AF7024
Corporate Reporting and Analysis
Financial analysis and interpretation III
Analysis and Interpretations of the Cash Flow
Statement (IAS 7)
International Financial Reporting
Alan Melville (8th edition)
Chapter 16
Statement of cash flows
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CHAPTER 23
Statement of cash flows
CHAPTER 31
Techniques of Financial Analysis
Overview
• The usefulness of cash flow statements and
cash flow reporting
• The usefulness of cash flow ratios and cash
flow analysis
Cash Flow Statement
Why do we need (usefulness of) cash flow statement?
Walking Paper
Cash Flow Statement Use
• Internal users
o Determine dividend policy
o Evaluate cash generated by operations
o Review investing and financing policy
• External users
o Assess firm’s ability to increase dividends
o Assess firm’s ability to pay debt from operations
o Assess firm’s relationship of cash from operations
to total cash
Advantages of Cash Flow Statement
• Viewed as important – cash is difficult to be creative with!
• Objective (about the past)
• Understandable
• Largely free from allocation issues
• Supports predictive value of accounting information
Format of cash flow statement - IAS 7
Group Discussion
Have a look at TESCO plc cash flow statement – from
published financial statements 2024
Can you see the three main headings under which cash
flows are categorised. List them in your groups
Identify and discuss the key information that users will be
paying most attention to – and why!
Consider the qualitative characteristics of information in the
conceptual framework. How can you see these reflected in
the cash flow statement? List them out and find examples.
Feedback – TESCO Cash Flow Statement
Main Headings
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
Key information for users – and why
Operating Section
Dividends paid ? ; CASH paid to shareholders – can
this and tax be serviced from operating activities?
Commitment to cash outflow to service debt (interest);
why? help support decision about borrowing more or
worry about what already borrowed!
Put amount in context of overall cash generated
Cash from operating activities; why? can the company
generate cash from day to day operating activities? This
tells the users something about the quality of profits
generated.
Key information for users – and why
Investing section
o Relative levels of investment in PPE and
acquisitions; Why? Says something about growth
and expansion.
Financing section
o Movements in cash from financing activities. Why?
Lenders interested, related to ability to pay
o Borrowings & repayments.
Key information for users – and why?
Overall
Cash inflow or outflow?
Why?
Ability of company overall to raise cash – but be careful,
as where that comes from is very important.
Cash management – Lets look at? surplus or deficit?
Discuss in small groups?
Cash Management
How to solve a cash deficit:
o Overdraft
o Short-term loan
o Sell surplus stock (inventory)
o Offer discount for quick payment
o Factor debts
o Delay payment of debts
Cash Management
How to solve a cash surplus:
o Increase stock (inventory) range
o Offer better terms to debtors
o Buy more fixed assets
o Pay off existing loans
o Buy short term investments
o Take over another company
Qualitative characteristics from
conceptual framework reflected in the
Cash Flow statement
• Faithful representation (fundamental). Why? cash is
cash! relatively free from bias, difficult to defraud,
objective.
• Relevant. Why? Predictive value – how? Where is
cash coming from? Operating profit is good source!
Relevant to users – lenders, evidence of sound cash
flow management; cover for interest paid each year.
• Comparable and Understandable are main
enhancing characteristics
Conclusions
• Cash flow gives additional information
• Useful to readers of annual reports
• Has qualitative characteristics
Procedures to Develop the Statement of Cash Flows
• Analyse all balance sheet accounts other than cash
and cash equivalents.
Financial Ratios and the Statement
of Cash Flows
Statement of cash flows is relatively new
o Required presentation began in 1987
Cash flow financial ratios were slowly developed
Traditional ratios relate balance sheet to income
statement
Income Quality Ratio
• This ratio reflects the company's quality of income.
• The higher this ratio, the better the firm's income
quality.
Operating Cash Flow to Sales
• This ratio indicates how efficient is the company to
generate operating cash flows related to net sales.
• Cash flows to sales are closely related to the
profitability measures of profit margin. The higher this
ratio, the better the firm's cash generating efficiency.
Operating Cash Flow to Assets
• This ratio indicates how efficient is the company to use total
assets to generate operating cash flows.
• Cash flows to assets are closely related to the profitability
measures of return on assts. The higher this ratio, the
better the firm's cash generating efficiency.
Operating Cash Flow/Current Maturities of
Long-Term Debt and Current Notes Payable
Operating Cash Flow
Current Maturities of Long-Term Debt
and Current Notes Payable
• Indicates a firm’s abilities to meet its current
maturities of debt
• Higher ratio indicates better liquidity
Operating Cash Flow to Total Debt
Operating Cash Flow
Total Debt
• Indicates a firm’s ability to cover total debt with the
yearly operating cash flow
• Conservative approach is to include all possible
balance sheet debt
Operating Cash Flow per Share
Operating Cash Flow - Preferred Dividends
Diluted Weighted Average
Common Shares Outstanding
• A better indication of a firm’s ability to make capital
expenditure decisions and pay dividends than earnings
per share
• Does not reflect firm’s profitability
Operating Cash Flow to Cash Dividends
Operating Cash Flow
Cash Dividends
• Indicates a firm’s ability to cover cash dividends with the
yearly operating cash flow
• The higher this ratio, the better the firm's ability to cover
cash dividends.
• For example if operating cash flow to cash dividends = 10.
Means, the company can pay dividends for 10 times.
Non-cash transactions
Some investing and financing activities do not require
direct outlays of cash.
Example 1:
Acquiring a building by assuming a mortgage.
o Under current disclosure rules, this transaction does
not appear as cash from financing or investing
activities.
o Must be disclosed in a footnote as “significant non-
cash financing and investing activities”
Non-cash transactions
o For analytical purposes, this transaction is identical
to the issuance of a bond to a third party using the
proceeds to acquire the building.
o This non-cash transaction reflects both a financing
and investing activity and should ideally be included
in each category.
Non-cash transactions
Example 2:
The conversion of convertible bonds into ordinary
shares.
o This effectively reduces the burden of interest and
principal payments and raises finance to the business.
o This non-cash transaction reflects an outflow financing
“payment of the bonds loan” and an inflow financing
“issuance of ordinary shares”
o The analyst must give attention to those non-cash
transactions, as they have some implications on future
cash flows of the business.
