Business Finance Online

Cash Flow to Investors

The Cash Flow to Investors in the firm, i.e., the debtholders and equityholders, indicates how the cash flow generated by the firm's assets are distributed to the debtholders and equityholders. The calculations illustrated on this page will refer to the Balance Sheet and Income Statement which follow.

Balance Sheet ($ in Millions)
Assets 1998 1997 Liabilities and Owners' Equity 1998 1997
Current Assets     Current Liabilities    
Cash 690 600 Accounts Payable 530 460
Accounts Receivable 340 300 Notes Payable 240 240
Inventory 120 100 Total Current Liabilities 770 700
Total Current Assets 1150 1000 Long-Term Liabilities    
      Long-Term Debt 571 710
Fixed Assets     Total Long-Term Liabilities 571 710
Property, Plant, and Equipment 1210 1200 Owners' Equity    
Less Accumulated Depreciation 357 280 Common Stock ($1 Par) 122 120
Net Fixed Assests 853 920 Capital Surplus 218 210
      Retained Earnings 322 180
      Total Owners' Equity 662 510
Total Assets 2003 1920 Total Liab. and Owners' Equity 2003 1920
Income Statement ($ in Millions)
  1998
Sales 1710
Cost of Goods Sold 1100
Administrative Expenses 100
Depreciation 77
Earnings Before Interest and Taxes 423
Interest Expense 50
Taxable Income 373
Taxes 30
Net Income 343
Dividends 201
Addition to Retained Earnings 142

Cash Flow to Debtholders

The Cash Flow to Debtholders is defined as debt service less new long term borrowing. (Debt service represents interest expense and repayments of principal.) An equivalent definition which makes use of values which can readily be obtained form the Balance Sheet and Income Statement is interest expense less net new borrowing. This can be calculated as follows:

Cash Flow to Debtholders = Interest Expense - Ending Long-term Debt + Beginning Long-term Debt

Interest Expense is the fundamental cash flow from the firm to its debtholders. Moreover, if a firm's Long-term Debt increases from one year to the next (i.e., more new debt was issued than was repaid) then the debtholders supplied the firm with additional cash.

Cash Flow to Debtholders Example

Using information from the above Balance Sheet and Income Statement.

Solution:

Cash Flow to Debtholders = $50 - $571 + $710 = $189

 

Cash Flow to Common Stockholders

The principal cash flow from the firm to its Common Stockholders is dividends. Firms also issue new stock periodically. This represents a cash flow from the Common Stockholders to the firm. (Some firm also repurchase their own stock, i.e., a cash flow from the firm to its stockholders. When this occurs the repurchased shares are recorded on the Balance Sheet as Treasury Stock. (The Balance Sheet used for the examples on this page indicates that the firm has no Treasury Stock.) The Cash Flow to Common Stockholders can be calculated as common dividends paid less net new common equity raised.

Cash Flow to Common Stockholders = Dividends Paid
  - (Ending Common Stock - Beginning Common Stock)
  - (Ending Capital Surplus - Beginning Capital Surplus)
  + (Ending Treasury Stock - Beginning Treasure Stock)

Cash Flow to Common Stockholders Example

Using information from the above Balance Sheet and Income Statement.

Solution:

Cash Flow to Common Stockholders = $201 - ($122 - $120) - ($218 - $210) - ($0 - $0) = $191

 

Cash Flow to Preferred Stockholders

The Cash Flow to Preferred Stockholders is defined as Preferred Dividends Paid less net new Preferred Equity raised.

Cash Flow to Preferred Stockholders = Preferred Dividends Paid
  - (Ending Preferred Stock - Beginning Preferred Stock)

In the example on this page, there is no Preferred Stock. Thus the Cash Flow to Preferred Stockholders for this firm is 0.

 

Cash Flow to Investors (Debtholders and Equityholders)

Once the above items have been determined, the Cash Flow to the Investors in the Firm can be calculated as follows:

Cash Flow to Investors = Cash Flow to Debtholders
  + Cash Flow to Common Stockholders
  + Cash Flow to Preferred Stockholders

Cash Flow to Investors Example

Using information from the previous examples.

Solution:

Cash Flow to Investors = $189 + $191 + $0 = $380

 

Notice that the Cash Flow to Investors equals the Cash Flow from Assets determined on the previous page. This was not by accident. Thus, just as there is a Balance Sheet Identity (Total Assets = Total Liabilities and Owners' Equity) there is also a Cash Flow Identity (Cash Flow from Assets = Cash Flow to Investors).

 

© 2002 - 2010 by Mark A. Lane, Ph.D.