3.4. SCF – a more advanced Example 2 (2)

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Core Concepts of Accounting – Numbers and People

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Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

7 ratings

Course 3 of 5 in the Specialization Understanding Modern Finance

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

From the lesson

The Statement of Cash Flows. Analysis and Use of Financial Statements. Financial Accounting and Project Valuation

In Week 3 of the Course we discuss the idea and format of the Statement of Cash Flows and use examples to delve deeper in its role and importance. Special attention is paid to the use of financial accounting inputs – cash flows, net income, and investments – in valuation. Then we briefly discuss the analysis and use of financial statements as a powerful tool in the overall assessment of performance, financial stability, and future development of a company or investment project. Finally, wrapping up the first part of the Course, we draw conclusions about the role of financial accounting in financial valuation in the world of uncertainty.

3.1. The statement of cash flows (SCF) – idea and format10:51

3.2. SCF – Example 114:05

3.3. SCF – a more advanced Example 2 (1)12:25

3.4. SCF – a more advanced Example 2 (2)8:24

3.5. Valuation revisited – cash flows, net income, and FCF7:04

3.6. Comparison of interest treatment in SCF and FCF9:49

3.7. The big question – why use earnings?10:25

3.8. Analysis and use of financial statements – an overview12:39

3.9. Ratio analysis (1) – current position and performance6:05

3.10. Ratio analysis (2) – capital structure5:56

3.11. Ratio analysis (3) – operating performance11:11

3.12. Financial accounting and valuation – conclusions8:55

Meet the Instructors

Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

Now, based on all these numbers from the previous spread along episode,

we're all set to start preparing the statement of cash flows.

As always, we start with the operations part.

Now, operations.

We use the indirect method.

So we start with net income.

Well, it's $39,000.

I will use zeros here. You will see why.

And that comes from our note three.

Now, go adjustments.

And I will first study the adjustments from all these notes and

then simple adjustments that come just from the changes

on the balances and compare the balance sheets.

We'll put at the very end.

So, first of all,

this is a loss on sale of long term investments, of securities.

That was number one,

and because it's a loss, it goes here.

The next thing is a loss on sale of property, plant, and equipment.

Remember that was the one that have the cost of 58,

was depreciated 80 percent,

and then the remaining cost was 10 and we sold that at eight.

So here, the loss is 2,000.

The next thing is depreciation,

and depreciation, also from number two,

and that was 24,000,

also goes on the side.

Now, patent amortization.

This is from number six.

Again, goes here, 3,000.

Bond premium amortization. This time,

that goes to the other side,

and this is 1,500.

That's number five.

And now, we add some adjustments from the balance sheet,

so decrease in the accounts receivable,

that is seven, goes here.

Increase in inventories, 27,000, goes here.

Here, I don't put notes because these are without notes.

Then increase in accounts payable.

This is on the left side, 5,000.

And then increase in salaries payable,

this is 4,000, also on this side.

So, these are taken from the balance sheet.

And the result is that if we sum everything up,

then cash flow from operations will

be equal to $64,500.

That's the first part.

Now, let's proceed.

Now, we have to cope with cash flow from investments and cash flow raised in financing.

Again, these are shorter and easier.

So cash flow investments,

what goes in here?

First of all, this is a sale of long-term investments.

Now, this is cash and this is number one,

and this is $39,000.

Again, you don't have to mix this up.

This is not nothing. This is the sale of securities.

Remember, the cost was 48 and we sold them at 39.

Loss on that we took into account earlier and here we just put this.

Now, sale of property, plant, and equipment.

This is sale and that was number two,

and this was 8,000.

Now, purchase of land.

This goes on the other side.

This is 41,000.

That was for stock and this was number four.

Now, purchase of patent,

and that was 10,000 from number six.

And then finally, cash purchases of PPE.

That's what we did this long calculation and that was 160 and that was number seven.

And the overall now,

we have that cash flow used in

investments is equal to a big negative 164,

because this is negative part,

this is the positive part.

So far, so good.

We are short of just cash flow raised in financing. Let's do it.

It's even shorter, cash flow financing.

Here come, first of all, cash dividends.

We pay this out,

so it's 6,000, number three.

Now, stock issued, that was a stock issued to purchase land,

and this is number four and that comes here, $41,000.

So, we did not get that in cash but we purchased land for that.

But we take into account both in investments and,

here, as cash equivalent.

And then, bond issued,

and that's number five,

and that's 81,500 here, also cash.

And so overall, we can see that cash

raised in financing is positive,

and this is 116,500.

Now, we put everything together and we can say that,

"What is the net change of cash flow?

Well, we can see that cash flow from operations gives us positive 64,500.

Cash flow from investment gives us a negative 164.

And then cash flow from financing is a positive 116, 500.

And you don't have to be a whiz to realize that

the overall net change in cash flow will be exactly $17,000,

as we saw on the balance sheet.

So, that ends up our calculations.

And in what follows,

we'll discuss why we spend

so much time and we use this indirect method although this number,

we could have seen the right away on the comparative balance sheets.

That was just a special case and unfortunately,

that is not always like that.

But that was a significant use or intellectual capacity,

and you'll be able to test that on your assignments to this week.

For now, we're all set.

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