copyright © cengage learning. all rights reserved. chapter 13 the statement of cash flows

Copyright © Cengage Learning. All rights reserved.

Chapter 13

The Statement of Cash Flows

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

Overview of the Statement of Cash Flows

• Objective 1– Describe the principal purposes and uses of the statement

of cash flows, and identify its components.


Shows how a company’s operating, investing, and financing activities

have affected cash during an accounting period

The Statement of Cash Flows

• Explains the net increase (or decrease) in cash during the accounting period


Cash and Cash Equivalents

• Cash includes cash and cash equivalents– Cash

• Money on hand

• Deposits in company checking accounts

– Cash equivalents• Can be quickly converted to cash

• Maturity of 90 days or less– Money market accounts

– Commercial paper

– U.S. Treasury bills

• Combined with the Cash account on the statement of cash flows


Purposes of the Statement of Cash Flows

• Provides information about a company’s cash receipts and cash payments during an accounting period.

• Provides information about a company’s operating, investing, and financing activities.


Uses of the Statement of Cash Flows

• Management uses the statement of cash flows as follows:– Assess liquidity

• Determine if short-term financing is necessary

– Determine dividend policy• Decide whether to raise or lower dividends

– Evaluate the effects of investment and financing decisions

• Plan for investing and financing needs


Uses of the Statement of Cash Flows (cont’d)

• Investors and creditors use the statement of cash flows to assess a company’s ability to– Manage cash flows

– Generate positive future cash flows

– Pay its liabilities

– Pay dividends and interest

– Anticipate its need for additional financing


1. Operating activities

2. Investing activities

3. Financing activities

Classification of Cash Flows

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


Cash InflowsReceipts from sale of goods and services Receipts from sale of trading securitiesInterest and dividends

Cash OutflowsPayments 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.

Operating Activities

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


Cash Inflows Receipts from selling

marketable securities and long-term assets

Collections on loans

Cash Outflows Expenditures on

purchase of securities and assets

Cash lent to borrowers

Investing ActivitiesInvolve 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

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Cash Inflows Proceeds from stock

issues and from short- and long-term borrowing

Cash Outflows Repayments of loans

(excluding interest) Payments to owners,

including cash dividends Treasury stock

transactions

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)


Classification of Cash Inflows and Cash Outflows


Classification of Cash Inflows and Cash Outflows (cont’d)


Required Disclosure of 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 liabilitySettle 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 disclose

these transactions in a separate schedule or as

part of the statement


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, dividend, and treasury stock transactions

1

2

3

4

Format of the Statement of Cash Flows


Analyzing Cash Flows

• Objective 2– Analyze the statement of cash flows.


Ratios used to calculate CGE:

Cash flow yield Cash flows to sales Cash flows to assets

Cash-Generating Efficiency (CGE)

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


Marriott 2004 Annual Report (in millions)2004 2003 2002

Net Sales $10,099 $9,014 $8,415

Total Assets 8,668 8,177 8,296

Shows how much of net sales actually results in cash inflows

Amazon.com generated positive cash flows to sales of 9.5 percent.

Sales

Activities Operating from FlowsCash Net Sales toFlowsCash

9.5% $14,835

$1,405

Cash Flows to Sales

Amazon.com2007 2006 2005

Net Sales $14,835 $10,711 $8,490

Total Assets 6,485 4,363 3,696


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

$1,405

Cash Flows to Assets

Amazon.com2007 2006 2005

Net Sales $14,835 $10,711 $8,490

Total Assets 6,485 4,363 3,696


Operating Activities

• Objective 3– Use the indirect method to determine cash flows from

operating activities.


Determining Cash Flows from Operating Activities

• There are two methods of converting the income statement from an accrual basis to a cash basis.– The direct method

• Adjusts each item in the income statement to its cash equivalent

• More easily understood by the average reader

– 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

• Both methods produce the same net figure.


Indirect Method:Determining Net Cash Flows from Operating Activities


Adjustment: Depreciation

expense added back to net

income for the period

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

DepreciationDepreciation expense appears on the income

statement, but involves no outlay of cash.


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






Gains and Losses


Changes in Current Assets

• Decreases in current assets (frees up cash) have a positive effect on cash flows.

• Increases in current assets (consumes cash) have a negative effect on cash flows.

• To reconcile net income to cash flows, a decrease is added to net income and an increase is subtracted from net income.

• Exclude Short Term Investments


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 $4,000 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 Assets


Changes in Current Liabilities

• Increases in current liabilities represent a postponement of cash payments and increases cash flows

• Decreases in current liabilities represent the use of cash, thereby decreasing cash flows

• Exclude Notes Payable


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

544,000

547,000Cash Paid to Suppliers Purchases

Changes in Current Liabilities







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

Net Income versus Cash Flows from Operating Activities


Add to or Deduct from Net Income

Depreciation expense Add Amortization expense Add Depletion expense Add Losses Add Gains Deduct

Items on the Income Statement That Do Not Affect Operating Cash Flows


Add to Net Income

Deduct from Net Income

Current Assets:

A/R Decrease Increase

Inventory Decrease Increase

Prepaid expenses Decrease Increase

Current Liabilities:

A/P Increase Decrease

Accrued Liabilities Increase Decrease

Income Taxes Payable

Increase Decrease

Adjustments for Changes in Current Assets and Liabilities


Investing Activities

• Objective 4– Determine cash flows from investing activities.


Cash Flows from Investing Activities

• Analyze increases and decreases in the Investments account to determine effects on Cash account

• Objective– Explain the change in each account balance from one

year to the next

• Focus – Long-term assets (balance sheet)

– Short-term investments (current asset section of the balance sheet)

– Investment gains and losses (income statement)


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

Investment Transactions Cash Flows Illustrated


1. Amir Corporation purchased plant assets totaling $60,000. These transactions caused a $60,000 decrease in cash flows (cash paid).

2. Amir sold plant assets that cost $5,000 and that had accumulated depreciation of $1,000 for $2,500. This transaction resulted in a loss of $1,500 and caused an increase in cash flows of $2,500 (cash received).


Purchase of plant assets ($60,000) Sale of plant assets 2,500

Plant Asset Transactions Cash Flows Illustrated

Examine the Plant Assets account and the related Accumulated Depreciation account


1. Laguna Corporation purchased plant assets totaling $120,000. 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 $5,000 (cash received).


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

Plant Asset Transactions Cash Flows Illustrated

Examine the Plant Assets account and the related Accumulated Depreciation account.


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

Noncash Transaction Illustrated


Financing Activities

• Objective 5– Determine cash flows from financing activities.


Cash Flows fromFinancing Activities

• Analysis similar to investing activities, including treatment of related gains or losses.

• Focus– Short-term borrowings

– Long-term liabilities

– Stockholders’ equity accounts

• Cash dividends from the statement of stockholders’ equity must also be considered.


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)

Bonds Payable 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).


Issue of common stock $175,000

Common Stock Transactions Cash Flows Illustrated


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


Payment of dividends $8,000

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

Dividend Transactions Cash Flows Illustrated


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


Purchase of treasury stock ($25,000)

Treasury Stock Transactions Cash Flows Illustrated


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:

Cash Flows from Financing Activities


Statement of Cash Flows

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Stop & Review

1. Dividends paid

2. Cash receipts from sales

3. Decrease in accounts receivable

4. Sale of plant assets

5. Gain on sale of investment

6. Issue of stock for plant assets

7. Issue of common stock

8. Net income

a) As cash flows from operating activities

b) As cash flows from investing activities

c) As cash flows from financing activities

d) In the schedule of noncash investing and financing transactions

e) Not at all

13-46

Using the indirect method to prepare the statement of cash flows, tell where each of items on the left would appear on the statement sections listed on the right:


a) As cash flows from operating activitiesb) As cash flows from investing activitiesc) As cash flows from financing activitiesd) In the schedule of noncash investing and financing transactionse) Not at all

1. Dividends paid2. Cash receipts from sales3. Decrease in accounts receivable4. Sale of plant assets5. Gain on sale of investment6. Issue of stock for plant assets7. Issue of common stock8. Net income

1. c2. e3. a4. b5. a6. d7. c8. a

Stop & Review (cont’d)

ANSWER:


Chapter Review

1. Describe the principal purposes and uses of the statement of cash flows, and identify its components.

2. Analyze the statement of cash flows.

3. Use the indirect method to determine cash flows from operating activities.

4. Determine cash flows from investing activities.

5. Determine cash flows from financing activities.

copyright © cengage learning. all rights reserved. chapter 13 the statement of cash flows

Documents

cash payments

cash equivalents cash

cash account

cash maturity

companys cash receipts

cash inflows receipts

accounts cash equivalents

assets cash lent