Learning Module 5
Analyzing Statements of Cash Flows II
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Analyze and interpret both reported and common-size cash flow statements, including evaluation of sources and uses of cash across operating, investing, and financing activities.
Calculate and interpret free cash flow to the firm (FCFF), free cash flow to equity (FCFE), and performance and coverage cash flow ratios used to evaluate profitability, efficiency, and solvency.
1 · Evaluating Sources and Uses of Cash
Cash flow analysis begins with a structured four-step evaluation. The goal is to understand where cash comes from, where it goes, and whether the pattern is sustainable and appropriate for the company's stage of development.
For a mature company: operating activities should be the primary source. Investors and lenders need to be repaid from operations eventually. If operating CF is consistently negative, borrowing or equity issuances are unsustainable long-term. Use excess operating CF for investing (if value-creative) or return to capital providers (financing) if no good investments exist.
What are the major sources and uses of cash?
Is operating CF positive and sufficient to cover capex?
Examine the most significant working capital drivers: changes in receivables, inventory, payables. Compare OCF to net income — for a mature company, OCF should exceed net income (because non-cash depreciation reduces NI but not cash). Large NI but poor OCF can signal aggressive accounting or poor earnings quality.
What are the major determinants of operating CF?
Is OCF higher or lower than NI? Why?
How consistent are operating cash flows?
Each line item is either a source or use. Review capex (how much invested for the future), acquisitions, and investment securities. If making major capital investments, where is the cash coming from (operating surplus or financing)? If assets are being sold, why — and what are the effects on future operations?
Is the company raising or repaying capital? What is the nature of its capital sources (debt vs equity)? If borrowing annually, when might repayment be required? Dividend payments and share repurchases indicate capital returned to owners. Assess why capital is being raised or repaid relative to the company's investment needs.
Danone 2016 vs 2017 case study: In 2016, the primary source of cash was operating activities (EUR2,652M); the company spent EUR925M on capex and OCF comfortably covered this. In 2017, the picture changed dramatically — the primary source of cash was financing activities (EUR8,289M inflow), funding a massive acquisition (EUR10,949M outflow in investing). OCF still grew to EUR2,958M and exceeded NI (EUR2,563M) — a positive sign. The acquisition of WhiteWave Foods for USD12.5B explains the unusual 2017 pattern.
Growth-stage company exception: for a new or growth-stage company, negative OCF for a period is acceptable as it builds receivables and inventory. But this is not sustainable long-term — eventually the cash must come primarily from operations.
OCF vs NI relationship: in a mature company, OCF > NI is the expected and desirable pattern because depreciation reduces NI (non-cash) but not OCF. If NI > OCF, this is a warning sign — the company may be recognising revenue before collecting cash, or management may be using aggressive accounting.
Earnings quality assessment: large NI but poor OCF can indicate improperly recognised revenue, aggressive capitalisation policies, or poor working capital management. Consistently strong OCF relative to NI is a positive signal of earnings quality.