Statement of Cash Flows Statement of Cash Flows answers questions such as: answers questions such as:

• Is the company generating sufficient positive cash Is the company generating sufficient positive cash flows from its ongoing operations to remain viable?flows from its ongoing operations to remain viable?

• Will the company be able to meet its financial Will the company be able to meet its financial obligations to creditors?obligations to creditors?

• Will the company be able to pay its customary cash Will the company be able to pay its customary cash dividend?dividend?

• Why is there a difference between net income and Why is there a difference between net income and net cash flow for the year?net cash flow for the year?

• To what extent will the company have to borrow To what extent will the company have to borrow money in order to make needed investments?money in order to make needed investments?

Statement of Cash FlowsStatement of Cash Flows

• Reports the Reports the CashCash Effects Effects– of an enterprise’s operations (of an enterprise’s operations (through CA & CLthrough CA & CL))

– its investing transactions (LT Assets)its investing transactions (LT Assets)

– its financing transactions (LT Liabilities & its financing transactions (LT Liabilities & Owners’ Equity)Owners’ Equity)

• Should Reconcile Net Income to Net Cash Should Reconcile Net Income to Net Cash Flow from operating activitiesFlow from operating activities

Statement of Cash Flows:Statement of Cash Flows:Investing ActivitiesInvesting ActivitiesCash Received From:Cash Received From:• Collection of principal from debtorsCollection of principal from debtors• Sale of loans to third partiesSale of loans to third parties• Sale of debt or equity securities of other entitiesSale of debt or equity securities of other entities• Sale of property, plant & equipmentSale of property, plant & equipment

Cash Paid For:Cash Paid For:• Loans made or purchased by the entityLoans made or purchased by the entity• Purchase of debt or equity securities of other Purchase of debt or equity securities of other

entitiesentities• Purchase of property, plant & equipmentPurchase of property, plant & equipment

Statement of Cash Flows:Statement of Cash Flows:Financing ActivitiesFinancing ActivitiesCash Received From:Cash Received From:• Issuance of equity securities (stock)Issuance of equity securities (stock)• Sale of bonds, mortgages, notes & other short-Sale of bonds, mortgages, notes & other short-

term or long-term borrowingsterm or long-term borrowings

Cash Paid For:Cash Paid For:• Cash dividendsCash dividends• Purchase of treasury stockPurchase of treasury stock• Repayment of principal on amounts borrowedRepayment of principal on amounts borrowed

Statement of Cash Flows:Statement of Cash Flows:Operating ActivitiesOperating ActivitiesCash Received From:Cash Received From:• Producing & selling goodsProducing & selling goods• Providing servicesProviding services• InterestInterest• DividendsDividends• otherother

Cash Paid For:Cash Paid For:• InventoryInventory• Salaries & wagesSalaries & wages• Taxes, duties, fines, fees, penaltiesTaxes, duties, fines, fees, penalties• InterestInterest• Other expensesOther expenses

Balance Sheet: 8 Major ClassificationsBalance Sheet: 8 Major Classifications1) Current Assets1) Current Assets

– CashCash– Short-Term InvestmentsShort-Term Investments– ReceivablesReceivables– InventoriesInventories– Prepaid ExpensesPrepaid Expenses

2) Long-Term 2) Long-Term InvestmentsInvestments

3) Property, Plant & 3) Property, Plant & EquipmentEquipment

4) Intangible Assets4) Intangible Assets5) Other Assets5) Other Assets

6) Current Liabilities6) Current Liabilities7) Long-Term Liabilities7) Long-Term Liabilities8) Owners’ Equity8) Owners’ Equity

– Capital StockCapital Stock– Additional Paid-in CapitalAdditional Paid-in Capital– Retained EarningsRetained Earnings– Treasury StockTreasury Stock– Other Items of Other Items of

Comprehensive IncomeComprehensive Income

Direct MethodDirect Method• Requires a supplemental Requires a supplemental

reconciliation of net reconciliation of net income to cash flow from income to cash flow from operating activities.operating activities.

• Net income is Net income is reconstructed on a cash reconstructed on a cash basis.basis.

• Used by 2.5% of Used by 2.5% of companies.companies.

Indirect MethodIndirect Method• No supplemental No supplemental

schedule is required.schedule is required.

• Net income is reconciled Net income is reconciled to cash flow from to cash flow from operating activities. operating activities.

• Used by 97.5% of Used by 97.5% of companies.companies.

Statement of Cash Flows:Statement of Cash Flows:Direct vs. Indirect MethodsDirect vs. Indirect Methods

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CASH FLOW FROM OPERATING ACTIVITIES:CASH FLOW FROM OPERATING ACTIVITIES:Net IncomeNet Income+ “Non-cash” Expenses+ “Non-cash” Expenses- “Non-cash” Revenues- “Non-cash” Revenues- Increases in Current Assets- Increases in Current Assets+ Decreases in Current Assets+ Decreases in Current Assets- Decreases in Current Liabilities- Decreases in Current Liabilities+ Increase in Current Liabilities+ Increase in Current Liabilities+/- Losses & Gains Reported on the Income Statement+/- Losses & Gains Reported on the Income Statement= Net Cash Flow from Operating Activities= Net Cash Flow from Operating Activities

CASH FLOW FROM INVESTING ACTIVITIES:CASH FLOW FROM INVESTING ACTIVITIES:+ Net Decrease in all other Long Term Assets+ Net Decrease in all other Long Term Assets- Net Increase in all other Long Term Assets- Net Increase in all other Long Term Assets= Net Cash Flow from Investing Activities= Net Cash Flow from Investing Activities

CASH FLOW FROM FINANCING ACTIVITIES:CASH FLOW FROM FINANCING ACTIVITIES:+ Net Decrease in all other LT Liabilities & Equities+ Net Decrease in all other LT Liabilities & Equities- Net Increase in all other LT Liabilities & Equities- Net Increase in all other LT Liabilities & Equities= Net Cash Flow from Financing Activities= Net Cash Flow from Financing Activities

Statement of Cash FlowsStatement of Cash Flows

• Reports the Reports the CashCash Effects Effects– of an enterprise’s operations (of an enterprise’s operations (through CA & CLthrough CA & CL))

– its investing transactions (LT Assets)its investing transactions (LT Assets)

– its financing transactions (LT Liabilities & its financing transactions (LT Liabilities & Owners’ Equity)Owners’ Equity)

• Should Reconcile Net Income to Net Cash Should Reconcile Net Income to Net Cash Flow from operating activitiesFlow from operating activities

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CASH FLOW FROM OPERATING ACTIVITIES:CASH FLOW FROM OPERATING ACTIVITIES:Net IncomeNet Income+ “Non-cash” Expenses+ “Non-cash” Expenses- “Non-cash” Revenues- “Non-cash” Revenues- Increases in Current Assets- Increases in Current Assets+ Decreases in Current Assets+ Decreases in Current Assets- Decreases in Current Liabilities- Decreases in Current Liabilities+ Increase in Current Liabilities+ Increase in Current Liabilities+/- Losses & Gains Reported on the Income Statement+/- Losses & Gains Reported on the Income Statement= Net Cash Flow from Operating Activities= Net Cash Flow from Operating Activities

CASH FLOW FROM INVESTING ACTIVITIES:CASH FLOW FROM INVESTING ACTIVITIES:+ Net Decrease in all other Long Term Assets+ Net Decrease in all other Long Term Assets- Net Increase in all other Long Term Assets- Net Increase in all other Long Term Assets= Net Cash Flow from Investing Activities= Net Cash Flow from Investing Activities

CASH FLOW FROM FINANCING ACTIVITIES:CASH FLOW FROM FINANCING ACTIVITIES:+ Net Decrease in all other LT Liabilities & Equities+ Net Decrease in all other LT Liabilities & Equities- Net Increase in all other LT Liabilities & Equities- Net Increase in all other LT Liabilities & Equities= Net Cash Flow from Financing Activities= Net Cash Flow from Financing Activities

Interpretation of the Statement of Interpretation of the Statement of Cash FlowsCash Flows

Examine the Examine the operating operating activities activities section carefully.section carefully.– Negative cash flow is usually a Negative cash flow is usually a

sign of fundamental difficulties.sign of fundamental difficulties.– Ultimately, a positive cash flow is Ultimately, a positive cash flow is

necessary to avoid liquidating necessary to avoid liquidating assets or borrowing money to assets or borrowing money to pay for day-to-day activities.pay for day-to-day activities.

Evaluate Financial Liquidity:

Net Cash Provided by OperationsNet Cash Provided by Operations

Average Current LiabilitiesAverage Current Liabilities

= Current Cash Debt Coverage = Current Cash Debt Coverage RatioRatio

Evaluate Financial Flexibility:

Net Cash Provided by Net Cash Provided by OperationsOperations

Average Total LiabilitiesAverage Total Liabilities

= Cash Debt Coverage Ratio= Cash Debt Coverage Ratio

Net Cash Provided by Net Cash Provided by OperationsOperations

- - Capital ExpendituresCapital Expenditures

- - Cash used for dividendsCash used for dividends

= = Free Cash FlowFree Cash Flow

Evaluate Financial Flexibility: