馃攳
Level I CFA: FRA Understanding Cash flow Statements-Lecture 3 - YouTube
Channel: IFT
[1]
Moving now to Investing Activities using the direct
[7]
method. CFI or cash flow from investing is calculated by
[12]
examining the changes in the gross asset account
[16]
that results from investing activities. Typically,
[20]
we are considering purchases or sale of equipment
[23]
i.e. long-term assets. The first thing we will look at
[29]
is how to determine cash paid for new equipment.
[35]
To do so, we must analyze whether old assets are
[39]
sold or not, and here is the simple expression that
[43]
you need to know, the cash paid for new equipment
[46]
is equal to ending gross equipment balance plus
[51]
gross cost of equipment sold minus beginning gross equipment
[55]
balance. You need to make sure you understand what
[58]
gross means. If you buy equipment for 100, and let's say, this
[64]
equipment will be used for 10 years, and every year
[67]
the depreciation is 10, then after 1 year the net book
[73]
value of the equipment will be 100 - 10, assuming 10
[76]
is the depreciation every year so, you will have
[79]
a book value of 90. After two years, you'd appreciate
[83]
10, again and you will have a net book value of 80.
[89]
So, the 80 is referred to as net book value. The gross
[95]
equipment value is still 100. So, notice the gross value
[104]
is the net value plus the accumulated depreciation.
[106]
Accumulated depreciation, in this example, is 20
[111]
so, cash paid for new equipment is ending gross equipment balance
[121]
plus the gross cost of equipment sold minus beginning gross equipment balance.
[125]
Let's say that we start with a simple example, where nothing
[128]
was sold during the year. If the ending gross equipment
[133]
balance is 500, and the beginning gross equipment
[139]
balance is equal to 400, then this obviously means
[146]
that the cash paid for new equipment must be a 100,
[150]
assuming of course that nothing was sold during
[154]
the year. You take the end number subtract the beginning
[158]
number and the difference has to be explained by
[161]
how much cash was paid for the new equipment. Now, let's say from the footnotes
[167]
you recognize that the gross cost of equipment sold was 50, then what
[173]
is the cash paid for new equipment? The answer
[178]
is as follows; you have an ending balance, let's say
[182]
of 500, so you will do 500 + 50.
[186]
The way you can think of this is if the equipment had
[189]
not being sold then the ending balance would have
[192]
been 550, and then you subtract the beginning balance
[196]
of 400, you have 550 - 400 which is equal to 150. Next, we
[209]
try to determine cash inflow from the sale of equipment.
[213]
This is a little more complicated and here we need
[218]
to understand the equipment amount, the accumulated
[223]
depreciation and the gain or loss on sale of equipment.
[229]
The cash from sale is equal to the historical cost of the equipment
[235]
sold, this is the same as the gross cost of the equipment
[241]
sold minus depreciation on equipment sold. When
[245]
you combine these two items, you have the net book
[249]
value of the equipment which is sold. Let's say
[252]
that the net book value is equal to 80 and let's say
[258]
that the gain on sale of equipment, you can easily
[261]
get from the income statement, is equal to 5. The cash
[267]
from sale of the equipment would then clearly be
[270]
80 + 5, which is 85, but these numbers however, are not
[278]
so easy to come up with, they're not given to you. They
[282]
have to be computed using the financial statements.
[286]
So, let's see how we compute these numbers. The historical
[289]
cost of equipment sold is equal to the beginning
[292]
balance of equipment. So this would be the gross
[297]
amount for equipment. If you are looking at a given
[303]
time period, let's say 2010, you will look at the beginning
[307]
balance of equipment, then you will add the equipment
[312]
purchased. This typically would be, this information
[315]
would be obtained from footnotes. So you add that
[319]
and then you subtract the ending balance, you subtract
[324]
the ending balance of equipment, and we look at example
[328]
on the slide. Depreciation on equipment sold
[332]
that is given by this formula, the beginning balance
[336]
of accumulated depreciation again, that would
[338]
be start of the period, plus depreciation expense minus ending
[344]
balance of accumulated depreciation. These two
[348]
items would come from the balance sheet, this would
[350]
come from the income statement, and then you add
[354]
the gain on sale of equipment, this is easy, this comes
[356]
straight from the income statement. Now, I want you to
[360]
memorize what you are looking at over here, or at
[365]
least make a note, and then attempt the question on
[369]
the next slide, which is given right here. So, here
[375]
is what you should be doing. This is simply reproducing
[379]
the information from the question, the correct
[382]
answer is 3.5. You first, compute historical cost
[387]
of equipment sold as 3 and to come up with 3 you
[391]
need to look at the beginning balance of equipment,
[394]
that's the gross amount, 80 + equipment purchased,
[399]
that's 14, minus ending balance, which is 91, and then you
[406]
subtract the depreciation on equipment sold that's
[409]
1, and you get that using this expression. Beginning
[413]
balance accumulated depreciation, which is 25
[417]
plus depreciation expense, 7, minus accumulated
[422]
depreciation at the end, 31, so that should give you
[426]
1, and then gain on sale of equipment from the income
[431]
statement is 1.5. Put these numbers together, and you should
[435]
get 3.5. Coming now to Financing Activities, and
[442]
as I mentioned before, both with investing activities
[445]
and financing activities, we only have the direct
[448]
method there is no indirect method. Financing activities
[453]
deals with cash flow between the firm and suppliers
[456]
of capital. The major suppliers of capital are either
[460]
lenders or bondholders and shareholders, either
[463]
the common shareholders or preferred shareholders. So,
[467]
all this cash flow needs to be shown on the financing segment
[474]
of the cash flow statement. It's referred to as
[478]
the CFF, Cash Flow from Financing. If you look at the
[483]
lender side, the net cash flow from creditors is equal
[488]
to the net borrowing, so in a given period, this would be
[493]
the net borrowing. This is how much money the firm
[496]
is getting from the lenders, minus the principal
[502]
amount repaid and these are the principal amount
[505]
repaid. In this particular scenario, we are assuming
[510]
that any interest paid is shown on the CFO part of
[516]
the cash flow statement. So, this clearly is U.S. GAAP
[521]
perspective, or it could also be IFRS where we are
[525]
assuming that interest is shown in the CFO segment.
[530]
In terms of interaction with shareholders, the net
[535]
cash flow from shareholders is equal to new equity
[539]
issued. When a firm issues new equity, it is going
[543]
to get cash from shareholders, so that's this
[547]
over here, minus shares repurchased. When the firm repurchases
[552]
shares, it is giving money to shareholders, and then
[556]
also minus any cash dividends. When cash dividends are
[560]
paid, the firm is giving cash to shareholders.
[565]
The combination of these two essentially form the
[570]
CFF part of the cash flow statement. Putting all
[576]
this together, you notice that we have operating
[580]
activities shown right up front and we have discussed
[583]
each of these elements, cash flow from customers,
[586]
and then various cash expenses are just cash paid
[589]
for rent, employees etc. Then, we have investing activities
[594]
where primarily we are dealing with the purchase
[596]
and sale of equipment even investment securities
[600]
would fall in this category. So, this is CFI, and
[606]
then financing activities are issues of stock increases
[610]
and notes payable, that means borrowing went up.
[613]
Repurchase of treasury stock, this is money going
[617]
out to the shareholders, cash flow from financing
[620]
activities, net amount is given right here. You add
[624]
all these together, and that's the total cash flow.
[628]
This then is a simple example of a overall cash flow statement
[634]
using the direct method. With the indirect method,
[637]
the only thing that would be different would be the
[640]
operating segment, where we would start with the net
[643]
income and reconcile down to CFO, the CFO number
[647]
would be the same. Let's briefly talk about the
[652]
indirect method now. Here, we begin with the net income
[657]
and this comes obviously straight from the income
[660]
statement. Then, we add back all non-cash charges
[664]
to income and subtract all non-cash components
[669]
of revenue. Classic example here would be depreciation
[676]
for non-cash charges, say, for a given company, the
[679]
net income is a 100, since, we are dealing with
[682]
cash flow, we need to add back depreciation, say, the
[686]
depreciation charge is 10. Remember, the depreciation
[690]
was subtracted, in order, to come up with net income.
[694]
So, if we are going to arrive at a CFO number, we need
[699]
to add back depreciation. We subtract gains or losses
[704]
that resulted from financing or investing activities.
[708]
So, actually, subtract gains or add the losses that
[713]
resulted from financing or investing activities.
[717]
The classic example would be, let's say that on the
[720]
income statement, we showed the gain of 5 from the
[724]
sale of equipment, now, the gain of 5 caused the
[729]
net income to be higher, but that wasn't a real cash
[734]
flow, the gain of 5 was not a operating cash flow. So, what
[739]
we are then doing is subtracting that gain, if this
[743]
had been a loss then we would be adding. When you add
[749]
or subtract changes to balance sheet operating
[752]
accounts, and we have discussed this before. Any increases
[756]
in operating asset accounts, such as accounts receivable
[761]
going up is a use of cash, so that would be a minus.
[765]
So, if accounts receivable is going up by 3, then we
[769]
would subtract 3, if inventory has gone up by 7 then
[773]
we would subtract 7. When we deal with increases in
[779]
operating liability account. So, if accounts payable
[783]
is going up by 6, we would add 6 over here. Once you
[790]
put all this together, you then have a reconciliation
[794]
between net income and the cash flow from operations.
[801]
In order to internalize what we are talking about,
[804]
over here, I would strongly encourage you to do example
[808]
7 from the curriculum. Coming down to the conversion
[813]
of cash flows from indirect to direct method. This
[818]
is a little bit complicated, but it is part of the learning
[822]
objectives. However, I think the probability of
[825]
you being tested on this material in detail is low.
[829]
Nevertheless, since it is part of the learning objectives,
[832]
we will go over the process. Step one, is to aggregate all
[837]
revenues and expenses. So, you come up with total
[841]
revenue subtract the total expenses, and you have
[844]
your net income, this is essentially, your income
[847]
statement. Then, you remove all non-cash items from
[851]
aggregate revenues and expenses and break out remaining
[855]
items into relevant cash flows. The major item here
[859]
would be to take your revenue and remove non-cash
[862]
revenue, such as gain on sale of equipment. This material,
[867]
by the way, is illustrated quite well in exhibit 11
[872]
in the curriculum. So, if you also follow along from
[875]
the curriculum, this discussion will be a little
[877]
bit easier. The cost of goods sold, salary and wages,
[882]
etc all this information, you can get from the
[885]
income statement, and then you convert accrual amounts,
[890]
these are the amount from the income statement
[892]
which are based on accrual accounting. So, you convert
[896]
these accrual amounts to cash flow amounts by adjusting
[899]
for working capital changes. The working capital
[903]
is your accounts receivable, accounts payable inventory,
[907]
etc, your current assets other than cash and
[911]
your current liability, such as accounts payable.
[915]
So, when we talk about cash from customers, you start
[919]
with the revenue number and make an adjustment based
[922]
on accounts receivable. To get cash to suppliers
[926]
you start with COGS and make an adjustment based
[929]
on changes in accounts payable, and inventory and
[932]
so on. This is exactly what we have talked about earlier.
[935]
So, you make the adjustments and come up with the various
[940]
cash payments, and then you have your final number
[943]
for CFO. Notice, we are only dealing with operating
[947]
cash flows, because for investing and financing
[951]
the material is always presented in the direct format
[954]
anyway.
Most Recent Videos:
You can go back to the homepage right here: Homepage