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2. Investing Activities:
Once the firm obtains funds, it must invest those funds to accomplish
its purposes. Most firms make both short term and long term
investments. Most short term investments are considered operating
activities, such as the purchase of raw materials and inventories.
Some short term investments, such as investment in stock of other
companies (called marketable securities) and most long term
investments are considered investment activities.
Long term investment in property, plant and equipment is one such
investing activity.
Long term investment in stock of other companies would also be
considered an investing activity.
3. Operating Activities:
Operating activities are those associated with developing, producing,
marketing, and selling the products and/or services of the firm.
The operating activities section shows the cash effects of revenue and
expense transactions. Stated another way, the operating activities
section of the statement of cash flows includes the cash effects of
those transactions reported in the Income Statement.
Typical operating activities:
Sales to customers
Collections on A/R
Purchase of inventory
Payment on A/P
Payment of operating expense
Payment of tax expense
1. A decrease in asset such as the firm’s cash balance is source of cash flow because
cash that has been tied up in the asset is released and can be used for some other
purposes, such as repaying a loan. On the other hand, an increase in the firm’s
cash balance is a use of cash flow, because additional cash is being tied up in the
firm’s cash balance.
2. The financial manager is concerned with cash flows rather than net profits as
reported on income statement. To adjust the income statement to show cash flow
from operations, all noncash charges must be added back to the firm’s net profit
after taxes.
Noncash charges are expenses that are deducted on income statement but don’t
involve an actual outlay of cash during the period. Depreciation, depletion and
amortization allowances are the examples.
Because depreciation charges are the most common noncash charges, we shall
focus on their treatment; amortization and depletion charges are treated in a
similar fashion.
The general rule for adjusting net profit after taxes by adding back all noncash
charges is expressed as follows;
Cash flow from operations = Net profit after taxes + Noncash charges
(This value is only approximate, because not all sales are made for cash and not
all expenses are paid when they are incurred.)
Note that a firm can have a net loss (negative net profits after taxes) and still have
positive cash flow from operations when noncash charges (typically depreciation)
during the period are greater than the net losses. In the statement of cash flows,
net profit / losses after taxes and noncash charges are therefore treated as separate
entries.
Depreciation and other noncash charges shield the firm from taxes by lowering
taxable income.
Some people don’t define depreciation as a source of funds; however, it is a
source of funds in the sense that it represents a “nonuse” of funds.
3. Because depreciation is treated as a separate source of cash, only gross rather than
net changes in fixed asset appear on the statement of cash flows. This treatment
avoids the potential double counting of depreciation.
4. Direct entries of changes in Retained earnings are not included on the statement
of cash flows. Instead, entries for items that affect retained earnings appear as net
profit or loss after taxes and dividend paid.
Step 3
Separately sum all sources and all uses found in steps 1 and 2. If this statement is
prepared correctly, total sources should equal total uses.
Step 4
• Net profits after taxes; typically can be taken directly from the income statement.
• Depreciation can also be taken directly from the income statement.
• Dividends may have to be calculated by using the following equation:
Dividends = net profits after taxes – change in retained earnings
The change in retained earnings can be found in the statement of sources and uses of
cash or can be calculated by using the beginning- and end –of- period balance
sheets.
The dividend value could be obtained directly from the statement of retained
earnings, if available.
Step 5
Classify relevant data into one of three categories:
1. Cash flow from operating activities.
2. Cash flow from investment activities
3. Cash flow from financing activities
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Cash flow from operating activities
Operating Profit XXXX
Add: noncash items
Depreciation XXX
Depletion XXX
Amortization XXX
Add:
Loss on sale of Fixed Assets XXX
Loss on sale of stock / debenture XXX XXXX
Less:
Gain on sale of Fixed assets (XX
X)
Gain on sale of investment (XX XXXX
X)
Add/ Less:
Change in all current Assets other than cash and XXX
Marketable Securities
Change in all current liabilities other than note XXX XXXX
payable
Return on investment and servicing of finance
Dividend Received XXX
Interest received XXX
Interest paid XXX
Net cash inflows from return on investment and XXXX
servicing of finance
Net cash inflow from operating activities $XXXX
Taxation:
Corporate tax paid (Including advance corporation XXX XXXX
tax)
Net cash flow from operations:
Investing Activities:
Payment to acquire intangible fix assets XXX
Payment to acquire tangible fix assets XXX
Receipts from sale of tangible fix assts XXX
Fire Insurance claims XXX
Net cash flow from investing activities: XXXX
Financing Activities:
Issue of ordinary share capital XXX
Repurchase of debentures loan (XXX)
Expenses paid in connection with share issues (XXX)
Dividend Paid (XXX)
Borrow of Loan from Public XXX
Net cash inflow / (outflow) from financing XXXX
Increase in cash and cash equivalents XXXX
XYZ
Income Statement
For the year ended, 2004
XYZ
Balance Sheet
For the year ended, 2004
December 31
Assets 2003 2004
Current Assets: 000 000
Cash $300 $300
Marketable securities $200 600
Accounts receivable $500 400
Inventories $900 600
Total current assets $1900 $2,000
Gross fixed assets (at cost)
Land and buildings $1050 $1,200
Machinery and equipment 800 850
Furniture and fixture 220 300
Vehicles 80 100
Other (includes certain leases) 50 50
Total gross fixed assets (at cost) $2200 $2,500
Less: Accumulated depreciation 1200 1300
Net fixed assets $1000 $1,200
Total assets $2900 $3,200
Liabilities and stockholders’ equity
Current liabilities
Accounts payable $500 $700
Notes payable 700 600
Accruals 200 100
Total current liabilities $1,400 $1,400
Long-term debt $400 $600
Total liabilities $1,800 $2,000
Stockholders’ equity
Preferred stock $100 $100
Common stock-- $ 1.20 per, 100,000 shares outstanding in
2003 and 2004. 120 120
Paid-in capital n excess of par on common stock 380 380
Retained earnings 500 600
Total stockholders’ equity $1,100 $1,200
Total liabilities and stockholders’ equity $2,900 $3,200
Solution:
XYZ Corporation Statement of Sources and Uses of Cash ($000) for the year ended
December 31, 2004.
(Step 1, 2 & 3)
Account Balance
Account December, 31 Change Classification
2004 2003 2004 -2003 Source Use
Assets
Cash 400 300 +100 100
Marketable Securities 600 200 +400 400
Account Receivable 400 500 -100 100
Inventories 600 900 -300 300
Gross fixed assets 2500 2200 +300 300
Accumulated Depreciation 1300 1200 +100 100
Liabilities
Account Payable 700 500 +200 200
Notes Payable 600 700 -100 100
Accruals 100 200 -100 100
Long term debt 600 400 +200 200
Stockholder’s Equity
Preferred Stock 100 100 0
Common Stock 120 120 0
Paid-in-capital in excess of par 380 380 0
Retained earnings 600 500 +100 100
Total 1000 1000
Step 4:
Net profit after taxes and Depreciation, and dividend can be found in its financial
statements.
Net profit taxes $180,000
Depreciation 100,000
Step 5:
XYZ Corporation Statement of Cash flows ($000) for the year ended December 31,
2004
Cash flow from operating activities $000 &000
Net profit after taxes 180
Depreciation 100
Decrease in A/R 100
Decrease in inventory 300
Increase in Accounts Payable 200
Decrease in Accruals (100)
Cash provided by operating Activities &780
Cash flow from investment activities
Increase in Gross fixed Assets (300)
Change in Business Interests 0
Cash provided by Investment Activities (300)
Cash flow from Financing activities
Decrease in Notes Payable (100)
Increase in long term debt 200
Change in Stockholders’ Equity 0
Dividend Paid (80)
Cash flow from Financing activities 20
Net Increase in Cash and Marketable Securities $500
Retained earnings are excluded here, because their change is actually reflected in the
combination of “Net profit after taxes” and dividend entries.