Cash Flow

Unit 5
 Cash Flow
• ‘Cash Flows’ implies movement of cash in and out due to some non-cash
items. Receipt of cash from a non-cash item is termed as cash inflow while
cash payment in respect of such items as cash outflow.
• For example, purchase of machinery by paying cash is cash outflow while
sale proceeds received from sale of machinery is cash inflow.
• Other examples of cash flows include collection of cash from trade
receivables, payment to trade payables, payment to employees, receipt of
dividend, interest payments, etc.
• Cash management includes the investment of excess cash in cash
equivalents.
• Hence, purchase of marketable securities or short-term investment which
constitutes cash equivalents is not considered while preparing cash flow
statement.
 Cash Flow
• Cash Flow (CF) is the increase or decrease in the amount of
money a business, institution, or individual has.
• In finance, the term is used to describe the amount of cash
(currency) that is generated or consumed in a given time
period.
• There are many types of CF, with various important uses for
running a business and performing financial analysis.
• Types of cash flow
• Cash from Operating Activities
• Free Cash Flow to Equity (FCFE)
• Free Cash Flow to the Firm (FCFF)
• Net Change in Cash
Cash Flow
• Cash from Operating Activities –
• Cash that is generated by a company’s core business activities
– does not include CF from investing. This is found on the
company’s Statement of Cash Flows (the first section).
• Free Cash Flow to Equity (FCFE) – FCFE represents the cash
that’s available after reinvestment back into the business
(capital expenditures).
• Free cash flow to equity (FCFE) is the amount of cash a business
generates that is available to be potentially distributed
to shareholders. It is calculated as Cash from Operations
less Capital Expenditures plus net debt issued.
 FCFE Example
• Amazon’s 2016 annual report and statement
of cash flows, which can be used to calculate
free cash flow to equity for years 2014 –
2016.

• Formula:
• FCFE = Cash from Operating Activities
– Capital Expenditures
+ Net Debt Issued (Repaid)

• As you can see in the image above, the

calculation for each year is as follows:
• 2014: 6,842 – 4,893 + 6,359 – 513 = 7,795
• 2015: 11,920 – 4,589 + 353 – 1,652 = 6,032
• 2016: 16,443 – 6,737 + 621 – 354 = 9,973
 Cash Flow
• Free Cash Flow to the Firm (FCFF) – This is a measure that assumes a
company has no leverage (debt). It is used in financial modeling and
valuation.
• Unlevered Free Cash Flow (also known as Free Cash Flow to the Firm or FCFF
for short) is a theoretical cash flow figure for a business. It is the cash flow
available to all equity holders and debtholders after all operating expenses,
capital expenditures, and investments in working capital have been made.
• Unlevered Free Cash Flow is used in financial modeling to determine
the enterprise value of a firm. It is technically the cash flow that equity
holders and debt holders would have access to from business operations.
 How to Calculate Free Cash Flow
to the Firm
• Here is a step-by-step example of how to calculate unlevered free cash flow (free
cash flow to the firm):
1.Begin with EBIT (Earnings Before Interest and Tax)
2.Calculate the theoretical taxes the company would have to pay if they didn’t
have a tax shield (i.e., without deducting interest expense)
3.Subtract the new tax figure from EBIT
4.Add back depreciation and amortization expenses
5.Subtract any increases in non-cash net working capital
6.Subtract any capital expenditures
 Cash Flow
• Net Change in Cash – The change in the amount of
cash flow from one accounting period to the next.
• This is found at the bottom of the Cash Flow Statement.
 Cash Flow Statement
• A Cash Flow Statement (also called the Statement of Cash Flows) shows how much
cash is generated and used during a given time period.
• It is one of the main financial statements analysts use in building a three statement
model.
• The main categories found in a cash flow statement are
• (1) operating activities,
• (2) investing activities, and
• (3) financing activities of a company and are organized respectively.
• The total cash provided from or used by each of the three activities is summed to arrive
at the total change in cash for the period, which is then added to the opening cash
balance to arrive at the cash flow statement’s bottom line, the closing cash balance.
Cash Flow Statement
• A cash flow statement provides information about the historical
changes in cash and cash equivalents of an enterprise by classifying
cash flows into operating, investing and financing activities.
• It requires that an enterprise should prepare a cash flow statement
and should present it for each accounting period for which financial
statements are presented.
• This chapter discusses this technique and explains the method of
preparing a cash flow statement for an accounting period
 Cash Flow Statement
• One of the primary reasons cash inflows and outflows are observed
is to compare the cash from operations to net income.
• This comparison helps company management, analysts, and
investors to gauge how well a company is running its operations.
• The cash flow statement reflects the actual amount of
money the company receives from its operations.
• The reason for the difference between cash and profit is because
the income statement is prepared under the accrual basis of
accounting, where it matches revenues and expenses for the
accounting period, even though revenues may actually not
have yet been collected and expenses may not have yet
been paid.
• In contrast, the cash flow statement only recognizes cash that
has actually been received or disbursed.
 Objectives of Cash Flow Statement
• A Cash flow statement shows inflow and outflow of cash and cash
equivalents from various activities of a company during a specific period.
• The primary objective of cash flow statement is to provide useful
information about cash flows (inflows and outflows) of an enterprise
during a particular period under various heads, i.e., operating activities,
investing activities and financing activities.
• This information is useful in providing users of financial statements with a
basis to assess the ability of the enterprise to generate cash and cash
equivalents and the needs of the enterprise to utilise those cash flows.
• The economic decisions that are taken by users require an evaluation of the
ability of an enterprise to generate cash and cash equivalents and the
timing and certainty of their generation.
Cash Flow Statement
 Benefits of Cash Flow Statement
• A cash flow statement when used along with other financial statements provides
information that enables users to evaluate changes in net assets of an enterprise, its
financial structure (including its liquidity and solvency) and its ability to affect the
amounts and timings of cash flows in order to adapt to changing circumstances and
opportunities.
• Cash flow information is useful in assessing the ability of the enterprise to generate
cash and cash equivalents and enables users to develop models to assess and
compare the present value of the future cash flows of different enterprises.
• It also enhances the comparability of the reporting of operating performance by
different enterprises because it eliminates the effects of using different accounting
treatments for the same transactions and events.
• It also helps in balancing its cash inflow and cash outflow, keeping in response to
changing condition.
• It is also helpful in checking the accuracy of past assessments of future cash flows and
in examining the relationship between profitability and net cash flow and impact of
changing prices.
How to Set Up the Cash Flow Statement?
• Below is a breakdown of each section in a statement of
cash flows.
• While each company will have its own unique line items,
the general setup is usually the same.
• This guide will give you a good overview of what to look
for when analyzing a company.
• #1 Operating Cash Flow
• #2 Investing Cash Flow
• #3 Financing Cash Flow
 Cash from Operating Activities
• Operating activities are the activities that constitute the primary or main activities of
an enterprise.
• For example, for a company manufacturing garments, operating activities are
procurement of raw material, incurrence of manufacturing expenses, sale of
garments, etc.
• These are the principal revenue generating activities (or the main activities) of the
enterprise and these activities are not investing or financing activities.
• The amount of cash from operations’ indicates the internal solvency level of the
company, and is regarded as the key indicator of the extent to which the operations
of the enterprise have generated sufficient cash flows to maintain the operating
capability of the enterprise, paying dividends, making of new investments and
repaying of loans without recourse to external source of financing.
• Cash flows from operating activities are primarily derived from the main activities of
the enterprise. They generally result from the transactions and other events that
enter into the determination of net profit or loss.
 Cash from Operating Activities
• Examples of cash flows from operating activities are:
• Cash Inflows from operating activities
• cash receipts from sale of goods and the rendering of services.
• cash receipts from royalties, fees, commissions and other revenues.
• Cash Outflows from operating activities
• Cash payments to suppliers for goods and services.
• Cash payments to and on behalf of the employees.
• Cash payments to an insurance enterprise for premiums and claims, annuities, and
other policy benefits.
• Cash payments of income taxes unless they can be specifically identified with
financing and investing activities.
 Operating Cash Flow
• The cash flow statement begins with
Cash Flow from Operating Activities.
• It starts with net income or loss, followed by additions to or
subtractions from that amount to adjust the net income to a
total cash flow figure.
• What is added or subtracted are changes in the account
balances of items found in current assets and current liabilities
on the balance sheet, as well as non-cash accounts (e.g.,
stock-based compensation).
• We then arrive at the cash version of a company’s net income.
• Net Earnings
• Plus: Depreciation and Amortization (D&A)
• Less: Changes in working capital
• Cash from operations
 Operating Cash Flow
• Net Earnings
• This amount is the bottom line of an income statement.
• Net income or earnings shows the profitability of a company over a period of time.
• It is calculated by taking total revenues and subtracting from them the COGS and
total expenses, which includes SG&A, Depreciation and Amortization, interest, etc.
• Plus: Depreciation and Amortization (D&A)
• The value of various assets declines over time when used in a business.
• As a result, D&A are expenses that allocate the cost of an asset over its useful life.
• Depreciation involves tangible assets such as buildings, machinery, and equipment,
whereas amortization involves intangible assets such as patents, copyrights,
goodwill, and software.
• D&A reduces net income in the income statement.
• However, we add this back into the cash flow statement to adjust net income
because these are non-cash expenses. In other words, no cash transactions are
involved.
Operating Cash Flow
• Less: Changes in working capital
• Working capital represents the difference between a company’s
current assets and current liabilities.
• Any changes in current assets (other than cash) and current liabilities
affect the cash balance in operating activities.
• For instance, when a company buys more inventory, current assets
increase. This positive change in inventory is subtracted from net
income because it is seen as a cash outflow.
• It’s the same case for accounts receivable. When it increases, it
means the company sold their goods on credit. There was no cash
transaction, so accounts receivable is also subtracted from net
income.
• On the other hand, if a current liability item such as accounts
payable increases, this is considered a cash inflow because the
company has more cash to keep in its business.
• This is then added to net income.
Operating Cash Flow
• Cash from operations
• When all the adjustments have been made, we arrive at
the net cash provided by the company’s operating
activities.
• This is not a replacement for net income, but rather a
summary of how much cash is generated from the
company’s core business.
Cash from Investing Activities
• Investing activities are the acquisition and disposal of long-term
assets and other investments not included in cash equivalents.
• Investing activities relate to purchase and sale of long-term assets or
fixed assets such as machinery, furniture, land and building, etc.
• Transactions related to longterm investment are also investing
activities.
• Separate disclosure of cash flows from investing activities is important
because they represent the extent to which expenditures have been
made for resources intended to generate future income and cash
flows
 Cash from Investing Activities
• Examples of cash flows arising from investing activities are:
• Cash Outflows from investing activities
• Cash payments to acquire fixed assets including intangibles and capitalised research and
development.
• Cash payments to acquire shares, warrants or debt instruments of other enterprises
other than the instruments those held for trading purposes.
• Cash advances and loans made to third party (other than advances and loans made by a
financial enterprise wherein it is operating activities).
• Cash Inflows from Investing Activities
• Cash receipt from disposal of fixed assets including intangibles.
• Cash receipt from the repayment of advances or loans made to third parties (except in
case of financial enterprise).
• Cash receipt from disposal of shares, warrants or debt instruments of other enterprises
except those held for trading purposes.
• Interest received in cash from loans and advances.
• Dividend received from investments in other enterprises
 Investing Cash Flow
• This category on the statement of cash flows is referred to as Cash Flow
from Investing Activities and reports changes in capital
expenditures (CapEx) and long-term investments.
• CapExcan refer to the purchase of property, plant, or equipment assets.
• Long-term investments may include debt and equity instruments of
other companies. Another important item found here is acquisitions of
other businesses.
• A key to remember is that a change in the long-term assets in the
balance sheet is reported in the investing activities of the cash flow
statement.
• Investments in Property and Equipment
• Cash from investing
 Investing Cash Flow
• Investments in Property and Equipment
• These CapEx investments might mean purchases of new office
equipment such as computers and printers for a growing
number of employees, or the purchase of new land and a
building to house business operations and logistics of the
company.
• These items are necessary to keep the company running.
• These investments are a cash outflow, and therefore will have
a negative impact when we calculate the net increase in
cash from all activities.
• Cash from investing
• This is the total amount of cash provided by (used in) investing
activities. In our example, we have a net outflow for each and every
year.
 Cash from Financing Activities
• As the name suggests, financing activities relate to long-term funds or
capital of an enterprise, e.g., cash proceeds from issue of equity shares,
debentures, raising long-term bank loans, repayment of bank loan, etc.
• As per AS-3, financing activities are activities that result in changes in the
size and composition of the owners’ capital (including preference share
capital in case of a company) and borrowings of the enterprise.
• Separate disclosure of cash flows arising from financing activities is
important because it is useful in predicting claims on future cash flows by
providers of funds ( both capital and borrowings ) to the enterprise.
 Cash from Financing Activities
• Examples of financing activities are:
• Cash Inflows from financing activities
• Cash proceeds from issuing shares (equity or/and preference).
• Cash proceeds from issuing debentures, loans, bonds and other short/ long-term
borrowings
• Cash Outflows from financing activities
• Cash repayments of amounts borrowed.
• Interest paid on debentures and long-term loans and advances.
• Dividends paid on equity and preference capital
 Cash Flow
• It is important to mention here that a transaction may include cash flows that
are classified differently.
• For example, when the instalment paid in respect of a fixed asset acquired on
deferred payment basis includes both interest and loan, the interest element
is classified under financing activities and the loan element is classified under
investing activities.
• Moreover, same activity may be classified differently for different enterprises.
For example, purchase of shares is an operating activity for a share brokerage
firm while it is investing activity in case of other enterprises
 Financing Cash Flow
• This category is also called Cash Flow from Financing
Activities and reports any issuance or repurchases
of stocks and bonds of the company, as well as any
dividend payments it makes.
• The changes in long-term liabilities and stockholders’
equity in the balance sheet are reported in financing
activities.
• Issuance (repayment) of debt
• Issuance (repayment) of equity
• Cash from financing
 Financing Cash Flow
• Issuance (repayment) of debt
• A company issues debt as a way to finance its operations.
• The more cash it has, the better, as it will be able to expand
rapidly.
• Unlike equity, issuing debt doesn’t grant any ownership
interest in the company, so it doesn’t dilute the ownership of
existing shareholders.
• The issuance of debt is a cash inflow, because a company
finds investors willing to act as lenders. However, when these
investors are paid back, then the debt repayment is a cash
outflow.
 Financing Cash Flow
• Issuance (repayment) of equity
• This is another way of financing a company’s operations. Unlike debt,
equity holders have some ownership stake in the business in exchange
for money given to the company for use.
• Future earnings must be shared with these equity holders or investors.
Issuance of equity is an additional source of cash, so it’s a cash inflow.
Conversely, an equity repayment is a cash outflow.
• This is buying back, through cash payment, the equity from its investors
and thereby increasing the stake held by the company itself.
• Cash from financing
• This is also called the net cash provided by (used in) financing activities.
• The cash from financing is calculated by summing up all the cash
inflows and outflows related to changes in long-term liabilities and
shareholders’ equity accounts.
 Cash Balance
• The last section on the statement of cash flows is a reconciliation of the
total cash position, which connects to the balance sheet.
• This is the final piece of the puzzle when linking the three financial
statements.
• Net Increase (decrease) in Cash and Closing Cash Balance
• Once we have all net cash balances for each of the three sections of the
cash flow statement, we sum them all up to find the net cash increase or
decrease for the given time period.
• We then take this amount and add it to the opening cash balance to
eventually arrive at the closing cash balance.
• This amount will be reported in the balance sheet statement under the
current asset section.
• Opening cash balance
• The opening cash balance is last year’s closing cash balance.
• We can find this amount from last year’s cash flow statement and
Cash Flow Statement
Real-Life Example of a
Cash Flow Statement
(Amazon)
Example