The document discusses key aspects of the statement of cash flows, including its requirements, sections, and how to compute cash flows from operating, investing, and financing activities. It provides an example cash flow statement for Kramer Corporation and explains why the statement of cash flows is an important financial analysis tool for investors, bankers, and creditors to evaluate a firm's liquidity and profitability. It also covers working capital, defining it as a measure of short-term financial health and efficiency, and how to calculate working capital and interpret working capital ratios. Finally, it discusses dividends, defining them as distributions of earnings to shareholders, different forms of dividend payments, and the importance of dividends in communicating a company's financial strength.
2. Requirements of Cash Flow
β’ Cash flows provide information on the amount and timing of
cash, to allow investors to make educated decisions when
evaluating investment opportunities.
β’ The statement of cash flow translates the income statement
and balance sheet data into cash flow information.
β’ This statement reports changes in cash and cash equivalents
which result from the activities of the organization during a
given period.
3. The Sections of the Cash Flow
1. Cash flow from operating activities Generation and
expenditures of funds from the firmβs 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.
4. Computing Cash Flow from Operating
Activities
Operating 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
5. 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
6. 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
7. Completed Statement of Cash Flow
KRAMER 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
8. Why is the Statement of Cash Flow
Important???
β’ 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.
β’ 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.
10. What is Working Capital???
ο Working Capital is a measure of firmβs short-term financial
state and efficiency.
ο Business cash needed for day to day operations.
ο It indicates the firmβs ability to pay its debts, or short-term
liabilities
ο Also known as βnet working capitalβ and βworking capital
ratioβ
11. Calculating Working Capital
ο Working Capital = Current Assets β Current Liabilities
ο Working Capital is often expressed as a ratio
ο Working Capital Ratio = Current Assets : Current Liabilities
12. Currents Assets
ο Cash
ο Accounts Receivable
ο Inventory
ο Marketable Securities
ο Prepaid Expenses
ο Other Liquid Assets
Current Liabilities
ο Short Term Debt
ο Accounts Payable
ο Accrued Liabilities
ο Other Debts
13. 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
14. Understanding Ratiosβ¦
ο Firm A -> Current Assets: $50,000 Current Liabilities: $25,000
Working Capital Ratio = 2 : 1
Adequate / Safe Working Capital Ratio for most businesses.
ο 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.
ο Firm C -> Current Assets: $20,000 Current Liabilities: $25,000
Working Capital Ratio = 0.8 : 1
This ratio is too low and unsafe.
15. Why is Working Capital important?
ο Every business needs adequate liquid resources in order to
maintain day-to-day cash flow.
ο More working capital means firm will be more successful
since they can expand and improve their operations.
ο Even a profitable business can fail if it does not have adequate
cash flow to meets its liabilities as they fall due.
17. What are dividends?
β’ Dividends are a distribution of a portion of an organizationβs
earnings which is decided by the board of directors to a class of its
shareholders.
β’ 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.
β’ 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.
18. Forms of Payment
β’ 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.
β’ . 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.
β’ 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.
19. The Importance of Dividends
β’ Dividends are important to a company because it
is one of the simplest ways to communicate their
financial strength and stability.
β’ 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.
20. Dividend Discount Model
β’ Value of Stock = dividend per share/discount rate
β dividend growth rate
β’ 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.
β’ If the value after the calculation is higher than
what the shares are trading at, then the stock is
undervalued.
