On Project Report/Readings
1. Market value, use number of shares outstanding, do not
use average number of shares outstanding
2. Identify source of data or quotes
3. Common size analysis, show amounts and percentages
4. Only analyze notes that are related to our current
lecture
5. Take turn to write the report, do not leave to one person
6. In final exams, I may provide you with raw materials
and a sample article from our readings for you to
analyze the raw materials and write a similar article. So
get familiar with all articles. Again, understand but do
not memorize.
Firm Names
Eagle Eye: Valuation Analysis Strategy
Investorium
Statement of Cash Flow
Cash flow from Operating activities: （营运活动）
cash receipts from customers
cash disbursed to:
suppliers of merchandise
employees for salaries
Cash flow from investing activities: （投资活动）
purchase of buildings, equipments, plants
proceeds (进帐）from sales of long term assets
Cash flow from financing activities: （融资活动）
borrowing/repay long term debts
issuing new shares
Overview of the Statement of Cash Flows
In AOL 2000 balance sheet, cash and cash
equivalent increased from $936 millions to $2,490
millions. How?
The statement of cash flows …
(a) explains the reasons for a change in cash.
(b) classifies the reasons for the change as an
operating, investing or financing activity.
(c) reconciles net income with cash flow from
operations.
Montgomery Ward . bankrupt
The difference between earnings and cash flows
1. I/S Explain change in
retained earnings
2. I/S is accrued-based
3. I/S recognize property
rights
4. I/S require estimates
5. I/S is an opinion
6. I/S is prone to (易于）
manipulation
7. Firms can survive a long
string（长串） of
negative earnings
1. SCF explain change in
cash and cash equivalent
2. N/A
3. SCF emphasize “actual
possessment”
4. SCF does not
5. SCF is a fact
6. SCF is so to a much less
degree
7. Firms go bankrupt with a
long string of negative
cash flows (outflow)
Cash flow equation
A = L + E
ΔA =ΔL+ΔE
Δcash +Δnon-cash A = ΔL+ ΔE
Δcash +Δ current A (other than cash) +Δnon-current
A= Δcurrent L+ Δnon-current L+ ΔE
Δcash = Δcurrent L+ Δnon-current L+ ΔE -Δ current
A (other than cash) -Δnon-current A
Cash flow from operation
Cash flows related to selling goods and services; that
is, the principle business(主营业务) of the firm
The main source of payoffs to shareholders and
creditors
The reason for the firms to exist
If firms do not in the long run generate more cash
from operation than the returns of funds to
shareholders and creditors, the firms go bankrupt
Cash flow from operation-components
Cash collected from customers
Cash collected as interest (利息）on loans to others
Cash collected as dividends （股利）on investment on
other firms’ stocks
Cash paid to suppliers
Cash paid to employees
Cash paid to other service providers: landlords,
marketing agency, auditors, consultants, …
Cash paid to government
Cash paid to creditors as interest on borrowed money
Cash flow from investing activities
Cash flows related to the acquisition or sale of non-
current assets: investment, land, property, plants,
equipments…
To maintain the current productivity of the
operation, a firm must replace assets that they
wear out (消耗）
To grow its operation, a firm must acquire additional
assets
Old assets may be sold as they become obsolete (过
时）, or as the firm change production
Investing activities thus provide resource to generate
cash flow from operations
Cash flow from investing activities-
components
Cash received from sales of land, investment, property,
plants and equipment
Cash paid to acquire land, investment, property, plants
and equipment
Cash flow from financing activities
Cash flows related to long-term liabilities and
owners’ equity
The source of cash to be used in investing and
operating activities
Two sources: shareholders and creditors
This part of SCF also indicates how much cash the
firm returns to its capital providers, ., cash
distribution to shareholders and creditors
Note: short-term liabilities generated in operation,
such as account payable, is not related to this
category
Cash flow from financing activities-
components
Cash received from issuing corporate debts or taking up
loans
Cash received from issuing common shares or preferred
shares
Cash paid to repay debts or loans
Cash paid to repurchase shares
Cash paid to shareholders as dividends
Relations among the cash flows from the three
categories of activities
1
CF
from
Fin.
Act.
CF
from
Inv.
Act
CF
From
Op.
Act.
Free Cash Flow
= Cash flow from operating activities
+ Cash flow from investing activities
If positive, normal operation generates more cash
that it consumes, such as the case of a stable firm
If negative, normal operation generates insufficient
amount of cash to be self-sustaining, such as a
growing firm
Two methods to prepare the operating portion
of SCF
Direct method of presentation calculates cash flow
from operations by subtracting cash disbursements
to supplies, employees, and others from cash
receipts from customers.
The indirect method calculates cash flow from
operations by adjusting net income for noncash
revenues and expenses.
Most firms present their cash flows using the indirect
method.
SCF-Direct method
The direct method is simple and straight:
Cash collected from customers
Cash collected as interest (利息）on loans to others
Cash collected as dividends （股利）on investment on other
firms’ stocks
Cash paid to suppliers
Cash paid to employees
Cash paid to other service providers: landlords, marketing
agency, auditors, consultants, …
Cash paid to government
Cash paid to creditors as interest on borrowed money
Indirect method SCF reconciles net income with
cash flow from operation
Δcash = Δcurrent L+ Δnon-current L+ ΔE -Δ current A
(other than cash) -Δnon-current A
Δcash = [Δcurrent L -Δ current A (other than cash) ]+
[Δnon-current L+ ΔE] –[Δnon-current A]
Op.
Fin. Inv.
Indirect method SCF reconciles net income with
cash flow from operation
Net Income is accrual-based, when we calculate net
income, we do not care whether cash has been
received or paid
But current assets and current liabilities accounts are
impacted when we calculate net income, ., we
debit account receivable and credit revenue when
finishing a sales activity
Indirect method SCF reconciles net income with
cash flow from operation
So in the example above, net income is higher than
cash flow from operation because this transaction
increases net income by increasing revenues, but
does not increase cash because we debit account
receivable and no cash is collected yet.
Therefore, to get to the balance of cash from net
income, we subtract the increase in account
receivable account.
This procedure confirms to the cash equation in
which increase (positive change) in current assets
other than cash decrease cash flow from operation.
Indirect method SCF reconciles net income with
cash flow from operation
The indirect method:
Net income
+ depreciation
• Increase in current assets accounts
+ decrease in current assets accounts
• decrease in current liabilities accounts
+ increase in current liabilities accounts
= Cash flow from operation
Notes to financial statements- on cash flows
Is cash the king?
Cash is the ultimate payoffs to capital providers
Established finance theory told us the the value of a
firm is the present value of all its future dividends
Is cash the king?
Earnings do not always go hand-in-hand with cash
flows
- Operational reason: a growing firm can have fast
growth in earnings, but due to the expansion, it is
consistently short of cash; a declining firm may
have declining earnings but throw out large
amount of cash due to lack of investing
opportunities
- Earnings management reason:A firm may manage
the non-cash earnings to increase earnings, but not
to increase cash flow.
Cash flow pattern for different firms
Cash flow from: A B C D
Operation $ (3) $ 7 $ 15 $ 8
Investing (15) (12) (8) (2)
Financing 18 5 (7) (6)
Net CF 0 0 0 0
New,
growing
firm
Growing
less
rapidly
Mature,
stable
firm
Declining
firm
Is cash the king?-Sloan [1996] Accounting Review
Is cash the king?-Sloan [1996] Accounting Review
Is cash the king?-Sloan [1996] Accounting Review
Is cash the king?-Barth el al. (2001)
Investing Motto
You can pocket cash, but you can not pocket
earnings!
---myself
