MGCR 211 Chapter Notes - Chapter 5: Cash Conversion Cycle, Cash Flow, Accrual
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The Statement of Cash Flows
- operating activities
o users will examine the statment to see whether the operating
activities are generating a positive cash flow.
- financing activities
- investing activities
- cash to cash cycle
o illustrates the lead/lag relationship between the cash going out to buy
inventory and the cash coming in from the collections of accounts
- **since the statement of earnings in prepared on an accrual basis and
measures performance in terms of the revenues earned and the expenses
incurred during a particular time period, regardless of whether the revenues
are collected in cash or the expenses are paid in cash during that period, it is
not very useful in tracking cash flows.
- ** because a company cannot operate w/out cash, it makes sense that we
need a statement of cash flows.
- Cash flow problems in companies
o 3 fundamental causes
1. High growth rate in sales
combat? Slow down the rate in sales? But obviously not
the best answer b/c it reduces net earnings and may
hurt the company in the long run.
2. Significant lead/lag relationships in cash inflows and
combat? Reduce lead/lag relationship – reduce the
length of the company’s cash conversion cycle – get
customers to pay cash or to not pay in 30days, maybe
3. Inadequate financing or undercapitalization (in this context
refers to the cash the company begins with)
combat? Increase capitalization/start with more cash? -
- > get it through equity financing and to borrow the
- Cash sitting in a chequing account typically earns little to no interest – proper
cash management would be investing that cash into something else.
- Must consider cash and cash equivalents – cash position: short-term, highly
liquid investments that can readily be converted into known amounts of
cash. Must be close enough to maturity that there is little risk of changes in
their value, due to changes in interest rates or other economic factors.
Suggested time frame = 3 months or less. Also includes temporary
borrowings that companies use for short periods of time, such as bank
overdrafts, lines of credit, or demand loans.
Components of Cash Flows
- Financing activities
o The activities involved in obtaining resources from lenders and
sharholders, and making payments to those lenders and shareholders.
o Typical inflows: issuing bonds, mortgages, notes
o Typical outflows: repayment of the principal of debt obgliations, the
payment of interest on debt, the repurchase of shares, and the
payment of dividends to shareholders.
o *dividend payments
o Typically includes the cash flows that result directly from the sale of
goods and services to customers
o Major inflow: collections of inflow from customers
o Major outflow: payments to suppliers
o *treat interest payments as operating activities in Canada
o direct approach: complete record of the cash generated by a
company’s operating activities would show the amounts of cash
received from revenues and collections from customers as inflows,
and the amounts of cash pad for expenses and payments to suppliers
very informative but rarely used in practice
o usually use indirect approach in practice: starts with reported net
earnings and then shows adjustments to convert the net earnings to a
cash basis and arrive at the net cash flows from operations.
Adjustments in two group --- adjustments to eliminate items
that are included in the net earning but do not involve cash
flows, and the one that adjust or the changes in various current
assets and current liabilities, to convert the revenue and
expense amounts that are included in the net earnings from the
accrual basis to their cash values.
o (read in book pg 322)
o Involve balance sheet accounts that are classified as long-term assets
o Typical transactions: acquisitions and disposals of capital assets and
other long-term investments.
How to prepare a statement of cash flows – see the book starting page 324
- the amount of net earnings is always the starting point for determining the
cash flows from operating activities.
- Indirect method – start with the net earnings amount and then adjust it to its
net cash flow
- LOOK FOR:
o Depreciation expense
o Any gains or losses on disposals of assets
** get her to explain/example in class, very confusing – just read it nothing more.
Questions to Ask to understand what the statement of cash flows reveals about the
1. Is the cash from operating activities sufficient to sustain the company over
the long term?
2. Do any of the items on the statement of cash flows suggest that the business
may be having problems?
3. Of the sources and uses of cash, which ones are related to items or activities
that will continue from period to period, and which are sporadic or non-
Users will be interested in predicting the company’s future cash flows and will want
to assess whether the cash inflow from operations will be sufficient to cover the
company’s investing and financing activities over the long term.
- look at the flows over the past years
- assess whether the cash flow is enogh to cor their needs
** because a company cannot operate w/out cash, it makes sense that we need a statement of cash flows. Cash flow problems in companies: 3 fundamental causes. But obviously not the best answer b/c it reduces net earnings and may hurt the company in the long run. Significant lead/lag relationships in cash inflows and outflows. Reduce lead/lag relationship reduce the length of the company"s cash conversion cycle get customers to pay cash or to not pay in 30days, maybe. Inadequate financing or undercapitalization (in this context refers to the cash the company begins with) > get it through equity financing and to borrow the cash. Cash sitting in a chequing account typically earns little to no interest proper cash management would be investing that cash into something else. Must consider cash and cash equivalents cash position: short-term, highly liquid investments that can readily be converted into known amounts of cash.