Course name: FIN3702
Presented by: Nicole Penny
Presenter’s email:
, While every care has been taken to include all
relevant facts, the author cannot be held
responsible for any omissions or errors in the
following notes.
Students are reminded that these notes are not a
substitute for prescribed textbooks.
Page 2
FIN3702
,FIN3702 revision notes
Analyzing a firms cash flow
Module objectives:
- Explain tax depreciation procedures and effect on business’ cash flow
- Explain why cash flow statement is different to the income statement
- Prepare a cash flow statement
- Prepare and operating cash flows and free cash flows
Introduction to analyzing a firm’s cash flow
1. Why is cash flow the lifeblood of a firm?
o Managing day-to-day operations
o Making strategic financial decisions and increasing shareholder value
o Operating cash flow line is monitored closely by managerial decision
making
o Free cash flow is monitored by capital markets as “cash pays the bills”
2. What are the key items affecting a firm’s cash flow?
o Depreciation
o Other non-cash items
Depreciation
Depreciation is to charge a portion of costs of fixed assets systematically against annual
revenues. It allocates the historical cost over time.
Accounting: Depreciation of historical cost over time
Depreciable life of an asset is the time period which as asset is depreciated and can
significantly affect the pattern of cash flows. How?
Tax purposes: the charge is regulated by SARS and may differ from the accounting
charge (wear and tear allowance - WTA)
The WTA applies to both new and used assets
Method of calculation:
1. Determine depreciable value of an asset = The amount to be depreciated
1.1 Initial cost of the asset R400 000
1.2 Outlays for installation R20 000
1.3 Minus: Expected salvage value (R5 000)
Depreciable value of the asset R415 000
2. Determine the recovery period and depreciate using the straight-line method
2.1 Recovery period is the appropriate depreciable life of a particular asset as
determined by WTA – SARS rules
2.2 Five broad recovery period categories – 3, 4, 5, 10 and 20 years (excluding
real estate) –
Page 3
FIN3702
, Figure 1 - Source Principles of Managerial FInance Lawrnece J. Gitman
Example:
ABC company acquired a new air conditioner system for an installed cost of R25 000 6
months into its financial reporting period. Management believes that the machine’s
expected useful life is only 4 years. Calculate the depreciation and WTA for the machine
for each year.
Year Cost (R) Depreciation Depreciation WTA rate – WTA
rate (R) from tables
1 25 000 12.5% 3 125 10% 2 500
2 25 000 25% 6 250 20% 5 000
3 25 000 25% 6 250 20% 5 000
4 25 000 25% 6 250 20% 5 000
5 25 000 12.5% 3 125 20% 5 000
6 25 000 0% 10% 2 500
Total 100% 25 000 100% 25 000
Developing the statement of cash flows
Sources of inflows:
- Decrease in asset – generally????
- Increase in liability
- Net profits
Page 4
FIN3702
Presented by: Nicole Penny
Presenter’s email:
, While every care has been taken to include all
relevant facts, the author cannot be held
responsible for any omissions or errors in the
following notes.
Students are reminded that these notes are not a
substitute for prescribed textbooks.
Page 2
FIN3702
,FIN3702 revision notes
Analyzing a firms cash flow
Module objectives:
- Explain tax depreciation procedures and effect on business’ cash flow
- Explain why cash flow statement is different to the income statement
- Prepare a cash flow statement
- Prepare and operating cash flows and free cash flows
Introduction to analyzing a firm’s cash flow
1. Why is cash flow the lifeblood of a firm?
o Managing day-to-day operations
o Making strategic financial decisions and increasing shareholder value
o Operating cash flow line is monitored closely by managerial decision
making
o Free cash flow is monitored by capital markets as “cash pays the bills”
2. What are the key items affecting a firm’s cash flow?
o Depreciation
o Other non-cash items
Depreciation
Depreciation is to charge a portion of costs of fixed assets systematically against annual
revenues. It allocates the historical cost over time.
Accounting: Depreciation of historical cost over time
Depreciable life of an asset is the time period which as asset is depreciated and can
significantly affect the pattern of cash flows. How?
Tax purposes: the charge is regulated by SARS and may differ from the accounting
charge (wear and tear allowance - WTA)
The WTA applies to both new and used assets
Method of calculation:
1. Determine depreciable value of an asset = The amount to be depreciated
1.1 Initial cost of the asset R400 000
1.2 Outlays for installation R20 000
1.3 Minus: Expected salvage value (R5 000)
Depreciable value of the asset R415 000
2. Determine the recovery period and depreciate using the straight-line method
2.1 Recovery period is the appropriate depreciable life of a particular asset as
determined by WTA – SARS rules
2.2 Five broad recovery period categories – 3, 4, 5, 10 and 20 years (excluding
real estate) –
Page 3
FIN3702
, Figure 1 - Source Principles of Managerial FInance Lawrnece J. Gitman
Example:
ABC company acquired a new air conditioner system for an installed cost of R25 000 6
months into its financial reporting period. Management believes that the machine’s
expected useful life is only 4 years. Calculate the depreciation and WTA for the machine
for each year.
Year Cost (R) Depreciation Depreciation WTA rate – WTA
rate (R) from tables
1 25 000 12.5% 3 125 10% 2 500
2 25 000 25% 6 250 20% 5 000
3 25 000 25% 6 250 20% 5 000
4 25 000 25% 6 250 20% 5 000
5 25 000 12.5% 3 125 20% 5 000
6 25 000 0% 10% 2 500
Total 100% 25 000 100% 25 000
Developing the statement of cash flows
Sources of inflows:
- Decrease in asset – generally????
- Increase in liability
- Net profits
Page 4
FIN3702
