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FIN3702 REVISION NOTES
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FIN3702REVISION NOTES
,FIN3702 revision notes
Analyzing a firms cash flow
Module objectives:
- Explain tax depreciation procedures and effect on business’ cash flow
- Explain why cash flow statement is different to the income statement
- Prepare a cash flow statement
- Prepare and operating cash flows and free cash flows
Introduction to analyzing a firm’s cash flow
1. Why is cash flow the lifeblood of a firm?
o Managing day-to-day operations
o Making strategic financial decisions and increasing shareholder value
o Operating cash flow line is monitored closely by managerial decision
making
o Free cash flow is monitored by capital markets as “cash pays the bills”
2. What are the key items affecting a firm’s cash flow?
o Depreciation
o Other non-cash items
Depreciation
Depreciation is to charge a portion of costs of fixed assets systematically against annual
revenues. It allocates the historical cost over time.
Accounting: Depreciation of historical cost over time
Depreciable life of an asset is the time period which as asset is depreciated and can
significantly affect the pattern of cash flows. How?
Tax purposes: the charge is regulated by SARS and may differ from the accounting
charge (wear and tear allowance - WTA)
The WTA applies to both new and used assets
Method of calculation:
1. Determine depreciable value of an asset = The amount to be depreciated
1.1 Initial cost of the asset R400 000
1.2 Outlays for installation R20 000
1.3 Minus: Expected salvage value (R5 000)
Depreciable value of the asset R415 000
2. Determine the recovery period and depreciate using the straight-line method
2.1 Recovery period is the appropriate depreciable life of a particular asset as
determined by WTA – SARS rules
2.2 Five broad recovery period categories – 3, 4, 5, 10 and 20 years (excluding
real estate) –
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FIN3702
, Figure 1 - Source Principles of Managerial FInance Lawrnece J. Gitman
Example:
ABC company acquired a new air conditioner system for an installed cost of R25 000 6
months into its financial reporting period. Management believes that the machine’s
expected useful life is only 4 years. Calculate the depreciation and WTA for the machine
for each year.
Year Cost (R) Depreciation Depreciation WTA rate – WTA
rate (R) from tables
1 25 000 12.5% 3 125 10% 2 500
2 25 000 25% 6 250 20% 5 000
3 25 000 25% 6 250 20% 5 000
4 25 000 25% 6 250 20% 5 000
5 25 000 12.5% 3 125 20% 5 000
6 25 000 0% 10% 2 500
Total 100% 25 000 100% 25 000
Developing the statement of cash flows
Sources of inflows:
- Decrease in asset – generally????
- Increase in liability
- Net profits
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FIN3702
, - Depreciation and other non-cash accounting charges
- Sale of shares
Sources of outflows:
- Increase in asset
- Decrease in liability
- Net loss
- Dividends paid
- Repurchase of shares
Format of cash flow statement
ABC Company
Statement of Cash Flows for the year ended Dec 2013
1. Cash flow from operating activities 850
Net profit before tax 1000
Elimination of items included in PBT which do not represent cash flow
Plus: Depreciation 100
(Increase)/decrease in trade receivables (100)
(Increase)/decrease in inventories (300)
Increase/(decrease) in trade and other payables 150
2. Cash flow from Investing activities (400)
-Additions in GROSS non-current assets (1000)
-Replacement of equipment 0
+Proceeds on sale of equipment 500
Investment in equity investments/sale of equity investments 100
3. Cash flow from financing activities 400
Increase/(decrease) in short-term debt -100
Increase/(decrease) in long-term debt 0
Changes in shareholder’s equity 300
-Dividends paid 200
Net increase in cash and marketable securities 850
Notes:
1. Operating cash flow
- Cash flow from normal opertions
- Remove interest and tax from operating cash flow to determine the “true” cash
flow from operations without the effect of interest and tax
- To obtain net profit after tax (NOPAT) = EBIT x (1-T)
- To convert NOPAT to OCF = NOPAT +depreciation
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FIN3702
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