Analyzing Statements of Cash Flows I: formula sheet

Key formulas

Net change in cash

CFO + CFI + CFF (+ effect of exchange rates on cash) = Net change in cash and cash equivalents

Beginning cash plus this net change equals ending cash on the balance sheet.

IFRS: interest paid

CFO or CFF (company's choice)

Must be applied consistently and disclosed.

IFRS: interest received

CFO or CFI (company's choice)

Financial institutions typically report these in CFO.

IFRS: dividends paid

CFO or CFF (company's choice)

Dividends paid to own shareholders.

IFRS: dividends received

CFO or CFI (company's choice)

Dividends from investments in other companies.

US GAAP: interest and dividends

Interest paid, interest received, dividends received = CFO; dividends paid = CFF

No choice under US GAAP.

Income taxes paid

CFO (unless specifically identified with an investing or financing transaction under IFRS)

US GAAP generally puts all taxes paid in CFO.

Non-cash transactions

Excluded from CFO, CFI and CFF; disclosed in notes

Examples: asset bought with debt or shares, debt-for-equity swap.

Cash received from customers

Revenue − increase in accounts receivable (or + decrease in accounts receivable)

If unearned revenue changes, add an increase and subtract a decrease.

Cash paid to suppliers

Cash paid to suppliers = Purchases − increase in accounts payable (or + decrease in accounts payable); Purchases = COGS + increase in inventory (or − decrease in inventory)

Do the inventory step first to get purchases, then the payables step.

Cash paid to employees

Cash paid to employees = Salary expense + decrease in salaries payable (or − increase in salaries payable)

The same logic applies to other operating expenses. For prepaid expenses, add an increase in prepaids and subtract a decrease.

Indirect CFO

CFO = Net income + non-cash charges − non-operating gains + non-operating losses − increase in operating assets + decrease in operating assets + increase in operating liabilities − decrease in operating liabilities

Non-cash charges include depreciation, amortisation and impairment. Gains and losses on asset sales are removed because the cash goes to CFI.

Direct and indirect equivalence

CFO (direct) = CFO (indirect)

If your two answers differ, find the error. They cannot differ.

Indirect CFO

CFO = Net income + Depreciation and amortization + Losses − Gains − Increase in operating assets + Decrease in operating assets + Increase in operating liabilities − Decrease in operating liabilities

Use only operating working capital accounts. Exclude cash and debt.

Dividends paid

Dividends paid = Opening retained earnings + Net income − Closing retained earnings

Assumes no other items hit retained earnings and dividends payable is unchanged.

Cash from asset sale

Proceeds = Carrying amount + Gain (or − Loss)

Carrying amount = historical cost − accumulated depreciation of the asset sold. Proceeds go in CFI.

Carrying amount of asset sold

Opening net PP&E + Capex − Depreciation − Closing net PP&E = Carrying amount of assets sold

Works for net PP&E with no revaluation or impairment.

Change in cash check

CFO + CFI + CFF (+ FX effect) = Change in cash

Your final check. It must tie to the balance sheet.

Cash collected from customers

Revenue − increase in accounts receivable + increase in unearned revenue

Reverse the signs for a decrease. Assumes no bad debt write-offs unless the question gives them.

Purchases

COGS + ending inventory − beginning inventory

Use this first, then adjust for accounts payable.

Cash paid to suppliers

Purchases − increase in accounts payable

Equivalent: COGS + increase in inventory − increase in accounts payable.

Cash paid for operating expenses

Operating expense + increase in prepaid − increase in accrued liabilities

Exclude depreciation and amortization because they are non-cash.

Cash taxes paid

Income tax expense − increase in taxes payable − increase in deferred tax liability + increase in deferred tax asset

If there are no deferred taxes, use only the change in taxes payable.

Book value of an asset sold

Cost − accumulated depreciation; sale proceeds = book value + gain (or − loss)

Proceeds go in CFI. Remove the gain or loss from CFO in the indirect method.

Capital expenditure from net PP&E

Ending net PP&E − beginning net PP&E + depreciation + book value of assets sold

Assumes no revaluation, impairment or non-cash acquisitions.

Dividends paid

Beginning retained earnings + net income − ending retained earnings

Assumes no other changes to retained earnings.

Net change in cash

CFO + CFI + CFF (+ effect of exchange rates on cash) = ending cash − beginning cash

Use this as the final reconciliation.

FCFF from CFO

FCFF = CFO + Int × (1 − t) − FCInv

Use when interest paid is inside CFO (always under US GAAP; a choice under IFRS). FCInv is fixed capital investment, net of asset sale proceeds if given.

FCFF from net income

FCFF = NI + NCC + Int × (1 − t) − FCInv − WCInv

NCC is non-cash charges such as depreciation. WCInv is the increase in net operating working capital. A decrease adds to FCFF.

FCFE from CFO

FCFE = CFO − FCInv + Net borrowing

Net borrowing = debt issued − debt repaid. No interest adjustment is needed when interest paid is in CFO. If IFRS interest paid is in financing, subtract it (after tax effect as given) from CFO first.

FCFE from FCFF

FCFE = FCFF − Int × (1 − t) + Net borrowing

Reverses the interest add-back and adds net borrowing.

Performance ratios

CFO ÷ revenue; CFO ÷ average total assets; CFO ÷ average equity; CFO ÷ operating income; (CFO − preferred dividends) ÷ weighted average ordinary shares

The ratios are cash flow to revenue, cash return on assets, cash return on equity, cash to income, and cash flow per share. Higher and stable is better.

Coverage ratios

Debt coverage = CFO ÷ total debt; Interest coverage = (CFO + interest paid + taxes paid) ÷ interest paid; Reinvestment = CFO ÷ cash paid for long-term assets; Debt payment = CFO ÷ cash paid for long-term debt repayment; Dividend payment = CFO ÷ dividends paid; Investing and financing = CFO ÷ cash outflows for investing and financing

Above 1 means CFO alone covers the item. Interest and taxes are added back because CFO is after both.

Common-size cash flow

Each line ÷ revenue, or each line ÷ total cash inflows (or outflows)

Use the same base for all periods. The revenue method is common for operating cash flows.

Quick revision

• CFO, CFI and CFF together explain the change in cash and cash equivalents.
• Under IFRS, interest paid and dividends paid can be CFO or CFF; interest and dividends received can be CFO or CFI. US GAAP puts interest and dividends received and interest paid in CFO, and dividends paid in CFF.
• Income taxes paid are generally in CFO.
• Direct method shows cash receipts and payments; indirect starts with net income. CFO is the same under both.
• Indirect method: add back non-cash charges such as depreciation, and remove gains on asset sales from CFO.
• Increase in accounts receivable or inventory lowers CFO; increase in accounts payable raises CFO.
• Proceeds from asset sales are CFI; the gain itself is removed from CFO.
• Non-cash investing and financing transactions are disclosed separately, not included in the three sections.
• FCFF: add back after-tax interest only if interest paid was deducted in CFO. If interest paid is in CFO (US GAAP, or an IFRS choice), FCFF = CFO + interest paid × (1 − t) − capex. Under IFRS, if interest paid is classified in CFF, CFO already excludes it, so do not add it back: FCFF = CFO − capex.
• Interest or dividends received that are classified in CFI under IFRS are excluded from CFO, so an FCFF built from CFO also excludes them. Add them separately only if the analyst wants them included.
• FCFE = CFO − capex + net borrowing. Here CFO is after interest paid, so no interest add-back is made. If interest paid is classified in CFF under IFRS, CFO excludes the interest outflow, so subtract the full interest paid: FCFE = CFO − interest paid − capex + net borrowing. Do not use interest paid × (1 − t). The tax saving on interest is already in the income taxes paid inside CFO, so deducting the full interest once gives the correct result. Using an after-tax amount would count the tax saving twice.
• Cash flow ratios compare CFO or FCF with sales, assets, equity, net income or debt to judge performance and coverage.
• Check your answer: the three sections must sum to the change in cash.

Common mistakes

• Putting interest paid in CFF under US GAAP. Fix: Under US GAAP, interest paid is CFO. Only IFRS lets you choose CFO or CFF.
• Including a non-cash transaction, such as buying equipment with a loan from the seller, in CFI and CFF. Fix: No cash changed hands, so it appears in neither total. It is disclosed in the notes.
• Adding an increase in receivables to net income. Fix: A bigger receivable means sales not yet collected. Subtract it. Memorise: operating asset up, cash down.
• Forgetting to remove a gain on sale of equipment in the indirect method. Fix: Subtract the gain from net income. The full sale proceeds appear in CFI.
• Adding an increase in receivables or inventory to CFO Fix: An increase in an operating asset means cash is tied up. Subtract it.
• Adding a gain on sale back in CFO Fix: A gain already inflated net income. Subtract it in CFO and show the full proceeds in CFI.
• Flipping the sign on a working capital change. Fix: Ask whether the change ties up cash. A rise in receivables or inventory uses cash. A rise in payables or accruals saves cash.
• Using COGS as cash paid to suppliers. Fix: Compute purchases first, then adjust for the change in accounts payable.
• Adding back pre-tax interest in FCFF. Fix: Always write Int × (1 − t). Interest expense reduced taxes, so only the after-tax amount was a cost in CFO.
• Subtracting net borrowing in FCFE, or using only debt issued. Fix: Net borrowing = issued − repaid, then add it. Borrowing gives shareholders access to more cash. Repayment reduces FCFE.

Exam tips

• Memorise the IFRS table of four items (interest paid, interest received, dividends paid, dividends received) and the single US GAAP rule. Most questions test this.
• If a stem mentions assets acquired by issuing shares or debt without cash, expect the answer to be that it is excluded from the statement.
• Read the standard named in the stem before reading the options. A choice that is valid under IFRS is often wrong under US GAAP.
• Use sign discipline: inflows are positive and outflows negative before adding totals.
• With no penalty for wrong answers, never leave a question blank. Eliminate non-cash and wrong-standard options first, then guess.
• Questions are standalone with three options, so test each distractor by flipping one sign. Wrong options are usually built from one sign error.
• Always ask whether an account is operating or not. Debt, equity and fixed assets rarely adjust CFO.
• Numerical options are listed smallest to largest, so check whether your answer sits at the edge of the range. Sign errors often push you to an extreme.