
Net plant and equipment 1,000 870 Long-term bonds 754 580
Total Liabilities 1,064 800
Preferred Shares (400,000) 40 40
Ordinary Shares (50,000,000) 130 130
Retained earnings 766 710
_____ ____ Total Ordinary Equity 896 840
Total assets 2,000 1,680 Total Liabilities and SHE 2,000 1,680

Common Shareholders’ Equity (Net Worth) =

Assets-Liabilities-Preferred Shares
 Net investment in Operating
Capital
Total Current Assets – AP – Accruals + FA
• 2018 = 810 – 30 – 130 = 650 + 870 = 1,520
• 2019 = 1,000 – 60 – 140 = 800 + 1,000 = 1,800
• Variance = 280
 2019 2018
Net Sales 3,000.0 2,850.0
Operating cost excluding depreciation and amortization 2,616.20 2,497.0
Earnings before interest, taxes, depreciation and 383.80 353.0
amortization (EBITDA)
Depreciation 100.0 90.0
Amortization 0.0 0.0
Depreciation and amortization 100.00 90.0
Earnings before interest and taxes (EBIT, or operating 283.80 263.0
income)
Less: interest 88.0 60.0
Earnings before taxes (EBT) 195.8 203.0
Taxes 78.3 81.2
Net income before dividends 117.5 121.8
Preferred dividends 4.0 4.0
Net income 113.5 117.8
 Gross investment in Operating
Capital
• = Net investment + Depreciation and
Amortization
• 2018 = 810 – 30 – 130 = 650 + 870 = 1,520
• 2019 = 1,000 – 60 – 140 = 800 + 1,000 = 1,800
• Net investment = 280
• Depreciation and Amortization = 100
380
 Free Cash Flow
• = Operating Cash Flow- Gross Investment in
Operating Capital
• 270.3 – 380 = 109.7

• = NOPAT – Net Investment in Operating

Capital
• =170.3 – 280 = 109.7
 MVA and EVA
• Since the primary goal of management is to
maximize the firm’s stock prices, we need to
bring stock prices into the picture.
• Financial analysts have therefore developed
two performance measures:
Market Value Added
Economic Value Added
Market Value Added (MVA) – measures the
effects of managerial actions since the
inception of a company
• MVA = Market value of stock – Equity capital
supplied by shareholders
= (Shares outstanding)(Stock price) -
Total ordinary equity
=50,000,000 x 23 = 1,150
= 1,150 – 896 = 254
• The higher its MVA the better the job
management is doing for the firm’s
shareholders.
 2019 2018
Net income 113.5 117.8
Ordinary share dividends 57.5 53.0
Addition to retained earnings 56.0 64.8

Per –share data

Ordinary share price 23.00 26.0
Earnings per share (EPS) 2.27 2.36
Dividends per share (DPS) 1.15 1.06
Book value per share (BVPS) 17.92 16.80
Cash flow per share (CFPS) 4.27 4.16
MVA Calculation 2019 2018
Price per share 23.0 26.0
Number of shares (millions) X 50 X 50
Market value of equity 1,150.0 1,300.0
Book value of equity - 896.0 - 894.0
MVA 254.0 460.0
 In millions
ASSETS 2019 2018 LIABILITIES AND SHE 2019 2018
Cash and marketable 10 80 Accounts Payable 60 30
securities
Accounts Receivable 375 315 Notes Payable 110 60
Inventories 615 415 Accruals 140 130
Total Current Assets 1,000 810 Total Current Liabilities 310 220
Net plant and equipment 1,000 870 Long-term bonds 754 580
Total Liabilities 1,064 800
Preferred Shares (400,000) 40 40
Ordinary Shares (50,000,000) 130 130
Retained earnings 766 710
_____ ____ Total Ordinary Equity 896 840
Total assets 2,000 1,680 Total Liabilities and SHE 2,000 1,680

Common Shareholders’ Equity (Net Worth) =

Assets-Liabilities-Preferred Shares
Economic Value Added (EVA) – focuses on
managerial effectiveness in a given year
• EVA = NOPAT – After tax cost of operating
capital
= EBIT(1-T)-[(Total investor supplied
operating capital)x(After-tax percentage
cost of capital)]
Total investor supplied operating capital
= sum of the interest-bearing debt,
preferred shares, and common equity
= net operating working capital + net
plant and equipment
EVA Calculation 2019 2018
EBIT 283.8 263.0
1-Tax rate X 60% X 60%
NOPAT 170.3 157.8
Total investor supplied operating 1,800.0 1,520.0
capital*
After tax cost of capital (%) 10% 10.3%
Peso cost of capital 180.0 156.6
EVA= NOPAT – Peso Cost of Capital ( 9.70 ) 1.20

*Equals the sum of notes payable, long-term debt, preferred stock

And common equity
Or
Equals total liabilities and equity minus accounts payable and
Accruals
Or
Equals to net operating working capital plus net fixed assets
 2019 2018
Net Sales 3,000.0 2,850.0
Operating cost excluding depreciation and amortization 2,616.20 2,497.0
Earnings before interest, taxes, depreciation and 383.80 353.0
amortization (EBITDA)
Depreciation 100.0 90.0
Amortization 0.0 0.0
Depreciation and amortization 100.00 90.0
Earnings before interest and taxes (EBIT, or operating 283.80 263.0
income)
Less: interest 88.0 60.0
Earnings before taxes (EBT) 195.8 203.0
Taxes 78.3 81.2
Net income before dividends 117.5 121.8
Preferred dividends 4.0 4.0
Net income 113.5 117.8
Financial Liquidity
Financial Flexibility