Cash Flows & Financial Planning: Statements, Analysis & Forecasting

Core Concepts: What is the Statement of Cash Flows?

The Statement of Cash Flows (SCF) is a financial statement that reports cash inflows and outflows over a period (usually a year). Unlike the income statement (which uses accrual accounting), the SCF focuses only on actual cash transactions.

Why is it important?

• Shows liquidity (can the company pay its bills?)
• Explains why cash changed from the start to the end of the period
• Helps investors and managers plan future cash needs

Key Definitions

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The Three Sections of the SCF

The SCF is divided into three main sections, each with specific rules for classification.

1. Operating Activities

Purpose: Measures cash generated from normal business operations. Key Items:

• Cash received from customers (sales)
• Cash paid to suppliers (inventory purchases)
• Cash paid for salaries, rent, utilities
• Cash paid for taxes
• Depreciation/Amortization (added back because it’s a non-cash expense)

How to Calculate?

• Indirect Method (Most Common): Start with net income and adjust for non-cash items (e.g., depreciation, bad debts). Formula:

  Operating Cash Flow = Net Income + Depreciation/Amortization – Increase in Working Capital
  

• Direct Method (Less Common): Lists actual cash receipts and payments (e.g., "Cash from customers = Rs. 50,000,000").

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2. Investing Activities

Purpose: Tracks cash used for long-term assets (investments in the business). Key Items:

• Purchase/Sale of Property, Plant & Equipment (PPE)
• Purchase/Sale of Investments (stocks, bonds, other companies)
• Loans made to other entities

Example: If Kathmandu Retailers Ltd. buys a new delivery truck for Rs. 2,000,000, this is recorded as:

Investing Cash Flow: – Rs. 2,000,000 (Cash Outflow)

Investing activity: Purchase of equipment by a Daraz warehouse (Image: Goterrestrial, CC BY 4.0, via Wikimedia Commons)

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3. Financing Activities

Purpose: Shows cash flows from debt and equity financing. Key Items:

• Borrowing money (loans, bonds)
• Repaying debt (loan principal)
• Issuing stock (selling shares)
• Paying dividends
• Buying back shares (treasury stock)

Example: If Nepal Bank Ltd. takes a Rs. 5,000,000 loan, it records:

Financing Cash Flow: + Rs. 5,000,000 (Cash Inflow)

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How to Prepare a Statement of Cash Flows (Step-by-Step)

The SCF is prepared using the indirect method (most common in exams). Here’s the process:

Step 1: Start with Net Income (from Income Statement)

Assume Kathmandu Electronics has:

• Net Income (2023): Rs. 10,000,000
• Depreciation Expense: Rs. 2,000,000
• Increase in Accounts Receivable: Rs. 1,500,000
• Increase in Inventory: Rs. 800,000
• Decrease in Accounts Payable: Rs. 500,000

Step 2: Adjust for Non-Cash Items (Add Back Depreciation)

Net Income = Rs. 10,000,000
+ Depreciation = + Rs. 2,000,000
= Rs. 12,000,000

Step 3: Adjust for Working Capital Changes

Working capital changes affect cash flow. Increases in assets (e.g., receivables, inventory) reduce cash, while increases in liabilities (e.g., payables) increase cash.

Calculation:

Rs. 12,000,000 (Step 2)
– Rs. 1,500,000 (Receivables)
– Rs. 800,000 (Inventory)
+ Rs. 500,000 (Payables)
= **Operating Cash Flow = Rs. 10,200,000**

Step 4: Investing Activities

Assume Kathmandu Electronics bought new machinery for Rs. 3,000,000 and sold old equipment for Rs. 1,000,000.

Investing Cash Flow:
– Rs. 3,000,000 (Purchase of Machinery)
+ Rs. 1,000,000 (Sale of Old Equipment)
= **Net Investing Cash Flow = – Rs. 2,000,000**

Step 5: Financing Activities

Assume the company:

• Took a loan of Rs. 4,000,000
• Paid dividends of Rs. 1,500,000

Financing Cash Flow:
+ Rs. 4,000,000 (Loan)
– Rs. 1,500,000 (Dividends)
= **Net Financing Cash Flow = + Rs. 2,500,000**

Step 6: Calculate Net Change in Cash

Operating Cash Flow = + Rs. 10,200,000
Investing Cash Flow = – Rs. 2,000,000
Financing Cash Flow = + Rs. 2,500,000
**Net Increase in Cash = + Rs. 10,700,000**

Final SCF Table for Kathmandu Electronics (2023)

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The Accounting Cycle & SCF Connection

The SCF is the last step in the accounting cycle. Here’s how it fits:

Key Insight:

• The Income Statement and Balance Sheet feed into the SCF.
• The SCF explains changes in cash between two balance sheets.

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Free Cash Flow (FCF): The Ultimate Liquidity Measure

Free Cash Flow (FCF) tells us how much cash a company can generate after paying for operations and capital expenditures.

Formula:

FCF = Operating Cash Flow – Capital Expenditures (CapEx)

Where:

• Operating Cash Flow = Cash from core business (from SCF)
• CapEx = Cash spent on long-term assets (e.g., new machinery, property)

Example: Ncell’s Free Cash Flow

Assume Ncell reports:

• Operating Cash Flow (2023): Rs. 20,000,000,000
• Capital Expenditures (New Towers, Equipment): Rs. 8,000,000,000

FCF = Rs. 20,000,000,000 – Rs. 8,000,000,000 = **Rs. 12,000,000,000**

What does this mean?

• Ncell has Rs. 12 billion left after operations and investments.
• This cash can be used for:
  • Dividends (shareholder returns)
  • Debt repayment
  • Acquisitions (e.g., buying a smaller telecom firm)

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Financial Planning: Using SCF for Future Decisions

The SCF helps businesses plan for future cash needs. Two key techniques:

1. Cash Budgeting

A cash budget predicts future cash inflows and outflows to avoid shortages.

Example: Kathmandu Café’s Monthly Cash Budget

Problem: In March, the café has a cash deficit (– Rs. 500,000). Solution:

• Delay rent payment
• Take a short-term loan
• Increase sales (e.g., promotions)

2. Pro Forma Financial Statements

Pro forma means "as a form of" or forecasted. Companies prepare pro forma SCFs to predict future cash flows.

Example: Daraz Nepal’s Pro Forma SCF (2024)

Why is this useful?

• Helps investors decide whether to buy Daraz shares.
• Helps management plan expansion (e.g., new warehouses).

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In the Real World

1. eSewa & Kathalti: Managing Cash Flows for Digital Payments

• Problem: eSewa and Khalti process millions of transactions daily, but liquidity management is critical.
• How SCF Helps:
  • Tracks cash inflows (user deposits, transaction fees).
  • Ensures sufficient cash reserves to cover withdrawals and refunds.
  • Helps plan loan repayments to banks (e.g., NMB, Global IME).
• Real Example:
  • During Dashain/Tihar, transaction volumes spike by 300%.
  • eSewa must ensure enough cash in its accounts to process all payments without delays.

2. NTC & Ncell: Capital Expenditures & Free Cash Flow

• Problem: Telecom companies like NTC and Ncell spend billions on 5G infrastructure.
• How SCF Helps:
  • Calculates FCF to see if they can afford new towers and fiber networks.
  • If FCF is negative, they may need to issue bonds or take loans.
• Real Example:
  • In 2022, Ncell reported Rs. 12 billion FCF.
  • Used Rs. 8 billion for 4G/5G upgrades and Rs. 4 billion for dividends.

3. Daraz & Pathao: Working Capital Management

• Problem: E-commerce (Daraz) and ride-hailing (Pathao) businesses have high working capital needs (inventory, driver payments, logistics).
• How SCF Helps:
  • Monitors cash from sales vs. cash paid to suppliers/drivers.
  • Helps avoid cash crunches (e.g., Pathao drivers demanding same-day payments).
• Real Example:
  • During lockdowns (2020-2021), Daraz’s inventory levels rose, reducing operating cash flow.
  • To fix this, Daraz negotiated longer payment terms with suppliers.

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Common Mistakes & How to Avoid Them

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Exam Tip: How to Score Full Marks

1. Understand the Three Sections

   • Operating: Core business cash flows.
   • Investing: Long-term assets (PPE, investments).
   • Financing: Debt and equity.

2. Memorize the Indirect Method Formula

   Operating Cash Flow = Net Income + Depreciation – (ΔWorking Capital)
   

3. Practice with Real Numbers

   • Exams often give income statements + balance sheet changes.
   • Always reconcile ending cash balance with the balance sheet.

4. Watch for Key Terms

   • Free Cash Flow (FCF) = Operating CF – CapEx
   • Cash Equivalents = Highly liquid short-term investments
   • Direct vs. Indirect Method (Indirect is more common in TU exams)

5. Use the SCF to Answer "Why?"

   • If cash increased, was it from sales (operating) or loans (financing)?
   • If cash decreased, was it due to investments or dividend payments?

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Worked Example: Nabil Bank’s SCF (Simplified)

Given:

• Net Income (2023): Rs. 8,000,000,000
• Depreciation: Rs. 1,200,000,000
• Increase in Loans Given to Customers: Rs. 2,000,000,000
• Purchase of New ATM Machines: Rs. 1,500,000,000
• Dividends Paid: Rs. 500,000,000
• Borrowing from RBI: Rs. 3,000,000,000

Step 1: Operating Cash Flow (Indirect Method)

Net Income = Rs. 8,000,000,000
+ Depreciation = + Rs. 1,200,000,000
– Increase in Loans Given (Working Capital) = – Rs. 2,000,000,000
= **Operating Cash Flow = Rs. 7,200,000,000**

Step 2: Investing Cash Flow

– Purchase of ATM Machines = – Rs. 1,500,000,000
= **Investing Cash Flow = – Rs. 1,500,000,000**

Step 3: Financing Cash Flow

+ Borrowing from RBI = + Rs. 3,000,000,000
– Dividends Paid = – Rs. 500,000,000
= **Financing Cash Flow = + Rs. 2,500,000,000**

Step 4: Net Change in Cash

Operating: + Rs. 7,200,000,000
Investing: – Rs. 1,500,000,000
Financing: + Rs. 2,500,000,000
**Net Increase in Cash = + Rs. 8,200,000,000**

Final SCF Table for Nabil Bank (2023)

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Summary Checklist for Exams

✅ Can you define:

• Statement of Cash Flows?
• Free Cash Flow?
• Operating vs. Investing vs. Financing activities?

✅ Can you prepare an SCF using the indirect method?

• Start with net income.
• Adjust for depreciation and working capital changes.
• Classify investing and financing correctly.

✅ Can you interpret an SCF?

• If operating cash flow is negative, is the business sustainable?
• If financing cash flow is high, is the company over-reliant on debt?

✅ Can you apply SCF to real businesses?

• How does eSewa manage liquidity?
• Why does Ncell need high CapEx?

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Final Thought: The Statement of Cash Flows is like a business’s bank statement—it tells the real story of where cash came from and where it went. Master this, and you’ll ace financial analysis in exams and real life! 🚀