Chapter 12: Decision Analysis: Cash Flow Analysis

To analyze the statement of cash flows effectively, we look at cash flow sources and uses across operating, investing, and financing activities and apply the cash flow on total assets ratio to measure the efficiency of a company's cash generation relative to its asset base. Analyzing Cash Sources and Uses Managers, creditors, and investors assess cash flows for insights into a company's operational strength and growth potential. Using Exhibit 12.15's example, three companies—BMX, ATV, and Trex—all have a $15,000 net increase in cash, but their cash sources differ significantly: 1. BMX: o Generates $90,000 from operating activities, using this to invest $48,000 in plant assets and repay $27,000 of debt. o Cash flow indicates BMX has strong internal cash generation, allowing it to invest in its future and reduce liabilities, signaling potential for sustained financial health. 2. ATV: o Generates $40,000 from operating activities, investing $25,000 in plant assets. o Cash flow shows moderate operational cash flow, with limited reinvestment in assets, suggesting a more restrained growth outlook compared to BMX. 3. Trex: o Experiences a $24,000 cash outflow from operations, offset by cash inflows from selling assets and incurring debt. o The cash flow profile suggests Trex relies on asset sales and borrowing to fund its activities, raising concerns about its cash sustainability and long-term growth. This comparison highlights the importance of examining the source of cash flows and understanding the impact of operating, investing, and financing activities on a company’s cash position. Cash Flow on Total Assets Ratio The cash flow on total assets ratio is a key measure that uses cash flow data to evaluate a company’s ability to generate cash from its assets. This ratio helps assess financial health, estimating a company's ability to manage its obligations and grow: Cash Flow on Total Assets=Net Cash Provided by Operating ActivitiesAverage To tal Assets Calculation of Average Total Assets: This is the sum of beginning and ending total assets for the period, divided by two. This ratio emphasizes actual cash flows, making it unaffected by non-cash accounting adjustments. Example Analysis with Cash Flow on Total Assets Ratio In Exhibit 12.17, the cash flow on total assets ratio for Nike and Under Armour illustrates the following: • • • Nike consistently has a higher cash flow on total assets ratio than Under Armour, indicating better efficiency in generating cash flows from its asset base. Nike’s upward trend in this ratio over two years shows improved cash flow generation, suggesting stronger financial performance and operational effectiveness. In contrast, Under Armour shows lower and inconsistent ratios, which can make cash flow timing and predictability challenging. Applying Cash Flow Analysis to Prepare a Statement of Cash Flows (Indirect and Direct Methods) To prepare a statement of cash flows, we use two methods: 1. Indirect Method: o Starts with net income and adjusts for non-cash items, such as depreciation, and changes in working capital accounts (e.g., accounts receivable, inventory, accounts payable). o Reflects cash provided by or used in operating, investing, and financing activities, culminating in the net change in cash. 2. Direct Method: o Lists cash receipts and payments directly from operating activities, organizing cash flows based on cash inflows (e.g., cash sales, collections from customers) and cash outflows (e.g., payments to suppliers and employees). o Also includes cash flows from investing and financing activities. These two approaches provide different perspectives on cash flow, with the direct method offering more transparency into the sources and uses of cash in operations. However, both methods will ultimately reconcile to the same net cash change for the period.