Introduction to Corporate Finance

2: Financial Statement and Cash Flow Analysis

statement. For a similar reason, the statement does not show a specific entry for the change in retained

earnings as an inflow (or outflow) of cash. Instead, the factors that determine the change in retained

earnings (that is, profits or losses and dividends) appear as separate entries in the statement.

By adding up the items in each category – operating, investment and financing activities – we obtain

the net increase (or decrease) in cash and marketable securities for the year. As a check, this value should

reconcile with the actual yearly change in cash and marketable securities, obtained from the beginning-

and end-of- year balance sheets.

By applying this procedure to GPC’s 2016 income statement and 2015 and 2016 balance sheets,

we obtain the company’s 2016 statement of cash flows (see Table 2.5). It shows that GPC experienced

a $234 million increase in cash and marketable securities in 2016. Looking at GPC’s balance sheets

for the two years in Table 2.1 (on page 32), we see that the company’s cash increased by $227 million

and that its marketable securities increased by $7 million. The $234 million net increase in cash and

marketable securities from the

statement of cash flows reconciles

with the total change of $234

million in these accounts during

2016. Therefore, GPC’s statement
      of cash flows reconciles with the
      balance sheet changes.
      The statement of cash flows
      allows the financial manager and
      other interested parties to analyse
      the company’s cash flow over time.
      Unusual changes in either the major
      categories of cash flow or in specific
      items offer clues to problems a
      company may be experiencing. For
      example, an unusually large increase
      in accounts receivable or inventory,
      resulting in major cash outflow, may
      signal credit or inventory problems.
      Financial managers and analysts
      can also prepare a statement of cash
      flows developed from projected,
      or pro forma, financial statements.
      They use this approach to determine
      if the company will need additional
      external financing or will generate
      excess cash that could be reinvested
      or distributed to shareholders. After
      you learn the concepts, principles
      and practices of corporate finance
      presented in this text, you will be
      able to glean a good amount of useful
      information from the statement of
      cash flows.

TABLE 2.5 STATEMENT OF CASH FLOWS FOR GLOBAL

PETROLEUM CORPORATION

This statement is constructed using the company’s income statements and

two most recent balance sheets. It groups cash flow into: (1) cash flow

from operations; (2) cash flow from investments; and (3) cash flow from

financing. The net change at the bottom of the statement should match the

net change in the cash and marketable securities balance shown between

the company’s most recent two balance sheets.

Global Petroleum Corporation

Statement of cash flows

for the year ended 30 June 2016 ($ in millions)

Cash flow from operating activities

Net income (net profit after tax) $949

Depreciation 633

Increase in accounts receivable (416)

Increase in inventories (85)

Decrease in other current assets 6

Increase in accounts payable 393

Increase in accrued expenses 61

Cash provided by operating activities $ 1,541

Cash flow from investment activities

Increase in gross fixed assets ($896)

Increase in intangible and other assets (287)

Cash provided (consumed) by investment activities ($1,183)

Cash flow from financing activities

Decrease in notes payable ($110)

Increase in deferred taxes 114

Increase in long-term debt 286

Changes in shareholders’ equity (66)

Dividends paid (348)

Cash provided (consumed) by financing activities ($124)

Net increase in cash and marketable securities $ 234