FSA MODULE 30-31

Question 1

30.1 What are the three cash flows?

Answer 1

CFI, CFF, CFO

investing, finances, operations

Question 2

30.1 Why are cashflow statements so useful to the analyst?

Answer 2

Question 3

30.1 What is the total of CFO, CFI, CFF?

Answer 3

change in balance sheet cash (last year vs this year)

Question 4

30.1 Why does the income statement not really tell us about cash flow?

Answer 4

We cannot know the sources and uses of cash to meet liabilities and operating needs because of ACCRUAL ACCOUNTING

income is recorded on a matching principle

Question 5

30.1 What is CFO?

Answer 5

Probably most important

Can be referred to as operating cash flows

cash that we generate from our day to day core business activities

KEY - removes non has charges (like depreciation and amortisation), which are characteristics of the income statement but are now actually backed by cash flow

(this example is under US GAAP)

Question 6

30.1 What is the formula for CFO?

Answer 6

CFO = NI + NCC - WC(inv)

Net income + non cash charges - (any increase in working capital investment)

Question 7

30.1 How do we treat accounts payable when calculating CFO?

Answer 7

Net income already deducted the expense for goods/services received.
But if the company hasn’t paid cash yet, the net income overstates the actual cash used.
Therefore:
Increase in AP → add to CFO (cash not yet paid)
Decrease in AP → subtract from CFO (cash paid off liabilities)

Question 8

30.1 How do we treat accounts receivable when calculating CFO?

Answer 8

Increase in AR → subtract from net income
Reason: net income includes revenue you haven’t actually received in cash, so you subtract the increase to reflect actual cash flow.

Decrease in AR → add to net income
Reason: you collected cash from prior credit sales, which increases cash flow even though it doesn’t appear in current net income.

Question 9

30.1 What do we do with an increase/decrease in inventory when calculating CFO?

Answer 9

Inventory is a current asset.

Net income already includes cost of goods sold, which assumes inventory was used.

Question 10

30.1 How do we treat increases/decreases in wages payable when calculating for CFO?

Answer 10

Question 11

30.1 Do we include the purchasing of new equipment in CFO calculations?

Answer 11

NO - it is a investing activity

Question 12

30.1 How should we treat increases/decreases in income tax payable when calculating CFO?

Answer 12

Think of them as a liability - therefore, increase in liability = add, decrease in liability = subtract

Question 13

30.1 Why do we add back the losses from sold equipment when calculating CFO?

Answer 13

Net income is calculated on an accrual basis and includes gains or losses from non-operating items like selling equipment.
The cash from selling equipment is actually an investing activity (CFI), not an operating activity (CFO).
To calculate CFO, we need to remove the effect of these non-cash items from net income.

Question 14

30.1 What is CFI? What is included/excluded?

Answer 14

EXAMPLES:

Cash flow investing in new infrastructure, cash raised to dispose of old infrastructure

Property plant and equipment (and proceeds fro the sales), intangibles, include long term investments in other companies

Question 15

30.1 What is CFF?

Answer 15

Looking at our capital structure

cash that we raise when we issue new debt and equity, cash we spend when we repurchase shares, treasury stock, or when we pay off principal or debt

Question 16

30.1 How are dividends received and paid treated under IFRS and GAAP?

Answer 16

dividends received under US GAAP are recorded in CFO, dividends paid are recorded in CFF

More flexibility under IFRS

Question 17

30.1 Where do the attached sections get recorded under US GAAP and IFRS?

Answer 17

Question 18

30.1 What are noncash charges and gains? Name them:

Answer 18

Things in the income statement which are not backed by cash!

DTA = deferred tax assets
DTL = deferred tax liabilities

KEY ONES:
- dep/Amort
- gains and losses on asset disposals
- changes in DTA and DTL

Question 19

30.1 How dot he direct and indirect methods of calculating CFO differ?

How do GAAP and IFRS treat them?

Answer 19

indirect - strip out anything that is not directly related to cash flow

Question 20

30.1 Step by Step of the direct method of calculating CFO:

What are the four rules? (or two)

Answer 20

5. adjust the income statement amount by the change in the balance sheet. for the adding/subtracting rules to work, items that increase net income must be treated as positive values, and items that decrease net income must be treated as negative items
6. move to the next item on the income statement and repeat
7. ignore depreciation/amortization and gains/losses on the disposal of assets as these are non cash charges or non-CFO items
8. keep moving down the income statement until all items included in net income have been addressed, applying steps 1-8
9. total up the amounts, and you have CFO

Question 21

30.1 Describe the step by step indirect method for calculating CFO:

Answer 21

If we start with net income, we have already included all of the NWC adjustments - and have also included all the non-cash charges as well

Question 22

30.1 Why do we add back non cash charges in the indirect method and ignore them in the direct method?

Answer 22

Because we are starting with net income this time, we have to add back things like depreciation in order to eliminate them

Question 23

30.1 What is an alternative indirect method for calculating CFO?

Answer 23

Using the equation more rigorously

Question 24

30.1 What is the equation for calculating CFI?

Answer 24

CFI = process from disposals - cash paid for additions

We’re looking at:
- investments
- PP&E (most likely to stick to this)
- intangibles
- investments (subsidiaries, JVs, associates, and held to maturity and available for sale securities

cats paid for additions = “additions to PP&E totaled 45000”

Question 25

30.1 What is CFF comprised of?

Answer 25

Question 26

30.1 What is cash flow from financing here?

Answer 26

Question 27

30.1 What kind of transaction is the retirement of debt through issuance of common stock?

Answer 27

NON CASH

Question 28

30.1 How do we calculate cash dividends paid?

Answer 28

FROM THE INCOME STATEMENT LHS: checking how much the proposed dividend will be. RHS: seeing if the dividend has been paid. Go into balance sheet (do last year dividend payable liability vs last year) - remember increase in liability = add

Question 29

30.1 How do we work out equity issued (repurchased)

Answer 29

take the common stock and the additional paid in capital (i.e contributed capital) So look at the change in contributed capital. Reduction of which we will assume is due to treasury stock buyback. Subtract this as well.

Question 30

30.1 how do we calculate debt principal raised (paid)?

Answer 30

No amortisation of premiums and discounts to worry about (CFA took this out as took difficult). Assume issued at par value and so we can look at the change in balance sheet debt and assume that is the net principal flow for the year.

Question 31

30.1 How do we combine CFO, CFI, and off in a cash flow statement?

Answer 31

Question 32

30.1 What are some main questions we may ask about analysing cash flow statement?

Answer 32

Question 33

30.1 How do we analyse CFO?

Answer 33

Question 34

30.1 what is the problem if CFO is lower than NI?

Answer 34

We would turn our attention to earnings in the income statement being of low quality because they are not backed by cash

Question 35

30.1 How do we analyse CFI?

Answer 35

Question 36

30.1 How do we analyse CFF?

Answer 36

Question 37

30.2 What are two approaches to common size statements? And what is each approach useful for?

Answer 37

Question 38

30.1 What is free cash flow?

Answer 38

Cash available for discretionary uses It is frequently used to value firms (reflects control)

Question 39

30.2 is Capex discretionary?

Answer 39

some analysts say only cash flow that is used to replace depreciating assets is non discretionary CFA = all Capex is deemed to be non-discretionary within the syllabus

Question 40

30.2 How do we calculate FCFF?

Answer 40

Free cash flow to the firm Interest net of tax, Fixed costs of investments (also known as pre-levered because it is pre any distributions to debt and equity holders)

Question 41

30.2 How do we calculate FCFE?

Answer 41

free cash flow to equity - known as post-levered - after all the equity and debt holders have been paid out

Question 42

30.2 What is the difference between CFO and FCFF, and how does it differ in terms of calculations?

Answer 42

OCF = “How much cash is generated by running the business?” FCFF = “How much cash could I give to debt and equity holders after reinvesting in the business?”

Question 43

30.2 Show some cash flow ratios:

Answer 43

Question 44

30.2 How dow e calculate cash flow to revenue?

Answer 44

cash version of - NI/Sales

Question 45

30.2 How do we calculate cash return on assets?

Answer 45

cash version of - NI/AVG total assets

Question 46

30.2 How do we calculate cash return on equity?

Answer 46

cash based version of ROE

Question 47

30.2 How do we calculate cash to income?

Answer 47

CFO / EBIT Dont want this ratio to be greater than 1. Otherwise

Question 48

30.2 How do we calculate cash flow per share?

Answer 48

Just replacing NI with CFO - net earnings

Question 49

30.2 Show some coverage ratios

Answer 49

Question 50

30.2 What is the formula for debt coverage?

Answer 50

Question 51

30.2 What is the formula for interest coverage?

Answer 51

Question 52

30.2 What is the formula for reinvestment?

Answer 52

apex denominator

Question 53

30.2 What is the formula for debt payment?

Answer 53

denim = principal

Question 54

30.2 What is the formula for dividend payment

Answer 54

Question 55

30.2 What is the formula for investing and financing?

Answer 55

Question 56

30.1 Under US.GAAP, dividends received form investments are classified as:

Answer 56

Operating cash flow

Question 57

30.1 Under IFRS, interest expense may be classified as:

Answer 57

either operating cash flow or financing cash flow.

Question 58

30.2 In preparing a common-size cash flow statement, each cash flow is expressed as a percentage of:

Answer 58

total revenue

Question 59

30.2 To calculate free cash flow to the firm based on operating cash flow, an analyst should add interest expense net of tax and subtract:

Answer 59

Fixed capital investment

Question 60

30.2 The reinvestment ratio measures a firm's ability to use its operating cash flow to:

Answer 60

Acquire long-lived assets

Question 61

Answer 61

Both are correct

Question 62

30.2 What are the two FCFF calcs?

Answer 62

One starting from NI, one starting from CFO (could be called 'net cash provided by operating activities' FCFF = NI + non cash charges + (cash interest paid x (1-t)) - fixed capital investment - WC investment OR FCFF = CFO + (cash interest paid x tax rate) - fixed capital investment

Question 63

30.2 what is the reinvestment ratio?

Answer 63

The reinvestment ratio measures a firm's ability to acquire long-term assets with cash flows from operations. In contrast, the investing and financing ratio, which is more comprehensive, measures the firm's ability to purchase assets, satisfy debts, and pay dividends.

Question 64

30.2 What is the cash-income ratio?

Answer 64

The cash-to-income ratio measures the ability to generate cash from a firm's operations and is a performance ratio for cash flow analysis purposes. The debt payment ratio measures the firm's ability to satisfy long-term debt with cash flow from operations but it is more of a coverage ratio than a performance ratio.