The Relations among the Cash Flow Activities
The organization of the statement of cash flows partitions a firm’s activities into three logical sections: operating activities, investing activities, and financing activities. One intuitive way to think about a firm is that it generates cash inflows and outflows every day from its operating activities, and continually reinvests cash by investing it in long term productive assets; cash shortfalls trigger the need for new financing, whereas excess cash flows allow firms to distribute cash by paying off debt or paying dividends to shareholders. The three sections of the statement of cash flows follow this logical progression
Operating activities include all activities directly involving the production and delivery of goods or services; examples include cash received from customers and cash used to purchase raw materials and to compensate employees. As we will discuss later, most firms report this section under what is referred to as the ‘‘indirect method,’’ which undoes the accrual accounting entries that determine net income in order to reveal the underlying cash flows. The investing activities section chronicles expenditures for (and proceeds from dispositions of) assets, such as equipment and joint ventures, that are intended to be used to generate cash flows. Also included in the investing section are cash flows related to acquisitions and divestitures. The section summarizing financing activities of the firm includes cash received from (or returned to) capital providers such as banks, other lending institutions, and shareholders. The subtotals for net operating, investing, and financing cash flows provide the net increase or decrease in cash and cash equivalents.
As an example, refer to PepsiCo’s Consolidated Statement of Cash Flows in Appendix A. Note the three activity sections presented in the statement of cash flows. For all years presented, PepsiCo generates very large positive cash flows from operating activities and negative cash flows for both investing and financing activities. For example, in 2012, PepsiCo generated $8,479 million from operating activities and used $3,005 million and $3,306 million for investing and financing activities, respectively. Thus, PepsiCo generates a great deal of cash from its core operations (as shown in the operating section) and uses much of it to invest in productive assets (shown in the investing section) and to return cash to capital providers (shown in the financing section). For PepsiCo, the net of operating, investing, and financing activities is an increase in cash and cash equivalents of $2,230 million (which includes an adjustment for the effects of exchange rate changes on cash balances).
Note several important line items in PepsiCo’s statement of cash flows for 2012. First, the largest adjustment in the operating section is for the addback of depreciation and amortization, which adds $2,689 million to PepsiCo’s $6,214 million of net income. The sum of other non-working capital adjustments (from ‘‘Stock-based compensation expense’’ through ‘‘Deferred income taxes and other tax charges and credits’’) is negative $658 million, indicating a net negative adjustment to net income due to these items. The large depreciation and amortization adjustment is offset partly by the net negative adjustment for the other non-working capital items, which is typical of a large, mature company such as PepsiCo. Second, the net cash flows from changes in working capital accounts (from ‘‘Change in accounts and notes receivable’’ through ‘‘Other, net’’) is $234 million, indicating a net decrease of investments in working capital during 2012. Third, investing cash flows primarily reflects capital spending ($2,714 million). The financing section shows that PepsiCo raised $3,550 million in net long-term debt. PepsiCo also used $3,305 million to pay dividends and $3,226 million to repurchase common and preferred shares. The net increase in long-term debt coupled with the dividends and share repurchases contributes to an increase in PepsiCo’s leverage.
The organization of the statement of cash flows partitions a firm’s activities into three logical sections: operating activities, investing activities, and financing activities. One intuitive way to think about a firm is that it generates cash inflows and outflows every day from its operating activities, and continually reinvests cash by investing it in long term productive assets; cash shortfalls trigger the need for new financing, whereas excess cash flows allow firms to distribute cash by paying off debt or paying dividends to shareholders. The three sections of the statement of cash flows follow this logical progression
Operating activities include all activities directly involving the production and delivery of goods or services; examples include cash received from customers and cash used to purchase raw materials and to compensate employees. As we will discuss later, most firms report this section under what is referred to as the ‘‘indirect method,’’ which undoes the accrual accounting entries that determine net income in order to reveal the underlying cash flows. The investing activities section chronicles expenditures for (and proceeds from dispositions of) assets, such as equipment and joint ventures, that are intended to be used to generate cash flows. Also included in the investing section are cash flows related to acquisitions and divestitures. The section summarizing financing activities of the firm includes cash received from (or returned to) capital providers such as banks, other lending institutions, and shareholders. The subtotals for net operating, investing, and financing cash flows provide the net increase or decrease in cash and cash equivalents.
As an example, refer to PepsiCo’s Consolidated Statement of Cash Flows in Appendix A. Note the three activity sections presented in the statement of cash flows. For all years presented, PepsiCo generates very large positive cash flows from operating activities and negative cash flows for both investing and financing activities. For example, in 2012, PepsiCo generated $8,479 million from operating activities and used $3,005 million and $3,306 million for investing and financing activities, respectively. Thus, PepsiCo generates a great deal of cash from its core operations (as shown in the operating section) and uses much of it to invest in productive assets (shown in the investing section) and to return cash to capital providers (shown in the financing section). For PepsiCo, the net of operating, investing, and financing activities is an increase in cash and cash equivalents of $2,230 million (which includes an adjustment for the effects of exchange rate changes on cash balances).
Note several important line items in PepsiCo’s statement of cash flows for 2012. First, the largest adjustment in the operating section is for the addback of depreciation and amortization, which adds $2,689 million to PepsiCo’s $6,214 million of net income. The sum of other non-working capital adjustments (from ‘‘Stock-based compensation expense’’ through ‘‘Deferred income taxes and other tax charges and credits’’) is negative $658 million, indicating a net negative adjustment to net income due to these items. The large depreciation and amortization adjustment is offset partly by the net negative adjustment for the other non-working capital items, which is typical of a large, mature company such as PepsiCo. Second, the net cash flows from changes in working capital accounts (from ‘‘Change in accounts and notes receivable’’ through ‘‘Other, net’’) is $234 million, indicating a net decrease of investments in working capital during 2012. Third, investing cash flows primarily reflects capital spending ($2,714 million). The financing section shows that PepsiCo raised $3,550 million in net long-term debt. PepsiCo also used $3,305 million to pay dividends and $3,226 million to repurchase common and preferred shares. The net increase in long-term debt coupled with the dividends and share repurchases contributes to an increase in PepsiCo’s leverage.
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