Cash flow

CH 2

Learning Objective 1

Identify cash flows arisingfrom operating, investing,and financing activities.

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OperationsOperationsCash received and paidCash received and paidfor day-to-day activitiesfor day-to-day activities

with customers, suppliers,with customers, suppliers,and employees.and employees.

InvestingCash paid and receivedfrom buying and selling

long-term assets.

FinancingCash received and paid

for exchanges withlenders and stockholders.

Business Activities and Cash FlowsThe Statement of The Statement of

Cash Flows focuses Cash Flows focuses attention on: attention on:

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CashChecking and Savings Accounts

Cash Equivalents

Highly liquid short-term investmentswithin three months of maturity.

Business Activities and Cash Flows

Currency

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Classifying Cash Flows

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Cash inflows and outflows that directly relate to revenues and expenses reported on the

income statement.

Operating Activities

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Direct and Indirect Reportingof Operating Cash Flows

We will concentrate on the indirect method for now, and wewill look at the direct method again later in the chapter.

Same result

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Investing Activities

Under Armour’s 2008 Investing Activities

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Financing Activities

Under Armour’s 2008 Financing Activities

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Relationships Between Classified Balance Sheet and Statement of Cash Flow (SCF) Categories

SCF Categories

Operating Current Assets Current Liabilities

Classified Balance Sheet CategoriesSCF Categories

Operating Current Assets Current Liabilities

Classified Balance Sheet CategoriesSCF Categories

Operating Current Assets Current Liabilities

Investing Noncurrent Assets

Classified Balance Sheet CategoriesSCF Categories

Operating Current Assets Current Liabilities

Investing Noncurrent Assets

Classified Balance Sheet CategoriesSCF Categories

Operating Current Assets Current Liabilities

Investing Noncurrent Assets Noncurrent Liabilities

Financing Stockholders' Equity

Classified Balance Sheet CategoriesSCF Categories

Operating Current Assets Current Liabilities

Investing Noncurrent Assets Noncurrent Liabilities

Financing Stockholders' Equity

Classified Balance Sheet Categories

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Relationship to Other Financial Statements

Information needed to prepare a statement of cash flows: Comparative Balance Sheets. Income Statement. Additional details concerning selected accounts.

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Relationship to Other Financial Statements

Recall that the basic Balance Sheet equation is:

We can recast the equation as follows:

The following equation is true:

From this basic Balance Sheet equation, wedevelop our model to solve for the change in cash:

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Learning Objective 2

Report cash flows from operating activities, using

the indirect method.

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Cash Flows from Operating Activities - Indirect Method

Net Income

Cash Flows from Operating

Activities - Indirect Method

Changes in current assets and current liabilities.

+ Losses and - Gains

+ Noncash expenses such as depreciation and

amortization.

The indirect method adjusts net incomeby analyzing noncash items.

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Use this table when adjusting Net Income to Operating Cash Flows using the indirect method.

Relationships to the Balance Sheet and the Income Statement

Change in accountbalances during the year

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Use the following financial statements for Under Armour,

Inc. and prepare the Statement of Cash Flows for the year

ended December 31, 2008.

Statement of Cash FlowsIndirect Method Example

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Statement of Cash FlowsIndirect Method Example

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Statement of Cash FlowsIndirect Method Example

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The Statement of Cash Flows

using the indirect

method will begin with

Under Armor, Inc.’s net

income from the Income Statement.

Statement of Cash FlowsIndirect Method Example

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Direct and Indirect Reportingof Operating Cash Flows

When using the indirect method, start with accrual basis net income and adjust it for:1.items that are included in net income but do not involve cash, and 2.items that are not included in net income but do involve cash.

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Next, adjust for the non-cash items includedin net income.

For Under Armour, the only non-cash adjustmentis for depreciation.

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Accumulated Depreciation increased by $16, from $31 in the Accumulated Depreciation increased by $16, from $31 in the 2007 Balance Sheet to $47 in the 2008 Balance sheet. The 2007 Balance Sheet to $47 in the 2008 Balance sheet. The

same $16 is shown as Depreciation in the 2008 Income same $16 is shown as Depreciation in the 2008 Income Statement. Statement.

To complete the cash flows from operating activities section, To complete the cash flows from operating activities section, we must examine comparative balance sheets to determine we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the the changes in current assets and current liabilities from the

beginning of the period to the end of the period.beginning of the period to the end of the period.12-22

Statement of Cash Flows Indirect Method ExampleThese five items were shown earlier in the current portions of

Under Armour’s comparative Balance Sheets for 2007 and 2008

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Learning Objective 3

Report cash flows from investing activities.

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Reporting Cash Flows from Investing Activities

We will need this additional data to preparethe investing portion of the statement.

1. No disposals or impairments of equipment or intangibles occurred

2. Equipment costing $36 million and intangibles costing $2 million were purchased with cash.

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Under Armour, Inc., has two investing activities on the Statement of Cash Flows that required the use of cash:1. Purchase of equipment, and2. Purchase of intangible and other assets.

Reporting Cash Flows from Investing Activities

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Learning Objective 4

Report cash flows from financing activities.

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Reporting Cash Flows from Financing Activities

We will need this additional data to preparethe financing portion of the statement.

1. No dividends were declared or paid.2. Long-term debt of $7 million was paid.3. $16 million in new long-term loans were

issued.4. Shares of stock were issued for $12 million.

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Reporting Cash Flows from Financing Activities

Long-term debt increased because of $16 inLong-term debt increased because of $16 innew loans during the year. The long-term debtnew loans during the year. The long-term debt

increase is a cash inflow.increase is a cash inflow.

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Reporting Cash Flows from Financing Activities

Payments on long-term debt resulted in a cash outflow of Payments on long-term debt resulted in a cash outflow of $7. The net effect of these two long-term debt $7. The net effect of these two long-term debt

transactions increased long-term debt by $9, from $14 on transactions increased long-term debt by $9, from $14 on the 2007 Balance sheet to $23 on the 2008 Balance Sheet. the 2007 Balance sheet to $23 on the 2008 Balance Sheet.

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Reporting Cash Flows from Financing Activities

The third financing activity is the issuance of common stock The third financing activity is the issuance of common stock resulting in a cash inflow of $12. Contributed Capital increased from resulting in a cash inflow of $12. Contributed Capital increased from

$163 in the 2007 Balance Sheet to $175 in the 2009 Balance Sheet.$163 in the 2007 Balance Sheet to $175 in the 2009 Balance Sheet.

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Now we can reconcile the change in cash to the ending $102 cash balance that appears on the Balance Sheet.

Reporting Cash Flows from Financing Activities

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Noncash Investing andFinancing Activities

Required Supplemental Information:

1. Cash paid for taxes and interest.

2. Significant non-cash investing and financing activities.

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Learning Objective 5

Interpret cash flows from operating, investing, and

financing activities.

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• Operating cash flows must be positive over the long-run for a company to be successful.

• An upward trend in operating cash flows over time indicates growth and efficient operations.

Evaluating Cash Flows

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Quality ofIncomeRatio

Net Cash Flow from Operating ActivitiesNet Income

=

A measure for determining what portion ofa company’s income was generated in cash.

A ratio near 1.0 indicates a high likelihood that A ratio near 1.0 indicates a high likelihood that revenues are realized in cash and that expensesrevenues are realized in cash and that expenses

are associated with cash outflows.are associated with cash outflows.

Evaluating Cash Flows

Quality ofIncomeRatio

7938

= = 2.08 for Under Armour in 2008

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CapitalAcquisitions

Ratio

Net Cash Flow from Operating ActivitiesCash Paid for Property, Plant, and Equipment

=

A measure for determining whether a company is generatingenough cash internally to purchase long-term assets.

A ratio greater than 1.0 indicates that outsideA ratio greater than 1.0 indicates that outsidefinancing was not needed to purchase long-term assets.financing was not needed to purchase long-term assets.

Evaluating Cash Flows

CapitalAcquisitions

Ratio

7936

= = 2.19 for Under Armour in 2008

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Learning Objective 6

Report and interpret cash flows from operating activities

using the direct method.

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Reporting Operating Cash Flows with the Direct Method

Provides more detailed information

Identifies cash inflows and

outflows relationships

Prepared by adjusting accrual

basis to cash basis

Investing and financing sections

for the two methods are identical

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When we prepared the operating section using the indirect method, we also arrived at net cash inflow of $79.

Let’s see how we arrive at these cash flows.

Direct Method Operating Activities

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Net Sales 725$ Cost of goods sold 370$ + Decrease in accounts receivable 13 + Increase in inventory 16

= Cash collected from customers 738$ – Increase in accounts payable (17)

= Cash payments to suppliers 369$

Interest expense 7$ SG&A expenses 262$

No change in interest payable 0 + Increase in prepaid expenses 9

Cash paid for interest 7$ – Increase in accrued liabilities (20)

= Cash payments for expenses 251$

Income tax expense 32$ No change in taxes payable 0Cash paid for income tax 32$

With the direct method, we convert each revenue and expense on the income statement to a cash flow.

Direct Method Operating Activities

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Supplement 12A

Reporting Sales of Property, Plant, and Equipment (Indirect Method)

Depreciation Expense

Loss on Saleof PPE

A loss on the sale of PPE is added back to net income just as

depreciation expense is added back. Adding these noncash items restores

net income to what it would have been had depreciation and the loss

not been subtracted at all.

Just the opposite is true for a gain on the sale of PPE. Subtracting the gain reverses the effect of the gain having

been added to net income.

Gain on Saleof PPE

Reporting Sales of Property, Plant, and Equipment (PPE) (Indirect)

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Supplement 12B

Spreadsheet Approach (Indirect Method)

A spreadsheet can be used to ensure that no reportable activities are inadvertently

overlooked.

Reconstructing the events and transactions that occurred during the period helps identify the

operating, investing and financing activities to be reported.

Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.

Spreadsheet Approach(Indirect Method)

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We begin by entering the

beginning and ending balances for each account

on the comparative

balance sheets.

The cash inflows and outflows

columns will be used later to explain the

changes in each account balance.

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Dec. 31, 2007 Debits Credits

Dec. 31, 2008

Items from Balance SheetCash and Cash Equivalents (A) 40 102 Accounts Receivable (A) 94 81 Inventories (A) 166 182 Prepaid Expenses (A) 22 31 Equipment (A) 84 120 Accumulated Depreciation (xA) 31 47 Intangible and other Assets (A) 16 18 Accounts Payable (L) 55 72 Accrued Liabilities (L) 41 61 Long-term Debt (L) 14 23 Contributed Capital (SE) 163 175 Retained Earnings (SE) 118 156

Inflows OutflowsStatement of Cash Flows

UNDER ARMOUR, INC.Spreadsheet for the Statement of Cash Flows

Changes

Cash

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Changes in balance sheet accounts are

analyzed in terms of debits and

credits in the top half of the

spreadsheet and recorded as cash

inflows and outflows in the

bottom half of the spreadsheet.

We will begin with operating activities.

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Dec. 31, 2007 Debits Credits

Dec. 31, 2008

Items from Balance SheetCash and Cash Equivalents (A) 40 102 Accounts Receivable (A) 94 C 13 81 Inventories (A) 166 D 16 182 Prepaid Expenses (A) 22 E 9 31 Equipment (A) 84 120 Accumulated Depreciation (xA) 31 B 16 47 Intangible and other Assets (A) 16 18 Accounts Payable (L) 55 F 17 72 Accrued Liabilities (L) 41 G 20 61 Long-term Debt (L) 14 23 Contributed Capital (SE) 163 175 Retained Earnings (SE) 118 A 38 156

Inflows OutflowsStatement of Cash FlowsOperating Activities:Net income A 38 Adjustments to reconcile net income to cash Depreciation B 16 Changes in assets and liabilities Accounts Receivable decrease C 13 Inventories increase D 16 Prepaid Expenses increase E 9 Accounts Payable increase F 17 Accrued Liabilities increase G 20

UNDER ARMOUR, INC.Spreadsheet for the Statement of Cash Flows

Changes

Cash

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Dec. 31, 2007 Debits Credits

Dec. 31, 2008

Items from Balance SheetCash and Cash Equivalents (A) 40 M 62 102 Accounts Receivable (A) 94 81 Inventories (A) 166 182 Prepaid Expenses (A) 22 31 Equipment (A) 84 H 36 120 Accumulated Depreciation (xA) 31 47 Intangible and other Assets (A) 16 I 2 18 Accounts Payable (L) 55 72 Accrued Liabilities (L) 41 61 Long-term Debt (L) 14 K 7 J 16 23 Contributed Capital (SE) 163 L 12 175 Retained Earnings (SE) 118 156

Inflows OutflowsStatement of Cash FlowsInvesting activities Purchase of equipment H 36 Purchase of intangible and other assets I 2

Financing activities Additional borrowings of long-term debt J 16 Payments of long-term debt K 7 Proceeds from stock issuance L 12

Net increase in cash and cash equivalents M 62

UNDER ARMOUR, INC.Spreadsheet for the Statement of Cash Flows

Changes

Cash

Changes in balance sheet accounts are

analyzed in terms of debits and

credits in the top half of the

spreadsheet and recorded as cash

inflows and outflows in the

bottom half of the spreadsheet. Now we will complete the analysis with

investing andfinancing activities.

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The top of the completed

spreadsheet is shown here.

Spreadsheet Approach(Indirect Method)

Dec. 31, 2007 Debits Credits

Dec. 31, 2008

Items from Balance SheetCash and Cash Equivalents (A) 40 M 62 102 Accounts Receivable (A) 94 C 13 81 Inventories (A) 166 D 16 182 Prepaid Expenses (A) 22 E 9 31 Equipment (A) 84 H 36 120 Accumulated Depreciation (xA) 31 B 16 47 Intangible and other Assets (A) 16 I 2 18 Accounts Payable (L) 55 F 17 72 Accrued Liabilities (L) 41 G 20 61 Long-term Debt (L) 14 K 7 J 16 23 Contributed Capital (SE) 163 L 12 175 Retained Earnings (SE) 118 A 38 156

132 132

UNDER ARMOUR, INC.Spreadsheet for the Statement of Cash Flows

Changes

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Spreadsheet Approach(Indirect Method)

The bottom of the completed

spreadsheet is shown here.

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Chapter 12Solved Exercises

E12-2, E12-3, E12-4, E12-5, E12-6, E12-7

End of Chapter 12