My Road to CFA

I said in my introduction to this blog that I want to try my best to summarize the material I have read for my own note and for your reference. After I have finished the financial statement analysis material for once, and attempt to summarize, I found that I don't know where to start with. But I have to anyway, because actually producing the knowledge in words by yourself will help you to consolidate in your memory.

So perhaps I would like to start with the Statement of Cash Flow, because I don't know why I found it the most difficult part, especially when I first encountered this part. The problem is that unless you know well about things from Study sessions 9 and 10, that is hard to fully understand the construction of cash flow statement.

So first of all, the need for constructing a cash flow statement is that, due to the accrual concept and the matching principle, the revenue and cost are recognized not by the actual cash inflows or outflows, but whether the revenue has been "earned" and whether the cost has been "incurred". As a result, often time the revenue is booked on the income statement, but the cash has not been collected, or the cost has been booked on the income statement, but the cash has not been paid. Also, there are costs or expenses on the income statement which has no cash flow, like depreciation and amortization expenses, earnings from unconsolidated affiliates, etc. So statement of cash flow is needed to provide information for investors and creditors about the acutal cash collection and inputs.

The statement of cash flow are divided into three main parts. The first part is the cash flow from operating activities (CFO), which attempts to capture the cash flow from the normal operation of the firm, like sales, cost of good solds, working capital changes, and so on. The next part is the cash flow from financing activities (CFF), which captures the cash flow from financing of the firm like raising debt, repaying principal of debt or mortgage, issuing stocks, etc. Then comes the cash flow from investing activities (CFI), which includes the items like capital expenditures, investment in lands, purchasing of property, plants and equipment, etc. After these three parts, there will be a seperate line item to reconcile the differences arose from translation of foreign currencies. So the change in cash balance in that particular fiscal year can be found. The change in cash in the statement of cash flow will reconcile with the cash asset value in the balance sheet:

End Cash balance = Beginning Cash balance + change in cash (as in the statement of cash flow)

There are two ways of constructing the statement of cash flow as allowed in the US GAAP. The more widely used method is the indirect method, while the second method is the direct method. The difference between two ways of constructing the statement of cash flow lies in the construction of the CFO part of the statement.

(to be continued next time)