1-Statement

1)- Statement of Cash Flows

The Statement of Cash Flows explains how changes in liquidity have occurred during the past year. The measure of liquidity is either cash or working capital, and is the bottom line of the statement showing the net change in that item. The statement of cash flows has three parts:
a)- cash flows from operations: net profit after tax net of dividends and other payments to owners, plus non-cash expenses such as depreciation;
b)- cash flows from investment activities: amount of cash generated from sale of fixed assets, less the cash used to buy new fixed assets; it is generally a negative amount for any firm that is expanding as it should;
c)- cash flows from financing activities: amount of cash raised from new sources of funds, less the repayment of any prior liabilities; it is normally a positive amount as a firm expands.

There are two methods of presentation of the statement of cash flows; they affect cash flows from operating activities only (i.e. cash flows from investing and financing activities remain the same). The direct method presents cash flows from operating activities by listing all cash inflow received (e.g. from sales) and all cash outflows paid out (e.g. for salaries, purchases, taxes). The indirect method starts with operating income as shown in the income statement, then a reconciliation adds back non-cash expenses and revenues and subtracts cash used to increase working capital components (or adds back in case of working capital decrease). In the direct method the reconciliation is presented below the statement of cash flow itself. An example of statement of cash flows in shown in table T-8.10.

Table T-8.10
Statement of Consolidated Cash Flows
Texaco Inc. and Subsidiary Companies
Million of dollars
.	1989	.	1990	.
Operating Activities
Reconciliation to net cash used in operating activities
Net income	2,413	.	1,450	.
Reconciliation to net cash used in operating activities	.	.	.	.
Depreciation	1,662	.	1,658	.
Deferred income taxes	72	.	-262	.
Exploratory expenses	361	.	499	.
Minority interest in net income	2	.	12	.
Dividends from affiliates	-207	.	-257	.
(Gains) losses on asset sales	-2,280	.	9	.
Special environmental reserves	446	.	129	.
Restructuring and associated charges	378	.	.	.
Changes in operating working capital	.	.	.	.
Accounts and notes receivable	-1,050	.	-957	.
Inventories	407	.	-25	.
Accounts payable and accrued liabilities	369	.	236	.
Other	-1,110	.	-234	.
Other reconciling items	410	.	-124	.
Net cash provided by operating activities	.	1,873	.	2,134
Investing Activities	.	.	.	.
Capital and exploratory expenditures	-1,952	.	-2,731	.
Proceeds from sales of assets	4,789	.	145	.
Purchases of investment instruments	-1,626	.	-867	.
Sales of investment instruments	1,496	.	877	.
Other investing activities	163	.	-22	.
Net cash used in investing activities	.	2,870	.	-2,598
Financing Activities	.	.	.	.
Borrowings having original terms in excess of three month	.	.	.	.
Proceeds	606	.	896	.
Repayments	-2,485	.	-1,110	.
Net increase (decrease ) in other borrowings	1,160	.	160	.
Issuance of preferred stock	-	.	50	.
Dividends paid to common stockholders	.	.	.	.
Quarterly	-773	.	-793	.
Special	-1,862	.	.	.
Dividends paid to preferred stock	-64	.	-102	.
Purchases of common stock	-95	.	-405	.
Other financing activities	-25	.	-21	.
Net cash from financing activities	.	-3,538	.	-1,325
Effect of Exchange Rate Changes on Cash and Cash Equivalents	.	.	.	.
Effect of Exchange Rate Changes on Cash and Cash Equivalents	-62	.	-57	.
Increase (Decrease ) in Cash and Cash Equivalents	.	1,205	.	-1,789
Cash and Cash Equivalents at Beginning of Year	.	1390	.	2149
Cash and Cash Equivalents at End of Year	.	2,595	.	360

When such a Statement of Cash Flows is a projection of future activity, the analyst can see clearly how the increase in fixed assets and working capital necessary for expansion is going to be carried out by using some cash from operations and some from new funding sources. For instance, if a sales promotion is planned and additional production is necessary, but no increase in plant and equipment and no increase in inventory appear in a pro forma statement of cash flows, the analyst can conclude that management expectations are unrealistic. If the analyst is asked to approve a loan to support the sales promotion alone, that loan should be denied. More will be said about the Statement of Cash Flows in subsequent chapters.

See review questions Q-8J.1 through Q-8J.4.

See research assignment R-8J1.1.

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