HANDOUTS ON FUNDAMENTALS OF FINANCIAL
MANAGEMENT 1 (For Classroom Discussion)
Ms. Carmelita U. de Guzman, CPA,MGM,CESO IV
Chapter 7: Funds Analysis, Cash Flow Analysis,
and Financial Planning
(Reference: Van Horne and John M.
Wachowicz, Fundamentals of Financial
Management, 13th edition)
1. Flow of Funds Statement – a summary of a
firm’s changes in financial position from one
period to another; also called a ‘sources and
uses of funds statement’ or a ‘statement of
changes in financial position’. This portrays net
rather than gross changes between two
comparable balance sheets at different dates.
2. Sources of Funds:
o Any decrease in an asset item
o Any increase in a claim item
Uses of Funds:
o Any increase in an asset item
o Any decrease in a claim item
3. Analyzing the Sources and Uses of Funds
Statement
a) The analysis of funds statements gives us
insight into the financial operations of a firm
that will be especially valuable if we assume the
role of a financial manager examining past and
future expansion plans of the firm and their
impact on liquidity. Imbalances in the uses of
funds can be detected and appropriate actions
taken.
b) Another use of funds statements is in the
evaluation of the firm’s financing. An analysis
of the major sources of funds in the past
reveals what portions of the firm’s growth were
financed internally and externally. In evaluating
the firm’s financing, we want to evaluate the
ratio of dividends to earnings relative to the
firm’s total need for funds.
c) Funds statements are also useful in judging
whether the firm has expanded at too fast a
rate and whether the firm’s financing capability
is strained. One can determine whether trade
credit from suppliers (accounts payable) has
increased out of proportion to increases in
current assets and to sales.
d) As a financial manager, an analysis of a funds
statement for the future will be extremely
valuable in planning intermediate and long-
term financing of the firm. It reveals the firm’s
total prospective need for funds, the expected
timing of these needs, and their nature – that
is, whether the increased investment is
primarily for inventories, fixed assets, and so
forth.
4. Analyzing the Statement of Cash Flows
a) The statement of cash flows has replaced
the flow of funds statement when the firm is
required to present a complete set of financial
statements. However, unlike the cash flow
statement, the flow of funds statement does
not omit the net effects of important noncash
transactions. In addition, the flow of funds
statement is easy to prepare and is often
preferred by managers over the more complex
cash flow statement.
b) A major benefit of the statement of cash
flows (especially under the direct method) is
that the user gets a reasonably detailed picture
of a company’s operating, investing and
financing transactions involving cash.
c) This three-part breakdown of cash flow aids
the user in assessing the company’s current and
potential future strengths and weaknesses.
Strong internal generation of operating cash,
over time, would be considered a positive sign.
Poor operating cash flow should prompt the
analyst to check for unhealthy growth in
receivables and/or inventory. Too much
reliance on external financing sources to meet
recurring needs may be a danger signal.
d) When used with other financial statements
and disclosures, the statement of cash flows
should help the analyst to assess a firm’s ability
to generate cash for dividends and investment,
identify a firm’s needs for external financing,
and understand the differences between net
income and net cash flow from operating
activities.
5. Cash Budget – a forecast of a firm’s future
cash receipts and disbursements.
a) This forecast is particularly useful to the
financial manager in determining the probable
cash balances of the firm over the near future
and in planning prospective cash needs.
b) In addition to analyzing expected cash flows,
the financial manager should take into account
possible deviations from the expected
outcome. An analysis of the range of possible
outcomes enables management to better
assess the efficiency and flexibility of the firm
and to determine the appropriate margin of
safety.
Chapter 13: Cash Flow Analysis
(Reference: Cabrera, Ma. Elenita Balatbat,
Financial Management (Principles and
Applications, vol. 1) 2015 edition)
1) Statement of Cash Flows, defined
a) It is a financial statement that shows the
firm’s cash flows over a given period of time. It
reports the amounts of cash that the firm
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generated and distributed during a particular
time period.
b) The bottom line on the statement of cash
flows (the difference between cash sources and
uses) equals the change in cash on the firm’s
statement of financial position from the
previous year’s cash account balance.
c) The statement of cash flows reconciles
income statement items and noncash
statement of financial position items to show
changes in the cash and marketable securities
account on the statement of financial position
over the particular analysis period.
2) Usefulness of the Statement of Cash Flows
a) The primary purpose of a cash flow
statement is to provide relevant information
about a company’s cash receipts and cash
payments during an accounting period that is
useful in evaluating the preceding items.
b) Phil. Accounting Standards (PAS) 7 states
that the information in a statement of cash
flows, if used with information in the other
financial statements, should help users to
assess and evaluate:
b.1) a company’s ability to generate positive
future net cash flows
b.2) a company’s ability to meet its obligations
and pay dividends
b.3) a company’s need for external financing
b.4) the reasons for differences between a
company’s net income and associated cash
receipts and payments, and
b.5) both the cash and noncash aspects of a
company’s financing and investing transactions
during the accounting period.
c) The following information may also be
obtained from the cash flow statement:
c.1) the changes in net assets of an enterprise
and its ability to affect the amounts and timing
of cash flows in order to adopt to changing
circumstances and opportunities.
c.2) the ability of the enterprise to generate
cash and cash equivalents and enables the
users to develop models to assess and compare
the present value of the future cash flows of
different enterprises, and
c.3) it 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.
d) The statement of cash flows likewise provide
the means of measuring a business firm’s
d.1) Financial Liquidity – which refers to the
“measures to cash” of assets and liabilities,
using the formula:
Current Cash Debt Coverage Ratio =
Net Cash Provided by Operating
Activities / Average Current Liabilities
This indicates whether the company can pay off
its current liabilities from its operations in a
given year. The higher the current cash debt
coverage ratio, the less likely a company will
have liquidity problems.
d.2) Financial Flexibility – which refers to a
company’s ability to respond and adapt to
financial adversity and unexpected needs and
opportunities, by using the formula:
Cash Debt Coverage Ratio =
Net Cash Provided by Operating
Activities / Average Total Liabilities
This indicates a company’s ability to repay its
liabilities from net cash provided by operating
activities, without having to liquidate the assets
employed in its operations. The higher the
ratio, the less likely the company will
experience difficulty in meeting its obligations
as they come due. It signals whether the
company can pay its debts and survive if
external sources of funds become limited or too
expensive.
A more sophisticated way to examine a
company’s financial flexibility is to develop a
free cash flow analysis by deducting from the
net cash provided by operating activities, those
of capital expenditures and dividends paid.
Free cash flow refers to the amount of
discretionary cash flow a company has. It can
use this cash flow to purchase additional
investments, retire its debt, purchase treasury
shares, or simply add to its liquidity.
If the free cash flow is positive, the
business firm could have satisfactory financial
flexibility. Companies that have strong financial
flexibility can (a) take advantage of profitable
investment even in tough terms; and (b) be free
from worry about survival in poor economic
terms.
3) Basic Approach to a Cash Flow Statement
a) Cash and Cash Equivalents, defined
Cash includes cash itself and cash equivalents
which consist of short-term, highly liquid
investments such as treasury bills, SEC
registered commercial papers and money
market funds. Such investments are made
solely for the purpose of generating a return on
funds that are temporarily idle.
b) Classification of Cash Flow Activities
b.1) Operating activities - include delivering or
producing goods for sale and providing services;
and the cash effects of transactions and other
events that enter into the determination of
income.
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 The amount of cash flows arising from
operating activities is a key indicator of the
extent to which the operations of the
enterprise have generated sufficient cash flows
to repay loans, maintain the operating
capability of the enterprise, pay dividends and
make new investments without recourse to
external sources of financing.
Examples:
INFLOWS: sales of goods; revenue from
services; returns on interest earnings assets
(interest); returns on equity securities
(dividends); receipts from contracts held for
dealing and trading purposes; tax refunds
unless identified with financing and investing
activities
OUTFLOWS: payments for the following:
purchases of inventories; operating expenses
(salaries, rent, insurance, etc); purchases from
suppliers other than inventory; lenders; taxes
unless identified with financial and investing
activities
b.2) Investing activities - include acquiring and
selling, or otherwise disposing of (a) securities
that are not cash equivalents and (b) productive
assets that are expected to benefit the firm for
long periods of time; and lending money and
collecting on loans.
The separate disclosure of cash flows
arising from investing activities is important
because the cash flows represent the extent to
which expenditures have been made for
resources intended to generate future income
and cash flows.
Examples:
INFLOWS: sales of long-lived assets such as
property, plant and equipment, intangibles and
other long-term assets; sales of debt or equity
securities of other entities; collection of loans
(principal) to others (other than advances and
loans made by a financial institution)
OUTFLOWS: acquisitions of long-lived assets
such as property, plant and equipment,
intangibles and other long-term assets;
purchases of debt or equity securities of other
entities; loans (principal) to others (other than
advances and loans made by a financial
institution)
b.3) Financing activities – include borrowing
from creditors and repaying the principal; and
obtaining resources from owners and providing
them with a return on the investment.
The separate disclosure of cash flows
arising from financing activities is important
because it is useful in predicting claims in future
cash flows by providers of capital to the
enterprise.
Examples:
INFLOWS: proceeds from borrowing (short-
term and long-term); proceeds from issuing the
firm’s own equity securities
OUTFLOWS: repayment of debt principal;
repurchase of a firm’s own shares; payment of
dividends; acquisition of the enterprise’s own
shares
4. Calculating Cash Flow from Operating
Activities
a) Direct Method
a.1) In reporting the cash flows from operating
activities, enterprises are encouraged to report
major classes of gross cash receipts and gross
cash payments and the net cash flow from
operating activities.
a.2) At a minimum, the following classes of
operating cash receipts and payments should
be separately reported:
o Cash collected from customers,
including lessees, licensees and the like
o Interest, fees, royalties and dividends
received]
o Other operating cash receipts, if any
o Cash paid to employees and other
suppliers of goods or services
o Interest paid
o Income taxes paid
o Other operating payments, if any
o Contracts held for dealing or trading
purposes
b) Indirect Method
b.1) Enterprises that choose not to provide the
major classes of operating cash receipts and
payments by the direct method shall determine
and report the same amount of net cash flow
from operating activities indirectly by adjusting
net income to reconcile it to net cash flow from
operating activities.
b.2) Regardless of whether the direct or
indirect method of reporting net cash flow from
operating activities is used, the reconciliation of
net income to net cash flow from operating
activities shall be presented.