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Copyright © 2004 by John S. Tjia. Click here for terms of use.
Chapter 11

The cash flow statement™s flows fall into three categories:
Cash flow from operations

Cash flow from investments

Cash flow from financing

Each category shows the sources and uses of cash, so that at
the end we have a total of the cash remaining from the year™s
earnings. This CF total should match, or ˜˜foot,™™ with the change
(which can be an increase or decrease) of cash on the balance sheet.
The BS cash total is not the same as the CF cash, because BS cash
includes the accumulated cash from previous year™s earnings.

A source of cash is:
Any decrease in the assets components

Any increase in the liabilities and shareholders™ equity

An accounting ˜˜credit™™ in the T-account (see p. 116)

Conversely, a use of cash is:
Any increase in the assets components

Any decrease in the liabilities and shareholders™ equity

An accounting ˜˜debit™™ in the T-account (see p. 116)

From this listing of sources and uses, we can also make a
connection to the discussion of debits and credits in Chapter 5.
A source of cash is an accounting credit, and a use of cash is an
accounting debit. So, finally, the system of debits and credits,
which has been confusing and hard to remember, makes sense.
Selling an asset (a credit) adds that much cash into a business (a
source of cash). By the same token, buying inventory (a debit) or
having capital expenditures (another debit) uses cash (a use of
cash). We will use these rules as we build our cash flow statement.

The CF Sheet 201

Cash Flow from Operations
This includes:
Any flows from the income statement

Any changes in balance sheet accounts that are related to

operations. Usually, these are all or most of the current
assets, excluding cash and cash equivalents, and all or most
of current liabilities, excluding any debt items such as
short-term notes or current portion of long-term debt.
These will appear in the ˜˜Cash from financing™™ section.

Cash Flow from Investments
This includes:
Capital expenditures

Any changes in the balance sheet accounts that are related

to investments

Cash Flow from Financing
This includes:
Any changes in the balance sheet accounts that are related

to debt or equity financing

Usually, it is easy to identify flows that are related to opera-
tions or to financing. If you are not sure if it is an investment-
related flow, simply ask yourself if it is an operating or financing
flow. If the answer is no, then it must be a flow from investments.

Positive for Source, Negative for Use
The titles to these sections say ˜˜Cash from . . . ™™ so, in the cash
flow statement, it is a good idea to follow the system that a source
of cash is shown as a positive number, but a use of cash is shown as
a negative number.

Chapter 11

Even in the simple model that we are building, there are a few
places where we can run into trouble if a ˜˜flow™™ number (such
as depreciation or capex) does not match with the change in the
corresponding balance sheet account. You may wonder how this
could be so, since the numbers should foot with each other.
Certain balance sheet accounts can be defined either by (1)
hard-coded inputs or (2) automatic running additions of the
prior year™s numbers plus the flows from the current year™s
income statement. In some cases, where there has been an error
in the input, or where the source data (e.g., another model you
are trying to replicate) have a mismatch error, the model will
have such discrepancies. We can avoid the resulting incorrect
flows in the cash flow statement through the use of reconciliation
Let™s use the net PPE (Plant Property and Equipment)
account, as an example. In fact, this account has two flows
going into it. From one year to the next, it increases by the
amount of capex and decreases by the amount of deprecation.
In the cash flow statement, the capex and depreciation numbers
will be shown, and they should account fully for the change in
the net PPE in the balance sheet. And if they do not, we have
to make sure that the discrepancy is included in the cash flow
statement. If we ignore it, the cash flow will not foot.
A reconciliation table for net PPE would look like the
following exhibit. I™ve used some quick ˜˜dummy™™ numbers to
illustrate. The beginning net PPE on the balance sheet, equivalent
to the prior year™s net PPE, is 100, and the ending number is
125. However, the flows suggest the ending number should
be different.

Beginning net PPE on balance sheet 100
þ Capex 50
À Depreciation 30
¼ Expected Ending net PPE 120
Ending net PPE on balance sheet 125
Other (increase) decrease (5)

The CF Sheet 203

Here, the table keeps track of the flows and comes up with
what it ˜˜expects™™ to be the final number. But the balance sheet
number is different, so the final Other (increase) decrease line
shows a number. The discrepancy is shown as a negative
number, and here you have to recall what a source is and what a
use is. In this case, because the ending net PPE on the balance sheet
is more than what is expected, there has been an unexplained
increase in this asset, which is therefore a use of cash. And in
the cash flow statement, a use is shown as a negative number.
It is important to do these reconciliation tables for all the
accounts in the balance sheet that are affected by ˜˜flow™™ numbers
and include them in the cash flow statement itself. You do not
need these reconciliation tables for accounts that exist only on the
balance sheet. In the model we are building, there are three such
accounts, shown with their flow numbers as follows.
Balance Sheet Account Flow Numbers

Net PPE Depreciation and capex
Intangibles Amortization of intangibles
Retained earnings Net to retained earnings

The reconciliation tables are built just under the cash flow
statement itself, and their lines are read into the lines of the
The following exhibit is what the CF will look like. The first
full column of numbers is shown as formulas. This column reads
the second year™s column in the IS and BS. There is no first year
in the CF because this sheet has to look at the changes in the
balance sheet accounts from year to year, and the first year has
no ˜˜prior™™ year.
The exception is the line for cash, which must begin with
a starting number, in this case, the amount of cash and cash
equivalents (surplus funds, which should be 0 of course, since
this is a historical year, and marketable securities) at the begin-
ning of the second year. This point in time is the same as the
end of the first year.
The reconciliation tables are shown separately, but with
the row numbers still in sequence with this first part of the
cash flow statement.

Chapter 11

To fully flesh out the cash flow statement, once you have
written in these formulas, copy the column C across to all the
columns up to column G.

1 First Corporation
3 Proj
4 CASH FLOW =IS!B4 =B4+1
6 Net income =IS!C28
8 Add back:
9 Depreciation =IS!C16
10 Amort of intangilbles =IS!C17
11 Operating cash flow =C6+SUM(C9:C10)
13 (Inc) in Accts receivable =BS!B8-BS!C8
14 (Inc) in Inventory =BS!B9-BS!C9
15 (Inc) in Other current assets =BS!B10-BS!C10
16 Inc in Accts Payable =BS!C20-BS!B20
17 Inc in Other current liabs =BS!C21-BS!B21
18 (Inc) in Oper working capital =SUM(C13:C17)
19 Cash from operations =C11+C18
21 Capex =-Input!C106
22 Other (inc) dec in net PPE =C54
23 Other (inc) dec in intangibles =C61
24 (Inc) dec in long-term assets =BS!B15-BS!C15
25 Cash from investments =SUM(C21:C24)
27 Inc (dec) in ST notes =BS!C19-BS!B19
28 Inc (dec) in nec to finance =BS!C24-BS!B24
29 Inc (dec) in debt 1 =BS!C25-BS!B25
30 Inc (dec) in debt 2 =BS!C26-BS!B26
31 Inc (dec) in debt 3 =BS!C27-BS!B27


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