Statement of Cash Flows Barry M Frohlinger Statement of Cash Flows Page 1 Barry M Frohlinger, Inc. copyright 1981-2010
Companies are required to present a Statement of Cash Flows (cash statement) for each period with the cash flows classified into three categories: Operating activities--all activities that are not specifically included in the other two categories; generally, activities involved in producing and delivering goods and providing services. (Includes cash dividends & interest income received from investing activities and interest paid for financing activities.) Investing activities--lending; investing in debt & equity instruments; investing in productive assets other than inventory (e.g., property, plant & equipment). Financing activities--borrowing & repaying debt (short- or long-term); issuing or reacquiring equity; dividends. There are two methods 1 for preparing a cash statement. Direct method--show the cash inflows and cash outflows from the cash T-account. Indirect method--show the changes in all T-accounts. Because each balance sheet balances, the changes between balance sheets balance also. Therefore, the change in the cash T- account equals the total changes in all other T-accounts. Significant non-cash investing activities and non-cash financing activities are disclosed in a footnote to the statement of cash flows. A simple illustration 2 of a typical cash statement is shown on the next page (twice, once for each of the two methods). Then, the T-accounts for the current year are shown. The last page contains the other financial statements for the company. ˆ ˆ Notice that the amounts for the direct method are from the cash T-account. Notice that the amounts for the indirect method are from the ALL T-accounts Indirect Method: Only the net increase or decrease is shown for the current asset and current liability accounts. The net increase or decrease in the cash account is shown as the bottom line on the cash statement. 1The explanation of operating activities is quite different for the two methods although the final net cash flow for operations is the same; the presentation of investing activities and financing activities is the same for both methods. 2 This illustration has no acquisitions or disposals, nor any foreign exchange activities or any non-cash investing or financing activities Statement of Cash Flows Page 2 Barry M Frohlinger, Inc. copyright 1981-2010
Important points about the Statement of Cash Flows The first line (net income) of the Statement of Cash Flow includes every revenue, expense, gain and loss from the income statement. (i.e., do not think of this as one net amount) The last line (increase or decrease in cash) includes every increase and every decrease in the cash account. (i.e., do not think of this as one net amount) The changes in balance sheet accounts are presented as follows: working capital accounts--only the net amount of increases less decreases is shown "Operating activities" is a precise accounting definition used only in the SCF. [Note: this is not the same definition that is used on the income statement.] Operating activities have been defined to exclude capital expenditures and dividends paid All companies must show the indirect presentation for operating activities (beginning with net income). Few companies also give the direct presentation of operating activities (showing cash inflows and cash outflows, rather than net amounts). Debits and Credits are precisely defined only in the SCF, where debits are in brackets and credits have no brackets Structure of the Operating Section The operating activities section of the SCF appears as follows: Net income (includes all income statement items) Adjustments: (to remove income statement items that never impact Operating Cash Flows) + Depreciation, asset writedowns, certain gains and/or losses, expense paid for with stock, etc. Adjustments: (to convert from the accrual basis to the cash basis) + Net increases and decreases in each operating asset and operating liability (one or more lines) =Cash provided by operating activities (the first subtotal on the SCF after Net Income) Income Statement Sales Revenue 15,000 Cost of Sales 6,000 Selling, General and Administrative 7,000 Operating Profit 2,000 Interest Income 100 EBIT 2,100 Interest Expense 500 EBT 1,600 Tax Expense 650 Net Income 950 From the SCF depreciation 300 amortization 100 stock based compensation 60 EBITDA Funds Flow Statement of Cash Flows Page 3 Barry M Frohlinger, Inc. copyright 1981-2010
Cashflow Company Statement of Cash Flows For year ended December 31, 2009 DIRECT METHOD INDIRECT METHOD Cash flows from operating activities: Cash flows from operating activities: a Cash received from customers 145 Net income 13 [1] Adjustments to reconcile net income to b Cash paid for production (102) cash provided by operating activities: c Cash paid for selling & administrative ( 25) Depreciation 10 [2] d Cash paid for interest ( 3) Increase in accounts receivable, net ( 6) [3] e Cash paid for income taxes ( 6) Increase in inventories ( 8) [4] f Net cash provided by operations 9 Increase in acct & acc pay - production 1 [5] Decrease in acct & acc pay - sell & adm ( 2) [6] Change in accrued interest payable -- [7] Increase in accrued income tax payable 1 [8] Net cash provided by operations 9 [9] Cash flows from investing activities: Cash flows from investing activities: Capital expenditures ( 9) Capital expenditures ( 9) Payment for long-term investment ( 10) Payment for long-term investment (10) Net cash used in investing activities (19) Net cash used in investing activities (19) Cash flows from financing activities: Cash flows from financing activities: Net repayment of short-term bank loans ( 2) Net repayment of short-term bank loans ( 2) Proceeds from long-term borrowing 20 Proceeds from long-term borrowing 20 Dividends paid ( 4) Dividends paid ( 4) Net cash provided by financing activities 14 Net cash provided by financing activities 14 Net increase in cash 4 Net increase in cash 4 Statement of Cash Flows Page 4 Barry M Frohlinger, Inc. copyright 1981-2010
T-accounts for Cashflow Company for year 2009 Cash Accounts receivable, net Inventories Beg 4 Beg 11 Beg 16 [ 4] 145 102 [ 2] [ 3] 151 145 [ 4] [ 1] 103 95 [ 5] 25 [ 7] End 17 End 24 [18] 20 3 [10] net 6 dr. net 8 dr. 6 [12] 4 [13] Long-term investments Building & equipment 9 [15] Beg 0 Beg 85 10 [16] [16] 10 [15] 9 2 [17] End 8 End 10 End 94 Accumulated depreciation Short-term bank loans pay. Accts & acc pay-production 32 Beg 5 Beg 14 Beg 10 [ 8] [17] 2 [ 2] 102 103 [ 1] 42 End 3 End 15 End net 2 dr. net 1 cr. Accts & acc pay-sell & adm Accrued interest payable Accrued income taxes pay. 6 Beg 1 Beg 2 Beg [ 7] 25 23 [ 6] [10] 3 3 [ 9] [12] 6 7 [11] 4 End 1 End 3 End net 2 dr. net -0- net 1 cr. Long-term debt Common stock Retained earnings 0 Beg 26 Beg 30 Beg 20 [18] [13] 4 13 NI* 20 End 26 End 39 End Explanations: [*] Net Income consists of entry #3 less 5, 6, 8, 9 & 11 [1] Costs incurred for inventories -- set up as accounts & accruals payable - $103 [2] Cash payment of accounts & accruals payable for production - $102 [3] Sales on account - $151 [4] Collection of accounts receivable - $145 [5] Cost of sales - $95 [6] Selling & Admin. expense -- set up as accounts & accruals payable - $23 [7] Cash payment of accounts & accruals payable for selling & admin. - $25 [8] Depreciation expense - $10 [9] Accrual of interest expense - $3 [10] Cash payment of interest expense - $3 [11] Accrual of income tax expense - $7 [12] Cash payment of income tax expense - $6 [13] Dividend paid - $4 [15] Purchase building & equipment - $9 [16] Purchase long-term investment for cash - $10 [17] Net cash flow-additional short-term borrowing and repayments - $2 reduction [18] Long-term borrowing - $20 Statement of Cash Flows Page 5 Barry M Frohlinger, Inc. copyright 1981-2010
Cashflow Company Financial Statements Balance Sheet December 31, 2009 2008 Cash & marketable securities 8 4 Accounts receivable, net 17 11 Inventories 24 16 Total current assets 49 31 Long-term investments, at cost 10 -- Building & equipment, at cost 94 85 Less accumulated depreciation (42) (32) Total assets 111 84 Short-term bank loans payable 3 5 Accounts & accruals pay. - production 15 14 Accounts & accruals pay. - sell. & adm. 4 6 Accrued interest payable 1 1 Accrued income taxes payable 3 2 Total current liabilities 26 28 Long-term debt, due 2008 20 -- Common stock 26 26 Retained earnings 39 30 Total liabilities & stock. equity 111 84 Statement of Income and Retained Earnings For year ended December 31, 2009 Revenues: Sales revenues 151 Total revenues 151 Expenses: Cost of sales 95 Selling & administrative exp. 23 Depreciation expense 10 Interest expense 3 Income tax expense 7 Total expenses 138 Net income 13 Beginning retained earnings balance 30 Less dividends paid ( 4) Ending retained earnings balance 39 Statement of Cash Flows www.learnfrombarry.com Page 6
Analysis of Operating Activities Many financial analysts attempt to compare (i) net income to (ii) cash provided by operating activities. This is an invalid comparison because of a change in definition and should not be attempted. [The change in definition in the SCF is to remove any investing activities and financing activities included in net income.] A valid comparison can be made if a new subtotal is inserted (with no change in the SCF amounts). This subtotal will be called "Potential cash provided by operating activities tm " or Expected Cash Flow m or Funds Flow. The operating activities section of the SCF appears as follows (where bold represents required reporting plus the new subtotal and the italics represents explanatory comment). Net income (includes all income statement items; i.e., all operating activities plus some investing 3 activities and some financing 4 activities) Adjustments: + Depreciation, asset writedowns, gains, losses, etc. (one or more lines) (to remove any investing 4 activities and any financing 5 activities) Funds Flow [Potential cash provided by operating activities} 6 (subtotal) Adjustments: (to convert from the accrual basis (potential) to the cash basis) + Net increases and decreases in each operating asset and operating liability (one or more lines) =Cash provided by operating activities (subtotal). } remainder of SCF. } Potential cash provided by operating activities may be compared to cash provided by operating activities because, over the entire life of any company, Potential cash provided by operating activities 5 = Cash provided by operating activities. 3 Mainly depreciation, amortization, write-down of long-lived assets and gain (loss) on sale of long-lived assets. 4 Mainly gain (loss) on retirement of long-term debt. [Deferred tax is a difficult adjustment in order to calculate Funds Flow, it is commonly adjusted in order to calculate Funds Flow ] 5 Also called Funds Flow Statement of Cash Flows www.learnfrombarry.com Page 7
Free Cash Flow Some analysts give too much importance to cash provided by operating activities. The subtotal for cash provided by operating activities represents only a portion of a company's cash outflows that are necessary to operate the business 6. In addition, the company must make capital expenditures (shown as investing activities) and, if planned, pay dividends (shown as financing activities). The concept of free cash flow defined 7 as (i) cash provided by operating activities less (ii) capital expenditures 8 and less (iii) dividends provides a very useful reminder for the financial analyst--don't stop at the subtotal for cash provided by operating activities. 6 The Blockbuster financial statements highlight the weakness of focusing on Cash Flow from Operations 7 For some purposes, the analyst may define free cash flow without subtracting dividends. 8 Many analysts also include acquisitions here Statement of Cash Flows www.learnfrombarry.com Page 8
BLOCKBUSTER INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2004 2003 2002 Cash flows from operating activities: Net loss $ (1,248.8) $ (978.7) $ (1,621.1) Adjustments to reconcile net loss to net cash flow provided by operating activities: Depreciation and amortization 249.7 268.4 240.8 Impairment of goodwill and other long-lived assets 1,504.4 1,304.9 Rental library amortization 748.0 954.8 1,024.3 Non-cash share-based compensation expense 17.0 Excess tax benefit from share-based compensation (5.1) Cumulative effect of change in accounting principle, net of tax 4.4 1,817.0 Deferred taxes and other (94.3) (73.5) 18.3 Change in operating assets and liabilities: (Increase) decrease in receivables 8.6 5.9 (27.8) Decrease in receivable from Viacom 0.8 14.0 82.9 (Increase) decrease in merchandise inventories (84.2) 55.1 (221.8) Increase in prepaid and other assets (97.5) (4.8) (38.7) Increase (decrease) in accounts payable 125.4 (221.9) 187.6 Increase in accrued expenses and other liabilities 91.4 101.7 0.8 Net cash flow provided by operating activities 1,215.4 1,430.3 1,462.3 Cash flows from investing activities: Rental library purchases (798.4) (836.6) (1,060.9) Capital expenditures (289.1) (191.0) (151.7) Cash used for acquisitions (25.5) (3.4) (106.0) Proceeds from notes receivable and other 1.2 4.5 3.6 Investments in affiliated companies (0.5) 1.9 0.4 Net cash flow used for investing activities (1,112.3 ) (1,024.6 ) (1,314.6 ) Cash flows from financing activities: Proceeds from credit agreements 820.0 140.0 170.0 Proceeds from senior subordinated notes 300.0 Repayments on credit agreements (170.0) (450.0) (360.0) Net repayments on other notes and lines of credit (23.8) (5.8) (10.1) Net proceeds from the exercise of stock options 2.8 18.1 39.3 Cash dividends (920.1) (14.4) (14.3) Payment of debt financing costs (18.7) Capital lease payments (21.0) (23.4) (24.1) Capital contributions received from Viacom 6.9 Excess tax benefit from share-based compensation 5.1 Net cash flow used for financing activities (18.8 ) (335.5 ) (199.2 ) Effect of exchange rate changes on cash 12.6 10.7 3.8 Net increase (decrease) in cash and cash equivalents 96.9 80.9 (47.7) Cash and cash equivalents at beginning of year 233.4 152.5 200.2 Cash and cash equivalents at end of year $ 330.3 $ 233.4 $ 152.5 Supplemental cash flow information: Cash payments for interest $ 23.2 $ 34.3 $ 45.8 Cash payments for taxes 44.4 98.1 12.6 Statement of Cash Flows www.learnfrombarry.com Page 9
Various Cash Flow Definitions Many companies use their own definitions of cash flow to enhance the reader s understanding of the firm s ability to generate cash, provide liquidity and satisfy rating agency and creditor requirements. These measures are not defined by Generally Accepted Accounting Principles management often considers these measures to be important to estimate the enterprise and shareholder values of the Company as a whole and of its core segments, and for allocating capital resources. Some common measures of financial results are: Earnings from Continuing Operations before Interest, Taxes, Depreciation, Depletion and Amortization (EBITDA) Adjusted Cash Available for Distribution (Adjusted CAD). Adjusted CAD is a non-gaap measure of cash generated during a period that is available for dividend distribution, repurchase of the common shares, debt reduction and for strategic acquisitions. A common definition of Cash Available for Distribution (CAD) is Cash Provided by Operating Activities less capital spending. Many firm define Capital Spending as Mandatory [or Maintenance or Custodial] Capital Spending, a non-gaap measure, as capital expenditures, net of proceeds from sales and retirements, required to maintain its current earnings level over the cycle and to keep facilities and equipment in safe and reliable condition as well as in compliance with regulatory requirements. The measure is important to properly evaluate the Company s cash requirements, to forecast potential uses of cash and for use in valuation models. Capital spending over the custodial level is often called discretionary capital spending. Owner s Cash Flow [this is a Warren Buffett definition of CFO Cap X]. Management Cash Flow [a common corporate definition of CFO- net CAP X]. Statement of Cash Flows www.learnfrombarry.com Page 10
Various Definitions of Cash Flow Credit Analytics Revenue Cost of Sales Selling and General Expenses Operating Profit Other Income/Expense EBIT EBITDA EBITDAR EBITDAX EBITDAM EBITDA - CapX Unleveraged pretax, core business unleveraged pretax rent exploration marketing can be a close proxy for EBIT Funds Flow Cash Flow from Operations CFO - Cap X CFO- CapX - Dividends EBIT * (1-T) + DA - CAP X - ^OpWC EBIT * (1-T) + DA leveraged after tax GAAP Free Cash Flow Free Cash Flow to the Firm unleveraged after tax Statement of Cash Flows www.learnfrombarry.com Page 11
Analytical Issues Invisible Cash Flow Issues: Cash Spent [within the financing section] for acquiring stock options Cash Spent [within the investing section] for acquisition, how much CapX is included with acquisitions and the distortion to Cash Flow from Operations from the subsequent sale of inventory and collection of receivables Be especially careful about firms placing operating like cash outflows in the investing sections o Capital Goods producers and their respective vendor financing o Entertainment and Media firms with payments for inventory o Consumer Products firms with cash payments to the distribution channel Tax payments arising from non-operating activities Statement of Cash Flows www.learnfrombarry.com Page 12
Stock based Compensation CABOT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended September 30 2006 2005 2004 (In millions) Net sales and other operating revenues $ 2,543 $ 2,125 $ 1,934 Cost of sales 2,124 1,692 1,457 Gross profit 419 433 477 Selling and administrative expenses 235 240 217 Research and technical expenses 58 59 53 Goodwill impairment charge 90 Long-lived asset impairment charge 121 Income (loss) from operations 126 (77 ) 207 Interest and dividend income 5 6 6 Interest expense (34 ) (36 ) (49 ) Income (loss) from continuing operations before taxes 97 (93 ) 164 Benefit (provision) for income taxes (9 ) 45 (39 ) Income (loss) from continuing operations 88 (48 ) 122 Income from discontinued businesses, net of tax 2 2 Income (loss) before loss from cumulative effect of changes in accounting principle 90 (48 ) 124 Loss from cumulative effect of changes in accounting principles, net of tax of $1 (2 ) Net income (loss) 88 (48 ) 124 Dividends on preferred stock, net of tax of $1, $1 and $1 (2 ) (3 ) (3 ) Income (loss) available to common shares $ 86 $ (51 ) $ 121 The accompanying notes are an integral part of these financial statements. EBITDA for 2006 = 97 + 34 + 131 [from SCF] + 26 = 288 Funds Flow for 2006 = 88 +131 +26 = 245 Statement of Cash Flows www.learnfrombarry.com Page 13
CABOT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended September 30 2006 2005 2004 (In millions) Cash Flows from Operating Activities: Net income (loss) $ 88 $ (48 ) $ 124 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 131 142 134 Deferred tax benefit 2 (57 ) Cumulative effect of accounting changes 2 Non-cash compensation 26 27 25 Other non-cash charges 9 217 22 Changes in assets and liabilities, net of acquisitions and the effect of consolidation of equity affiliates: Accounts and notes receivable (58 ) (39 ) (45 ) Inventories 82 (9 ) (20 ) Prepaid expenses and other current assets (22 ) 5 Accounts payable and accrued liabilities 24 26 7 Income taxes payable (41 ) 11 4 Other liabilities 2 (48 ) (15 ) Other, net 7 (9 ) 5 Cash provided by operating activities 252 218 241 Cash Flows from Investing Activities: Additions to property, plant and equipment (188 ) (186 ) (119 ) Proceeds from sales of property, plant and equipment 9 1 4 Increase in assets held for rent (3 ) (4 ) (4 ) Purchase of marketable securities investments (20 ) (94 ) (110 ) Acquisition of interest in equity affiliate (19 ) (2 ) Proceeds from maturity of marketable securities investments 56 164 5 Cash used in investing activities (165 ) (119 ) (226 ) Cash Flows from Financing Activities: Borrowings under financing arrangements 65 91 11 Repayments under financing arrangements (51 ) (95 ) (47 ) Repayments of debt related to Cabot Japan (25 ) Increase in notes payable to banks, net 15 13 Purchases of preferred and common stock (39 ) (52 ) (54 ) Sales of preferred and common stock 9 5 9 Proceeds from cash contributions received from minority interest shareholders 2 6 Cash dividends paid to stockholders (43 ) (43 ) (40 ) Cash dividends paid to minority interest stockholders (7 ) (8 ) (6 ) Proceeds from restricted stock loan repayments 7 6 13 Cash used in financing activities (82 ) (75 ) (101 ) Effect of exchange rate changes on cash 3 (2 ) (2 ) Increase (decrease) in cash and cash equivalents 8 22 (88 ) Cash and cash equivalents at beginning of year 181 159 247 Cash and cash equivalents at end of year $ 189 $ 181 $ 159 Income taxes paid $ 18 $ 34 $ 36 Interest paid 28 26 27 Restricted stock issued for notes receivable, net of forfeitures 7 6 13 end Statement of Cash Flows www.learnfrombarry.com Page 14