Statement of Cash Flow

Requirements of Cash Flow

• Cash flows provide information on the amount and timing of cash, to allow investors to make educated decisions when evaluating investment opportunities.

• The statement of cash flow translates the income statement and balance sheet data into cash flow information.

• This statement reports changes in cash and cash equivalents which result from the activities of the organization during a given period.

The Sections of the Cash Flow

1. Cash flow from operating activities Generation and expenditures of funds from the firm’s normal operations.

2. Cash flow from investing activities Liquidation of long term investment. (i.e. Sale of Plant or equipment)

3. Cash flow from financing activities Sale of bonds, common stocks, preferred stocks, and other corporate securities.

Computing Cash Flow from Operating ActivitiesOperating Activities

Net Income (earnings aftertaxes) $110,500

Add items not requiring an outlay of cash:

Amortization $50,000 50,000

Cash flow from operations 160,500

Changes in noncash working capital:

Increase in accounts receivable -30,000

Increase in inventory -20,000

Decrease in prepaid expenses 10,000

Increase in account payable 35,000

Increase in accrued expenses -5,000

Net change in noncash working capital 10,000

Cash provided by (used in) operating

activities $150,500

Computing Cash flow from Investing Activities

Increase in investment (long-term securities) -30,000

Increase in plant and equipment -100,000

Cash used in investing activities -$130,000

Computing Cash flow from Financing Activities

Increase in bonds payable 50,000

Preferred stock dividends paid -10,500

Common stock dividends paid -50,000

Cash used in financing activities -$10,500

Completed Statement of Cash FlowKRAMER CORPORATION

Statement of Cash Flows

For the Year Ended December 31, 2009

Operating Activities

Net income (earnings after taxes) $ 110,500

Add items not requiring an outlay of cash:

Amortization $ 50,000 50,000

Cash flow from operations 160,500

Changes in non-cash working capital

Increase in accounts receivable (30,000)

Increase in inventory (20,000)

Decrease in prepaid expenses 10,000

Increase in accounts payable 35,000

Decrease in accrued expenses (5,000)

Net change in non-cash working capital (10,000)

Cash provided by (used in) operating activities $ 150,500

Investing Activities:

Increase in investments (long-term securities) ( 30,000)

Increase in plant and equipment (100,000)

Cash used in investing activities ($130,000)

Financing Activities:

Increase in bonds payable 50,000

Preferred stock dividends paid (10,500)

Common stock dividends paid (50,000)

Cash used in financing activities (10,500)

Net increase (decrease) in cash and cash equivalents during the year 10,000

*Cash, beginning of year 30,000

*Cash, end of year $ 40,000

Why is the Statement of Cash Flow Important???

• Upon its completion it will provide us with a financial analysis that the income statement and the balance sheet would not be able to generate.

• The statement of cash flow is also the statement which is tremendously valuable to investors, bankers and creditors who are interested in the liquidity and profitability of the firm and its capability of generating cash flow.

Working Capital

What is Working Capital???

Working Capital is a measure of firm’s short-term financial state and efficiency.

Business cash needed for day to day operations.

It indicates the firm’s ability to pay its debts, or short-term liabilities

Also known as “net working capital” and “working capital ratio”

Calculating Working Capital

Working Capital = Current Assets – Current Liabilities

Working Capital is often expressed as a ratio

Working Capital Ratio = Current Assets : Current Liabilities

Currents Assets

Cash

Accounts Receivable

Inventory

Marketable Securities

Prepaid Expenses

Other Liquid Assets

Current Liabilities

Short Term Debt

Accounts Payable

Accrued Liabilities

Other Debts

Working Capital Ratio

Invalid Solutions Inc. has total current assets of 100,000 and has total current liabilities of 50,000. Calculate the working capital ratio.

Working Capital Ratio = Current Assets : Current Liabilities

Working Capital Ratio = 100,000 : 50,000

= 2 : 1

Understanding Ratios… Firm A -> Current Assets: $50,000 Current Liabilities: $25,000

Working Capital Ratio = 2 : 1

Adequate / Safe Working Capital Ratio for most businesses.

Firm B -> Current Assets: $50,000 Current Liabilities: $50,000

Working Capital Ratio = 1 : 1

Acceptable but generally low for most businesses. Often seen in business with high stock turnovers and few account receivables.

Firm C -> Current Assets: $20,000 Current Liabilities: $25,000

Working Capital Ratio = 0.8 : 1

This ratio is too low and unsafe.

Why is Working Capital important?

Every business needs adequate liquid resources in order to maintain day-to-day cash flow.

More working capital means firm will be more successful since they can expand and improve their operations.

Even a profitable business can fail if it does not have adequate cash flow to meets its liabilities as they fall due.

Dividends

What are dividends?

• Dividends are a distribution of a portion of an organization’s earnings which is decided by the board of directors to a class of its shareholders.

• Dividends can be quoted in terms of the dollar amount each share receives, also known as dividend per share or a percent of the current market price, also referred to as the dividend yield.

• Dividends can be provided in the form of cash, stock or property. Many organizations offer dividends to their stockholders while high-growth companies are hesitant to offer dividends due to their profits being reinvested to help sustain higher than average growth.

Forms of Payment

• Cash dividends are most common and are mostly paid in the form of a cheque. In the form of investment income, it is the most common method of sharing profit in an organization with the shareholders. For each share owned, a declared amount of money is distributed. Therefore, if an individual owns 100 shares and the cash dividend is $0.50 per share, a cheque will be issued for $50.

• . Stock or scrip dividends are paid in the form of additional stocks of the shareholders; usually issued in proportion of the shares owned. For example, for every 100 shares owned, 5% stock dividends will yield 5 extra shares.

• Property dividends are paid out in the form of assets from the corporation. In most cases they are rare and most frequently are securities, however, they can take other forms such as products and services.

The Importance of Dividends

• Dividends are important to a company because it is one of the simplest ways to communicate their financial strength and stability.

• While reducing market uncertainty, they are the evidence of both the profitability and financial health of the company. Dividends cannot be manipulated, disguised, restated, or written off.

Dividend Discount Model

• Value of Stock = dividend per share/discount rate – dividend growth rate

• The dividend discount model is a procedure for calculating the value of price of a stock by using predicted dividends and discounting them back to the present value.

• If the value after the calculation is higher than what the shares are trading at, then the stock is undervalued.