Interpretation of Cash Flow Statement (CFS)

The sole purpose of CFS is to provide ease of understanding cash movement of a Company. Easier said than done, understanding the story behind it turn out to be the opposite.

Format of CFS

Data from the CFS is extracted from both the Income Statement (IS) and Balance Sheet (BS). Despite the inter-connected relationship, CFS is distinct from the IS and BS, as shown below:-

CFS – Measures ‘real’ cash movements

IS and BS – Measurement based on accrual accounting

CFS allows investors to see cash movements by the major categories, namely; Operating, Investing and Financing activities. Under each category is details of cash flow movement during the financial period.

Operating Activities

Measures cash movement from core business operations, reflecting cash generated from sales of company’s products or services and cash paid from purchase of inventories. Examples of accounts affected by company’s business operations are; cash, receivables, inventory, payables, inventory.

Investing Activities

Measures cash movement from investment in property, plant and equipment. Due to the nature of investing activities, cash movements are usually cash outflows. Cash inflow will only occur when the company sells of an asset.

Financing Activities

Measures cash movement from debt, loans and dividends. Loans received from bank or new capital raised through bond issue are considered as cash inflows, while dividend payments and loan repayments are considered cash outflows.

Analyzing a CFS

Let us examine the categories and accounts of a CFS and how we can interpret the movement at our advantage.

2012

2011

Cash flow from operating activities

$’000

$’000

Source

Explanatory notes
Net profit

29,500

21,200

IS

Obtained from the IS, showing positive profit from operating activities
Adjustments for:
– Depreciation

2,500

2,150

IS

Non-cash item are added back, only considered as cash when sold
– Income tax

5,150

11,800

IS

Non-cash item are added back, only considered as cash when paid
– Interest income

(500)

(450)

IS

Non-cash item are added back, only considered as cash when received
Operating cash flow before working capital changes

36,650

34,700

Change in operating assets and liabilities
– Trade and other receivables

30,850

28,510

BS

Positive amount here represents lower receivables from customers versus prior year
– Inventories

(17,670)

6,750

BS

Negative inventory here represents higher inventory held on hand versus prior year
– Trade and other payables

9,160

(30,720)

BS

Positive amount here represents higher payables outstanding to suppliers versus prior year
Cash generated from operations

58,990

39,240

Income tax paid

(10,990)

(19,220)

BS

Actual income tax paid to the Inland Revenue Authority
Interest received

400

200

BS

Actual interest income received from bank deposits
Net cash provided by operating activities

48,400

20,220

Cash flows from investing activities

 

 

Purchases of property, plant and equipment

(13,500)

(140)

BS

Payment for PPE
Net cash used in investing activities

(13,500)

(140)

Cash flows from financing activities

 

 

Bank loan paid

(5,000)

Repayment of bank load due during the financial year
Dividend paid

(50,000)

(8,000)

BS

Dividend paid to shareholders
Net cash used in financing activities

(55,000)

(8,000)

Net movement in cash and cash equivalent (CCE)

(20,100)

12,080

CCE at beginning of financial year

240,760

252,840

BS

CCE at end of financial year

220,660

240,760

BS

From the above CFS, we can see a drop in CCE from $240,760k in 2011 to $220,660k in 2012. Changes in CCE can be seen from the self-explanatory CFS, which is mainly caused by dividends paid ($50,000k) and purchases of PPE ($13,500k). This is a very good explanation for the current financial year, so let us look at how we can interpret and forecast what is going to happen next year.

As mentioned, operating activities are real cash movement from the company’s core business activities. The majority of the company’s positive cash inflow are coming from this area, with an increase of $28,180k (2012: $48,400k vs. 2011: $20,220k). This is good news and it means that the core operations are generating favorable cash inflow. This also allows the company to invest in new equipment ($13,500k) and purchase more inventory ($17,670k) for growth and capturing of new market share. It is not an obligation for the company to distribute dividends, but the directors had agreed to share the company’s earnings with all shareholders, in hope of securing trust of current shareholders and getting more investments in future.

The amount of cash surplus available to the company should ease investors’ concern on future loan repayments and hope of more dividends payout next year.

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