Cash Flows from Investing and Financing Activities The computation of the cash flows from investing and financing activi-

Cash Flows from Investing and Financing Activities The computation of the cash flows from investing and financing activi-

ties is straightforward. The cash flow from (used for) investing activi- ties includes cash flow due to investments in plant assets, the disposal of plant assets, acquisitions of other companies, and divestitures of subsid- iaries. For Fictitious Corporation, the $1 million invested in plant and equipment shows up as a net outflow on the statement of cash flows.

The cash flow from (used for) financing activities includes cash flows due to the sale or repurchase of common or preferred stock, the issuing or retirement of long-term debt securities, and the payment of common and preferred dividends.

The flows attributed to these activities are shown in Exhibit 6.5 for Fictitious Corporation. By design, the statement of cash flows is a rec-

Financial Statements

onciliation of the cash flows from the firm’s three cash sources: opera- tions, investing, and financing. It takes us from net income to the change in the cash account over the accounting period. For example, for Ficti- tious Corporation the net change in the cash balance during 1999 is an increase of $200,000 as shown in the first line of Exhibit 6.1. Exhibit

6.5 shows us that this increase is the result of net cash flows during 1999 of $1.8 million from operations, less $1 million from investing activities, less $600,000 from financing activities.

Consider another example. Suppose the Pretend Corporation has the following financial results:

■ Net income of $40,000 ■ Increase in current assets of $5,000 ■ Increase in current liabilities of $2,000 ■ Sale of $10,000 of plant and equipment ■ Purchase $20,000 of plant of equipment ■ Depreciation of $12,000 ■ Repurchase $20,000 of common stock ■ Dividends on common stock of $2,000

What is the Pretend’s cash flow? The first step is to adjust net income for the changes in the working capital accounts: a downward adjustment of $5,000 for the increase in current assets and an upward adjustment of $2,000 for the increase in current liabilities. Adding depreciation, the cash flow from operating activities is $49,000. The cash flows from investing activities consists of the flow for Pretend’s sale and purchase of plant and equipment. The cash flow from financing activities involves Pretend’s repurchase of common stock and its pay- ment of common dividends. The statement of cash flows for Pretend Corporation is shown in Exhibit 6.7.

The financial analyst can use the statement of cash flows to learn more about a company’s financial health. Consider the cash flows shown in Exhibit 6.8 for different companies in 2001. Wal-Mart Stores, Dell, Disney, and Intel have cash flows that are typical of healthy, growing companies: funds are generated internally (that is, through operating activity) and funds are applied to investing activities. Motorola is gener- ating funds from both operations and investments (that is, selling off assets). Wal-Mart Stores and Walt Disney are generating sufficient funds to fund their investment activity and reduce their dependence on exter- nally-raised funds (as indicated by the cash flow used for financing activities). Dell and Disney are able to generate sufficient cash flows through operating activities to reduce dependence on external financing.

FOUNDATIONS

EXHIBIT 6.7 Pretend Corporation Statement of Cash Flows Cash flow from operations

Net income

Increase in current assets

Increase in current liabilities

Cash flow from operations

Cash flow from investing activities Sale of plant and equipment

Purchase of plant and equipment

Cash flow used for investing activities

Cash flow from financing activities Repurchase of common stock

Dividends on common stock

Cash flow used for financing activities $(22,000) Increase in cash flow

EXHIBIT 6.8 Cash Flows from (Used for) Operating, Investment, and Financing

Activities (In millions) Cash Flows Cash Flows Cash Flows

Increase from (for)

from (for) (Decrease) Operating

from (for)

Financing in Cash and Company

Activities Cash Equivalents

Dell Computer $4,195

(3,465) 4,994 Wal-Mart Stores

113 107 Source: Statement of cash flows from the 2001 10-K reports for the respective

companies.

Financial Statements

EXHIBIT 6.9 Fictitious Corporation Statement of Shareholders’ Equity

Common Retained

Shares

Stock

Earnings Total

Balance at December 31, 2001

$1,900 $3,900 Common stock sold (repurchased)

— — Net income

900 900 Cash dividend declared

(400) (400) Balance at December 31, 2002

$2,400 $4,400 Common stock sold (repurchased)

— 1,000 Net income

1,100 1,100 Cash dividend declared

(500) (500) Balance at December 31, 2003