13–1 chapter 13 the statement of cash flows. 13–2 copyright © cengage learning. all rights...

13–1

Chapter 13

The Statement of Cash Flows

13–2Copyright © Cengage Learning. All rights reserved.

Statement of Cash Flows

Shows how a company’s operating, investing, and financing activities have affected cash during an accounting period

Explains the net increase or decrease in cash

Statement of Cash Flows includes: Cash Cash equivalents Money market accounts Commercial paper U.S. Treasury bills

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How Is the Statement of Cash Flows Used?

Pay dividends and interest

Pay its liabilities

Generate positive future cash flows

Manage cash flows

Investors and creditors assess the company’s ability to

Evaluate financing decisions

Evaluate investment decisions

Determine dividend policy

Assess liquidity

Managers


Classification of Cash Flows

The statement of cash flows classifies cash receipts and cash payments into categories

Operating Activities

Investing Activities

Financing Activities


Operating Activities

Involve the cash inflows and outflows from activities that enter into the determination of net income

Cash Inflows Receipts from sale of

goods and services Receipts from sale of

trading securities Interest and dividends

Cash Outflows Payments for wages,

inventory, expenses, taxes

Payments for purchase of trading securities

Trading securities are a type of marketable security that a company buys and sells for the purpose of making a profit in the near term.


Investing Activities

Involve the acquisition and sale of property, plant, and equipment and other long-term assets, including long-term investments; the acquisition and sale of short-term marketable securities, other than trading securities, and the making and collecting of loans

Cash Inflows Receipts from selling

marketable securities and long-term assets

Collections on loans

Cash Outflows Expenditures on

purchase of securities and assets

Outflows of cash lent to borrowers


Financing Activities

Obtaining resources from stockholders and providing them with a return on their investments, and obtaining resources from creditors and repaying the amounts borrowed (settling the obligations)

Cash InflowsProceeds from stock

issues and from short- and long-term borrowing

Sales of treasury stock

Cash OutflowsRepayments of loans

(excluding interest) Payments to owners,

including cash dividends

Purchases of treasury stock


Noncash Investing and Financing Transactions

Significant transactions that involve only long-term assets, long-term liabilities, or stockholders’ equity

Noncash examples: Exchange of long-term

asset for a long-term liability

Settle a debt by issuing capital stock

Take out a long-term mortgage to purchase real estate

Not reflected on the statement of cash flows;

no cash inflows or outflows

Future cash flows are affected, so required to

disclose these transactions in a

separate schedule or at the bottom of the

statement


Format of the Statement of Cash FlowsSE1/HwkE3

Operating Activities section

Investing Activities section

Financing Activities section

Reconciliation of beg. and end. balances of cash

Indirect method begins with net income and ends with cash flows from operating activities

Cash transactions involving capital expenditures

Ties to cash balances of the balance sheet

Debt, cash stock transactions, dividends, and treasury stock transactions

1

2

3

4


Analyzing Cash Flows

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Cash-Generating Efficiency (CGE)

Shows the company’s ability to generate cash from its current or continuing operations

Ratios used to calculate CGE:

Cash flow yield Cash flows to sales Cash flows to assets


Cash Flow Yield

IncomeNet

Activities Operating from FlowsCash Net Yield FlowCash

times3.0 $476

$1,405

Shows how much of net income actually results in operating cash inflows

Amazon.com’s operating activities were generating about $3 of cash for every dollar of net income


Cash Flows to Sales

Shows how much of net sales actually results in cash inflows

Amazon.com generated positive cash flows to sales of 9.5 percent or in other words that every dollar

of sales generates 9.5 cents in cash

SalesNet

Activities Operating from FlowsCash Net Sales toFlowsCash

9.5% $14,835

$1,405 *

* Rounded


Cash Flows to Assets

2007 2006 2005

Total Assets 6,485 4,363 3,696

Amazon.com's 2007 Annual Report (in millions)

Shows how much cash is being generated by operations for each dollar of assets

Assets Total Average

Activities Operating from FlowsCash Net Assets toFlowsCash

25.9% 2 $4,363) ($6,485

$1405

*

*Rounded


Free Cash Flow

Amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level

Net Cash Flows from Operating Activities– Dividends – Purchases of Plant Assets + Sales of Plant Assets Free Cash Flow


Free Cash Flow (continued) SE2-3/HwkE4

• If free cash flow is positive, the company– Has met all of its planned cash commitments – Has cash available to reduce debt or expand

• If free cash flow is negative, the company will have to– Sell investments– Borrow money – Issue stock in the short term

to continue at its planned level of operation


Determining Cash Flows from Operating Activities

1. The direct method• Adjusts each item on the income statement to its

cash equivalent• More easily understood by the average reader

There are two methods of converting the income statement from an accrual basis to a cash basis.

Both methods produce the same net figure


Determining Cash Flows from Operating Activities

2. The indirect method• Lists only necessary adjustments to convert net income

to net cash flows• Superior from an analyst’s perspective• Used by most companies

We will be using the indirect method for determining operating activity cash flows.


Using the Indirect Method

We start with Net Income and then adjust for those income statement items that do not affect cash.

Cash flows from operating activities

Net income $16,000 Adjustments to reconcile net income to net cash flows from operating activitiesDepreciation $37,000

Gain on sale of investments (12,000)

Loss on sale of plant assets 3,000Changes in current assets and current liabilities

Decrease in accounts receivable 8,000Increase in inventory (34,000)Decrease in prepaid expenses 4,000Increase in accounts payable 7,000Increase in accrued liabilities 3,000Decrease in income taxes payable (2,000) 14,000Net cash flows from operating activities $30,000


Using the Indirect MethodDepreciation

Depreciation expense appears on the income statement, but involves no outlay of cash

Adjustment: Depreciation

expense added back to net

income for the period







Gains and Losses

Do not affect cash flows from operating activities; should be removed from net income

Adjustments: Gain/Losses

subtracted and added to net

income for the period







Treatment of Noncash Items

Noncash Item Add to or Deduct from Net Income

Depreciation Expense Add

Amortization Expense Add

Depletion Expense Add

Losses Add

Gains Deduct


Changes in Current Assets

Decreases in current assets are added to net income Increases in current assets are deducted from net income

Example: Laguna Corporation’s Accounts Receivable decreased by $8,000 as illustrated below.

Accounts Receivable

Beg. Bal. 55,000

End. Bal. 47,000

698,000

706,000

Sales toCustomers

Cash Receipts from Customers

The $8,000 decrease in Accounts Receivable should be added to net income on the statement of cash flows.


Changes in Current Liabilities

Decreases in current liabilities are deducted from net income Increases in current liabilities are added to net income

Example: Laguna Corporation’s accounts payable increased by $7,000 as illustrated below.

The $7,000 increase in Accounts Payable shouldbe added to net income on the statement of cash flows.

Accounts Payable

Beg. Bal. 43,000

End. Bal. 50,000

554,000

547,000Cash Payments to Suppliers Purchases


Net Income versus Cash Flows from Operating Activities






A net income of $16,000, after adjustments, actually yielded $30,000 in positive cash flows from operating activities


Adjustments for Changes in Current Assets and Liabilities SE4-5/HwkE5-7

Add to Net Income

Deduct from Net Income

Current Assets:

Accounts receivable (net)

Decrease Increase

Inventory Decrease Increase

Prepaid expenses Decrease Increase

Current Liabilities:

Accounts payable Increase Decrease

Accrued liabilities Increase Decrease

Income taxes payable Increase Decrease


Examining Investment Transactions

To determine cash flows from investing activities, accounts involving cash receipts and cash payments from investing activities are examined individually

Long-term assets

Short-term investments

Investment gains and losses


Investment Transactions Cash Flows Illustrated

1. Laguna Corporation’s purchases of investments totaled $78,000 during 2010. These transactions, caused a $78,000 decrease in cash flows (cash paid).

2. Laguna sold investments that cost $90,000 for $102,000. This transaction resulted in a gain of $12,000 and caused an increase in cash flows of $102,000 (cash received) .

Investing activities section, statement of cash flows:

Purchase of investments ($78,000) Sale of investments 102,000


Plant Asset Transactions Cash Flows Illustrated

Examine the Plant Assets account and the related Accumulated Depreciation account

1. Laguna Corporation purchased plant assets totaling $1200,000. These transactions, caused a $120,000 decrease in cash flows (cash paid).

2. Laguna sold plant assets that cost $10,000 and that had accumulated depreciation of $2,000 for $5,000. This transaction resulted in a loss of $3,000 and caused an increase in cash flows of $3,000 (cash received) .

Investing activities section, statement of cash flows:

Purchase of plant assets ($120,000) Sale of plant assets 5,000


Cash Flows from Investing ActivitiesSE6/HwkE8-9

Cash flows from investing activitiesPurchase of investments ($78,000)Sale of investments 102,000Purchase of plant assets (120,000)Sale of plant assets 5,000Net cash flows from investing activities (91,000)

The transactions for Laguna Corporation we have examined are listed below on its statement of cash flows in the investing activities section:


Examining Financing Transactions

To determine cash flows from financing activities, accounts involving cash receipts and cash payments from financing activities are examined individually

Short-term borrowings

Long-term liabilities

Stockholders’ equity


Bonds Payable Transactions Cash Flows Illustrated

Laguna Corporation repaid $50,000 of bonds at face value at maturity. This transaction caused a $50,000 decrease in cash flows (cash paid).

Financing activities section, statement of cash flows: Repayment of bonds ($50,000)



Common Stock Transactions Cash Flows Illustrated

Laguna Corporation issued 15,200 shares of $5 par value common stock for $175,000. The Common Stock account increased by $76,000, and the Additional Paid-in Capital account increased by $99,000. This transaction caused an $175,000 increase in cash flows (cash received).

Financing activities section, statement of cash flows:

Issue of common stock $175,000


Dividend Transactions Cash Flows Illustrated

Laguna Corporation paid cash dividends in the amount of $8,000. This amount decreased Retained Earnings. This transaction caused a $8,000 decrease in cash flows (cash paid).

Financing activities section, statement of cash flows: Payment of dividends ($8,000)

Only the payment of dividends appears on the statement of cash flows, not the declaration of dividends.



Treasury Stock Transactions Cash Flows Illustrated

Laguna Corporation purchased treasury stock for $25,000. This transaction created a cash outflow of $25,000.

Financing activities section, statement of cash flows:

Purchase of treasury stock ($25,000)


Cash Flows from Financing ActivitiesSE7/HwkE10

Cash flows from financing activitiesRepayment of bonds ($50,000)Issue of common stock 175,000Payment of dividends (8,000)Purchase of treasury stock (25,000)Net cash flows from financing activities 92,000

The transactions of Laguna Corporation that we have examined are presented in the financing section of the statement of cash flows:


Statement of Cash FlowsHwkE11

Laguna Corporation Statement of Cash Flows

For the Year Ended December 31, 2010

Net cash flows from operating activities $30,000 Net cash flows from investing activities (91,000)Net cash flows from financing activities 92,000Net increase (decrease) in cash $31,000 Cash at beginning of year 15,000Cash at end of year $46,000

All three sections are presented in summary form here, followed by the net increase or decrease in cash:


Noncash Transaction Illustrated

Laguna Corporation issued bonds at face value ($100,000) for plant assets. There are no cash inflows or outflows, but it is a significant transaction.

Schedule of Noncash Investing and Financing Transactions:

Issue of bonds payable for plant assets $100,000

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13–1 chapter 13 the statement of cash flows. 13–2 copyright © cengage learning. all rights...

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