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CASH FLOW ANALYSISMonique Flores ~ Mariel de Lara ~ Jae Young Manabat Learning objectivesDescribe the nature and purposes of the Statement of Cash FlowsDefine cash and cash equivalentsState the general rules for determining whether transactions should be classified as operating, investing or financing activitiesDescribe the content and form of Statement of Cash FlowsExplain the differences between the direct method and indirect methodCompute the net cash flow provided by operating activities using the direct and indirect methodPrepare the Statement of Cash Flows using both visual inspection method and worksheet method

CONTENT AND FORM OF THE STATEMENT OF CASH FLOWSNet cash provided or used by:Operating ActivitiesInvesting ActivitiesFinancing Activities

B. Net effect of those inflows and outflows on Cash and Cash EquivalentsReporting Requirement #1Report cash flows from operating activitiesusing either:Direct MethodIndirect MethodDirect MethodIn reporting the cash flows from operating activities enterprises are encouraged to report major classes of gross receipts and gross cash payments and the net cash flow from operating activities.5Under the direct method, for this example, you would then report the following in the cash flows from operating activities section of the cash flow statement: Cash Inflows from Operating ActivitiesCash receipts from customersInterest and dividends collectedOther operating receiptsCash Outflows for Operating ActivitiesCash payments to suppliersCash paid for operating expensesInterest paidOther operating paymentsTaxes paidEquals net cash provided by (used in) operating activities

6Cash receipts from customers:Net sales per the income statementPlus beginning balance in accounts receivableMinus ending balance in accounts receivablePlus ending balance in deferred revenueMinus beginning balance in deferred revenueEquals cash receipts from customers

7Interest and Dividends CollectedInterest revenue and dividend income per income statementPlus beginning balance in interest receivableMinus ending balance in interest receivablePlus amortization of premium on investment in bondsorMinus amortization of discount on investment in bondsEquals interest and dividends collected

8Other operating receiptsOther revenues per income statementPlus ending balance in unearned revenuesMinus beginning balance in unearned revenuesMinus gains on disposal of assets and liabilitiesMinus investment income (equity method)Equals cash inflows from other operating receipts9Cash payments to suppliers:Cost of goods soldPlus ending inventoryMinus beginning inventoryPlus beginning balance in accounts payable to vendorsMinus ending balance in accounts payable to vendorsEquals cash payments for inventory10Cash paid for operating expenses:Operating expenses per income statementMinus depreciation expenses, depletion and amortizationPlus ending balance in prepaid expensesMinus ending balance in prepaid expensesPlus beginning balance in accrued expensesMinus ending balance in accrued expensesEquals cash paid for operating expenses

11Interest paid:Interest expense per the income statementPlus beginning balance in interest payableMinus ending balance in interest payablePlus amortization of premium on bonds payable orMinus amortization of discount on bonds payableEquals interest paid12Other operating payments:Other expenses per income statementMinus losses on disposal of assets and liabilitiesMinus investment loss (equity method)Equals other operating payments13Taxes paid:Tax expense per the income statementPlus beginning balance in taxes payableMinus ending balance in taxes payablePlus beginning balance in deferred tax liabilityorMinus ending balance in deferred tax liabilityEquals taxes paid14Indirect MethodIn preparing the cash flows from operating activities section under the indirect method, you start with net income per the income statement, reverse out entries to income and expense accounts that do not involve a cash movement, and show the change in net working capital.

Entries that affect net income but do not represent cash flows could include income you have earned but not yet received, amortization of prepaid expenses, accrued expenses, and depreciation or amortization. Under this method you are basically analyzing your income and expense accounts, and working capital. 15The following is an example of how the indirect method would be presented on the cash flow statement:Net income after taxesPLUSA decrease in current assets would be shown as a positive figure, because other current assets were converted into cash.An increase in current liabilities (excluding short-term debt which would be reported in the financing activities section) would be shown as a positive figure since more liabilities mean that less cash was spent.Depreciation, depletion and amortization expenseAmortization of discount on bonds payableAmortization of premium on investment in bondsIncreased in deferred income taxesLoss (net) on disposal of assets or liabilitiesInvestment loss under the equity methodInterest expenseIncome taxes

16ContinuationMINUSAn increase in current assets (excluding cash and cash equivalents) would be shown as a negative figure because cash was spent or converted into other current assets, thereby reducing the cash balance.A decrease in current liabilities would be shown as a negative figure, because cash was spent in order to reduce liabilities.Amortization of premium on bond payableAmortization of Discount on investment in bondsDecrease in deferred income taxesGain (net) on disposal of assets or liabilitiesInvestment income under the equity method

17EQUALSNet Cash Flow From OperationsLESSInterest paidIncome Taxes PaidNet Cash From Operating Activities18Example:The Menschken Company reported net income of $150,000 for the current year. Depreciation recorded on buildings and equipment amounted to $65,000 for the year. Balances of the current asset and current liability accounts at the beginning and end of the year are as follows:End of YearBeginning of YearCash $20,000$15,000Accounts receivable 19,00032,000Inventories 50,00065,000Accounts payable 12,00018,000InstructionsPrepare the cash flows from the operating activities section of the statement of cash flows using the indirect method.

19Solution:Net income $150,000Adjustments to reconcile net income to net cash provided by operating activities:Depreciation expense 65,000Decrease in accounts receivable 13,000Decrease in inventories 15,000Decrease in accounts payable (6,000)Net cash provided by operating activities $237,000

20Example:Assume the indirect method is used to compute cash flows from operations. For each item listed below, indicate the effect on net income in arriving at cash flows from operations by choosing one of the following code letters.CodeCash Flows From Operating ActivitiesAdd to Net Income ADeduct from Net Income D1.Increase in accounts receivable2.Increase in inventory3.Decrease in prepaid expenses4.Decrease in accounts payable5.Increase in accrued liabilities6.Increase in income taxes payable7.Depreciation expense8.Loss on sale of investment9.Gain on disposal of equipment10.Amortization expense21Solution:1.D2.D3.A4.D5.A6.A7.A8.A9.D10.A

22Reporting Requirement #2Report separately major classes of receiptsand payments arising from investing andfinancing activitiesReporting Requirement #3Cash flows arising from the following operating,investing or financing activities may be reported on anet basis:Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the entityCash receipts and payments for items in which the turnover is quick, the amounts are large and the maturities are short

Reporting Requirement #4Cash flows arising from each of the followingactivities of a financial institution may be reported ona net basis:Cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity datePlacement of deposits with and withdrawal of deposits from other financial institutionsCash advances and loans made to customers and the repayment of those advances and loans

Reporting Requirement #5Cash flows arising from transactions in a foreign currency that should be recordedin an entitys functional currencyReporting Requirement #6Cash flows from interest and dividendsreceived and paid should each be disclosedseparately.Reporting Requirement #7Cash flows arising from taxes on incomeshall be separately disclosed and shall beclassified as cash flows from operatingactivities.