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Level I CFA: FRA Understanding Cash flow Statements-Lecture 1 - YouTube
Channel: IFT
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understanding cash flow statements
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in this reading we will talk about the
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components and format of the cash flow
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statement
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we will talk about the linkages between
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the
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balance sheet income statement and cash
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flow statement
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we will talk about how the cash flow
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statement is
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prepared and that is perhaps the most
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testable
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element of this reading and then finally
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we will talk about
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cash flow statement analysis
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the cash flow statement provides
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important information about a company's
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cash receipts and payments during an
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accounting period
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note that the income statement gives us
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information about revenue
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expenses and net income but revenue
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expenses and net
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income are all based on accrual
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accounting so just because a net income
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is high
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doesn't necessarily mean that the
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company generated a lot of cash
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on the other hand the cash flow
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statement tells us exactly
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how much cash is coming in and from what
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sources the cash flow statement is a
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vital information source
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that assists users to evaluate
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a company's liquidity solvency and
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financial flexibility for an analyst
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it is crucial to estimate future cash
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flows
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as you will see in later readings to
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value
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a company we need future cash flows
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and then we discount those future cash
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flows in order to come up
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with a current value of a company so
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clearly it is essential to value
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or to estimate these future cash flows
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the cash flows can then also help us
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determine whether there is sufficient
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money to pay for
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investments whether there is sufficient
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money to pay back
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lenders and equity holders
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coming now to the components and format
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of the cash flow statement
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the cash flow statement has three parts
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the first part
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shows us cash flows related to operating
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activities
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operating activities are activities that
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are part of the day-to-day
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business operation of the company and
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here
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are classic examples of operating
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activities
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the second part of the cash flow
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statement is investing
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activities these are activities
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associated with acquisition
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and disposal of long-term assets
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and the third part is financing
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activities
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activities related to obtaining or
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repaying
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capital and here are the typical
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examples of financing activities
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i just want to make a note here that
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operating activities in the context of
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the cash flow statement
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is not exactly the same as the operating
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part of a income statement
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because in a income statement under the
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operating segment you might see
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items such as gain on sale of equipment
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so on the income statement that appears
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as a operating item
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however on a cash flow statement the
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cash related to the sale of
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equipment would show up as a investing
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activity let us look at a quick
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example jfk enterprises recorded the
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following
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and we need to look at these entries and
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determine
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what is the net cash flow from investing
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activities
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for a question like this you need to
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look for two
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items one is you need to look for cash
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flows
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and whether the cash flow is a investing
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activity so let us create two additional
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columns
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whether or not each item is a cash flow
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and the second is whether or not it is a
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investing activity purchase of equipment
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this
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is a cash flow equipment
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falls under investing activity so
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this is investing gain from sale of
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a van so van is equipment
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so it would be investing but it is not a
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cash flow the gain
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from sale is not a cash flow in of
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itself
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however the receipts from sale of the
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van
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this would be a cash flow and this is a
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investing activity dividends paid
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are not uh investing activity these
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this is a financing activity so
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clearly it does not fall in here
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interest
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and preferred dividend paid again this
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would not
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fall under investing
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and salary spade would also not fall
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under investing so we are only left with
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these two elements
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the purchase of equipment means that
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money went out so that is negative
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receipt from sale of van would be
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a positive so the net cash flow is minus
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70
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plus 18 which gives us
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a net outflow of 52 000
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so negative 52 000 is the investing
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activity
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we can either say it's negative or we
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can say that it is a
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outflow this is a very important slide
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from a testability perspective and it
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talks about the summary of differences
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between
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ifrs and u.s gaap related to different
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cash flow
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items when a company
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receives interest income should we
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classify that as
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operating or investing a company
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receives
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interest income when it invests
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in the bonds of another company
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now notice i use the term invest what
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ifrs says
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is that this interest received could be
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either
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shown as a operating cash flow or a
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investing cash flow so ifrs gives
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flexibility
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to companies to decide how to categorize
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interest received u.s gaap however says
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that
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interest received is always an operating
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cash flow interest paid this is where a
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company
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issues a bond or this is where a company
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borrows money
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and then pays interest ifrs says
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that this cash flow can be classified as
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operating or financing
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u.s cap says that it is always operating
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and i hope you can see the rationale
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behind this
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financing option in ifrs when a company
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is issuing a
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bond that is a financing mechanism
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so the interest paid when a company
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issues a bond could arguably be
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classified as
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a financing activity dividends
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received this is where a company invests
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in the shares of another company
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and receives dividends ifrs says that
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the cash received as the dividends
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received
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could be classified as operating or
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investing u.s gaap says
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that this has to be shown as operating
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and finally dividend speed this would be
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dividend on the company's own stock
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under
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ifrs the classification would be
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operating or financing
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under u.s gap the categorization
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is financing notice us gaap
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does not give any options so in a sense
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remembering the us gaap categorization
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is easier it is always operating except
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when a company
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pays dividends with ifrs
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you need to recognize that there is
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always an option
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one of the options is always operating
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and the
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other option depends on whether the
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activity
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is financing or investing you must
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learn this table
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the curriculum provides a little more
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detail related to other cash flow
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elements such as
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bank overdrafts taxes paid and then the
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curriculum also talks about the format
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of the cash flow statement you can
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simply read these
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i don't think they are overly testable
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but
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still it would not hurt to go over this
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material
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from a format perspective ifrs
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allows both direct or indirect but the
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direct
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is encouraged u.s gaap also says direct
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or indirect
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direct is again encouraged
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reconciliation of net income to cash
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flow from operating activities must be
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provided regardless of
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the method used as you probably
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gathered from the previous slide a cash
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flow statement can be presented
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in either a direct format or a indirect
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format
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and specifically it is the operating
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activities that can be presented in one
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of these two
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formats the direct format is easy to
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understand
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essentially it is taking the income
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statement
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and expressing the items on the income
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statement
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from a cash perspective so instead of
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saying revenue
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we say cash collected from customers
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instead of saying cost of goods sold we
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say
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cash paid to suppliers and so on
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at the bottom we have the operating
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cash flow and this will be arrived at by
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taking the cash from customers
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and then subtracting all these cash
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payments with the indirect format
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we start with the net income and make
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several adjustments to come up with the
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operating cash flow
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non-cash activities a non-cash
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transaction is any transaction that does
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not
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involve an outflow or inflow of cash
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it must be disclosed in either a
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footnote
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or supplemental schedules to
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the cash flow statement an analyst
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should incorporate non-cash
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transactions into analysis of past
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and current performance and include
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their effects
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in estimating future cash flows
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an example of a non-cash activity is
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given right here
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the conversion of a face value 1 million
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convertible bond to 1 million worth
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of common stock now this is clearly
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non-cash
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but this might have implications on how
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much money is available to
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common shareholders in the future
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