Quiz 2

• 7.5% of overall grade
• 1 hour to complete
  • When finished, revise or turn in at the front
• 20 minute break after
• Class will resume after the break

Learning objectives

What is the SCF?

• Categorizes and presents all cash receipts and cash payments
  • Cash inflows: where cash came in from
  • Cash outflows: where cash went out to
• Describes cash changes over a period

Why use an SCF?

• Helpful in assessing companies’…
  • Ability to generate future cash flows
  • Ability to pay dividends
  • Difference between net income and change in cash
  • Investing and financing activities during the period
  • Value using DCF models (finance)
• Provides information on three types of cash flows, accounting for all cash flows of the company
  • Operating activities
  • Investing activities
  • Financing activities

SCF and the balance sheet

Special cases: Interest and dividends

• IFRS, under IAS 7.31
  • Pick any categorization
    • Dividends paid/received can be any cash flow type
    • Interest paid/received can be any cash flow type
    • Keep it the same year-after-year
• US GAAP specifies where to put these – follow this if you don’t have a strong opinion on where to put interest and dividends
  • Inflows from dividends or interest: operating activities
  • Interest payments: operating activity
  • Dividend payments: financing activity

Operating activities

• Cash from standard business transactions
• Useful in:
  • Identifying sustainable cash flows
  • Management of current assets and current liabilities
    • I.e., working capital
  • Identifying liquidity issues
    • Important for loans!

Operating activities

Focus on changes in current assets, changes in current liabilities, and the income statement

Investing activities

• Cash transactions that increase or decrease long-term assets
• Useful in:
  • Identifying one-time or non-recurring cash inflows and outflows

Investing activities

Focus on PP&E

Financing activities

• Cash-based increases and decreases in long-term liabilities and shareholders’ equity
• Useful in:
  • Predicting future claims on cash
  • Identifying how a company is financed
    • Internally vs. externally

Financing activities

Focus on long term liabilities and shareholders’ equity

Significant non-cash activities

• Includes:
  • Issuing common stock in exchange for PP&E
  • Bond conversion (Bond \(\rightarrow\) equity)
  • Debt issuance for PP&E
  • PP&E exchange
• Useful in:
  • Determining other future claims on cash
  • Getting a more complete picture of financing and investments
• Reported at the bottom of SCF or in supplementary schedule

Practice: Identifying cash flows

What type of cash flows are each of the following? [Operating/Investing/Financing/Non-cash/None]
If it is a cash flow, is it an inflow or outflow?

1. Reissued treasury shares for a warehouse
2. Paid off a note payable
3. Paid interest on a bond
4. Issued new shares for $10 each
5. Paid accounts payable
6. Recorded $10,000 depreciation on PP&E
7. Sold machinery at a loss
8. Sold land
9. Paid a dividend
10. Bought a warehouse
11. Sold goods for cash

Operating cash flows

Two equivalent methods:

• Both methods will get you to the same operating cash flow amount

We will cover the direct method next week when we construct an SCF

Indirect method

1. Start with net income
2. Add back non-cash expenses (i.e., pure accruals)
   • Depreciation, depletion, amortization
   • Bond discount amortization
   • Bad debt expense, warranty expense
3. Subtract out any gains from asset sales
4. Add back any losses from asset sales
5. Subtract changes in non-cash current assets
6. Add changes in current liabilities

Indirect method: Calculation

• Steps 1 through 4 are available in the income statement
• Steps 5 and 6 can be calculated by comparing balance sheets
  • Current year versus prior year balance sheets
  • Compare change in accounts such as…
    • A/R
    • Inventory
    • Prepaid expenses
    • Accounts Payable
    • Unearned revenue

Practice: Indirect method

You find the following information in Kopi Corp’s 20X9 and 20X8 financial statements. Based on this information, what is their operating cash flow for 20X9?

For next week

• Reading
  • Chapter 11 (Cash flows)
• Take a week and relax (or work on the project)
• Extra practice available
  • Cash flows eLearn quiz