Statement of Cash Flows

CENTRAL FACT

Over long enough periods:

NI = Cash from Ops. + Cash from Inv.

= Free Cash Flows

• The difference is timing

• The goal of SCF is to explain the difference

Why do we care about cash?

• Information on:– Liquidity– “Quality” of earnings– “Free cash flows” for valuation

• Problem:– interpretation is difficult and context specific– depends on the life-cycle of the company– it is hard to know what is a good cash flow

Fundamental Relations

Assets = Liabilities + Owners’ Equity

Cash = Liabilities + OE - Noncash Assets

Cash = Liab. + OE - Noncash Assets

Cash = NI + Liab. + CC - Div. - NCA

Formats

• Two formats for the operation section

• Financing and investing are always the same

Miscellaneous Cash Flow Stuff

• Why don’t lines on SCF tie to changes on B/S?

• Foreign currency translation– subsidiaries are generally accounted for in local currency

– in consolidation local currency is converted to dollars

– changes in accounting balances that result from changes in currency are handled as a separate line item on SCF

– changes in shareholders’ equity go to “other equity” on the balance sheet

Example

• Foreign sub with the following ‘96 and ‘97 ¥ B/S and the ¥ weakening from ¥100/$ to ¥111/$.

‘96 & ‘97 ‘96 ‘97

Cash ¥100 $1.0 $0.9

Inventory ¥200 $2.0 $1.8

Equity (100% owned) ¥300 $3.0 $2.7• B/S--change in equity ($0.3) is “foreign currency translation

adjustment” in shareholders’ equity• SCF--the change in cash ($0.1) is separate line item (not spread

across change in inventory, etc)

Acquisition Accounting

• You buy a company with identifiable assets with a book value of $100 (fair value of $200) for $250.

Identifiable Assets $200

Goodwill $50

Cash $250

Goodwill will appear as an intangible asset

On the SCF, the only effect will be $250 as an investing use of cash, even though lots of other accounts change

Major Noncash Transactions

• Transactions not involving cash are not reported on the face of the statement– e.g., purchase PP&E for debt, acquire other

companies for stock, swap assets

• Disclosure is required– typically at the bottom of the SCF

Other Items

• Firms must disclose interest and taxes paid– income statement gives “accrual” amounts– cash interest & taxes are used in some analysis– generally disclosed at the bottom of SCF– sometimes disclosed in notes (e.g., Coke)