Cash Flow Statement Construction

Overview

• Building a cash flow statement from scratch using an income statement and balance sheet.
• Common interview question in finance/accounting.

Required Documents

• Balance Sheets: Current year and previous year.
• Income Statement: For the period between the two years.

Importance of Cash Flow Statement

• Checks the total assets, liabilities, and shareholders' equity.
• Divided into three main sections:
  1. Cash Flow from Operating Activities
  2. Cash Flow from Investing Activities
  3. Cash Flow from Financing Activities
• Summing these gives the change in cash.

Section 1: Cash Flow from Operating Activities

• Involves cash inflows/outflows from core business activities (e.g., buying inventory, receiving payments).
• Methods to Calculate Cash Flow:
  • Direct Method: Uses only cash transactions.
  • Indirect Method: Starts with net income and adds back non-cash transactions like depreciation (more popular due to accrual accounting).

Indirect Method Steps

1. Start with Net Income: Link this from the income statement.
2. Depreciation and Amortization: Add back non-cash expenses.
3. Changes in Working Capital:
   • Calculate difference between current assets (excluding cash) and current liabilities.
   • Current Assets: Link changes in accounts receivable, inventory, etc.
     • Increase in accounts receivable = cash outflow (change sign).
     • Decrease in inventory = cash inflow.
   • Current Liabilities:
     • Changes in short-term debt and accounts payable should reflect cash outflows/inflows accordingly.
4. Sum Results: To find cash flow from operating activities.

Section 2: Cash Flow from Investing Activities

• Involves investment in assets like property, plant, and equipment (PPE).
• Calculation:
  • Use gross PPE figures (account for accumulated depreciation already recorded).
  • Calculate purchases of long-term investments and other assets.
  • Sum results to find cash flow from investing activities.

Section 3: Cash Flow from Financing Activities

• Reflects how a company funds operations (debt/equity).
• Include:
  • Increases in long-term debt and other liabilities as cash inflows (positive).
  • Proceeds from share issuance as cash inflow.
  • Dividends paid as cash outflow (negative value).
• Note: Unrealized gains/losses (comprehensive income) are not included.

Final Calculations

1. Ending Cash Balance:
   • Determine beginning cash balance from the balance sheet.
   • Calculate change in cash from all three sections.
   • Ensure ending cash balance matches the balance sheet.

Formatting the Cash Flow Statement

• Use proper number formatting, bold totals, and apply borders to create a clear and professional layout.

Additional Resources

• Investment banking interview skills course available with discount code.
• Links to further financial modeling and valuation resources.