The The Statement Statement

of Cash of Cash FlowsFlows

2

Describe the circumstances in which the cash flow statement is a particularly important companion of the income statement.

Outline the structure of and information reported in the three main categories of the cash flow statement: operating, investing, and financing.

Learning Objectives

3

Appreciate the historical process involved in the development of the modern statement of cash flows.

Compute cash flow from operations using either the direct or the indirect method.

Prepare a complete statement of cash flows and provide the required supplemental disclosures.

Learning Objectives

4

Learning Objectives

Understand the differences among cash flow statements prepared according to U.S. GAAP, U.K. GAAP, and International Accounting Standards.

Assess a firm’s financial strength by analyzing the relationships among cash flows from operating, investing, and financing activities and by computing financial ratios based on cash flow data.

5

Learning Objectives

Use knowledge of how the three primary financial statements tie together in order to prepare a forecasted statement of cash flows.

Use a T-account or work sheet approach to prepare a statement of cash flows.

EXPANDED MATERIAL

6What Good Is a Cash Flow Statement?

Does a statement of cash flows tell us anything we don’t already know from

other statements?

Does a statement of cash flows tell us anything we don’t already know from

other statements?

7What Good Is a Cash Flow Statement?

Yes, because there are situations where net

income does not give us an accurate picture.

Yes, because there are situations where net

income does not give us an accurate picture.

Also, everything you want to know about a

company is summarized in this one statement.

Also, everything you want to know about a

company is summarized in this one statement.

Finally, a statement of cash flows is an excellent

forecasting tool.

Finally, a statement of cash flows is an excellent

forecasting tool.

8

Purposes of Cash Flow Statement

• Statement of Cash Flows--The primary financial statement that summarizes an entity’s cash receipts and payments during a period.

• Predicts an entity’s ability to:– generate positive future cash flows.

– meet current and long-term obligations.

– pay future dividends.

9

Cash Equivalent

What is a cash equivalent?

What is a cash equivalent?

It is a short-term, highly liquid investment.

It is a short-term, highly liquid investment.

It must be readily convertible to cash and it must be so near to

maturity that there is insignificant risks of changes in value due to

changes in interest rate.

It must be readily convertible to cash and it must be so near to

maturity that there is insignificant risks of changes in value due to

changes in interest rate.

10

Three Categories of Cash Flows

Cash Inflows

OperatingActivities

InvestingActivities

FinancingActivities

11

Cash Flow CategoriesOperating Activities--Transactions and events that

enter into the determination of net income.Investing Activities--Transactions and events that

involve the purchase and sale of securities, property, plant, equipment, and other assets not generally held for resale, and the making and collecting of loans.

Financing Activities--Transactions and events whereby cash is obtained from or repaid to owners and creditors.

12General Format of aStatement of Cash Flows

Cash Provided by or Used in:

Operating Activities $XXX

Investing Activities XXX

Financing Activities XXX

Net Increase (Decrease) in Cash $XXX

Cash--Beginning of Year XXX

Cash--End of Year $XXX

13

Operating Activities

Cash Inflow

• Cash Receipt of Sales

• Collection of Receivables

• Interest Revenue

• Dividend Revenue

Cash Inflow

• Cash Receipt of Sales

• Collection of Receivables

• Interest Revenue

• Dividend Revenue

Cash Outflow

•Inventory Payments

•Interest Payments

•Wages

•Utilities

•Rent

Cash Outflow

•Inventory Payments

•Interest Payments

•Wages

•Utilities

•Rent

14

Investing Activities

Cash Inflow• Sale of plant assets

• Sale of securities, other than trading securities

• Collection of principal on loans

Cash Inflow• Sale of plant assets

• Sale of securities, other than trading securities

• Collection of principal on loans

Cash Outflow• Purchase of plant assets

• Purchase of securities, other than trading securities

• Making of loans with other entities

Cash Outflow• Purchase of plant assets

• Purchase of securities, other than trading securities

• Making of loans with other entities

15

Financing Activities

Cash Inflow• Issuance of own

stock

• Borrowings

Cash Inflow• Issuance of own

stock

• Borrowings

Cash Outflow• Dividend payments

• Repayment of loans

• Treasury stock purchase

Cash Outflow• Dividend payments

• Repayment of loans

• Treasury stock purchase

16

Noncash Transactions

Noncash Transactions--Investing and financing activities that do not affect an entity’s cash flow.

Significant transactions should be disclosed separately.

These transactions do not affect the statement of cash flows.

17

Reporting Operating Cash Flows

• Direct Method--A method of reporting net cash flows from operations that shows cash receipts and payments for a period of time. This method is more straight forward.

• Indirect Method--A method of reporting net cash flow from operations that involves reconciling net income to a cash basis. It shows how noncash flows affect net income.

18

The Direct Method

• This method reports directly the major classes of operating cash receipts and payments of an entity during a period.

• Accrual-basis revenues and expenses must be converted to equivalent cash receipts and payments.

• The amount of cash actually collected or paid is determined.

19

Sales and Cash Collected from Customers: Beginning accounts receivable $140

+ Sales 150= Cash available for collection $190- Ending accounts receivable 60= Cash collected from customers $130

Example: Cash Receipts

20

Cost of Goods Sold and Cash Paid for Inventory:Ending inventory $ 75

+ Cost of goods sold 80= Required inventory $155- Beginning inventory 100= Cash paid for inventory this year $ 55

Example: Inventory

21

Wages Expense and Cash Paid for Wages:Beginning wages payable $ 7

+ Wages expense 25= Total obligation to employee $32- Ending wages payable 10= Cash paid for wages $22

Example: Wages

22

Indirect Method

• Adjustments for receivables and other current operating assets.

• Adjustments for payables and other current liabilities.

• Adjustments for depreciation and other noncash items.

• Adjustments for gains and losses.

The indirect method makes the following adjustments:

23Adjustments for Gains and Losses

Gains or losses do not represent the cash effect of the transaction.

Adjustment toAccount Net Income

Losses

Gains

These adjustments are made to net income since the sale of an investment is an investing activity, not an operating activity.

These adjustments are made to net income since the sale of an investment is an investing activity, not an operating activity.

24

Adjustments for Receivables

Changes in accounts directly affect revenues recorded on an accrual basis.

Account Adjustment toAccount Change Net Income

Accounts Receivable

Accounts Receivable

25

Adjustments for Payables

Changes in liabilities mean the reverse of changes in current operating asset accounts.

Account Adjustment toAccount Change Net Income

Accounts Payable

Accounts Payable

26

Noncash Adjustments

• Depreciation and similar noncash items do not affect cash and are not reported on the statement of cash flows.

• Any noncash item that reduces net income should be added back to net income in the indirect method.

• Any noncash item that increases net income should be subtracted from net income in the indirect method.

27Relationship Between Net Income and Operating Cash Flow

Business engages in operating activities

Business engages in operating activities

Cash is received and disbursed

Cash is received and disbursed

Operating cash flowOperating cash flow

Net incomeNet income

Apply accrual accounting rulesApply accrual

accounting rules“Undo” accrual

accounting to get back to cash flow

“Undo” accrual accounting to get back to cash flow

28Steps for Preparing aCash Flow Statement

Compute how much the cash balance changed during the year.

Convert the income statement from an accrual-basis to a cash-basis summary of operations.

a. Eliminate expenses that do not involve the outflow of cash, such as depreciation.

b.Eliminate gains and losses associated with investing or financing activities.

c. Adjust for changes in the balances of current assets and current liabilities.

29

Analyze the long-term assets to identify the cash flow effects of investing activities.

Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions.

Make sure that the total net cash flow from operating, investing, and financing activities is equal to the net increase or decrease in cash as computed in Step 1. Then, prepare a formal statement of cash flows.

Prepare supplement disclosure of significant noncash transactions.

Steps for Preparing aCash Flow Statement

30Example: ComparativeBalance Sheet

Accounts PayableLong-Term Notes PayableCommon StockRetained EarningsTotal Liabilities and Equity

20X2 20X1AssetsCash and Cash EquivalentsAccounts ReceivableInventoryEquipmentAccumulated DepreciationTotal AssetsLiabilities and Equity

$ 82 180 170 200 (72)$560

$100 100 250 110$560

$ 40 150 200 140 (60)$470

$ 80 50 250 90$470

31

Income Statement, 20X1

Sales Expenses: Cost of Goods Sold Selling and General Expense Depreciation Interest ExpenseOperating IncomeGain from Sale of EquipmentIncome before Income TaxesIncome Tax ExpenseNet Income

$345

$120 58 20

2 200 $145 5 $140 30 $110

32

Cash 20X1........................... $ 40

Cash 20X2........................... 82

Change in Cash................... $ 42

Determine change in cash and cash equivalents:

Step 1

33

Convert from an accrual-basis to a cash-basis summary of operations:

Step 2

EXAMPLE: Eliminate depreciation expense, $44, because it does not require the use of cash.

EXAMPLE: Eliminate depreciation expense, $44, because it does not require the use of cash.

Cash Provided by Operations 44Accumulated Depreciation 44

(T-account or work sheet entry)

34

Convert from an accrual-basis to a cash-basis summary of operations:

Step 2

EXAMPLE: Eliminate the $5 gain from selling equipment.

EXAMPLE: Eliminate the $5 gain from selling equipment.

Cash 33Accumulated Depreciation 32

Equipment 60Gain on Sale of Equipment 5

Add back $5 to cash Add back $5 to cash provided by operations.provided by operations.

35

Analyze the long-term assets to identify the cash flow effects of investing activities.

Step 3

Expenditures for Property, Plant, and Equipment: Beginning equipment $140

- Equipment sold during the year 60= $ 80- Ending equipment 200= Expenditures for equipment during

year $120

36

Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions:

Step 4

Expenditures for Long-Term Debt: Beginning L-T notes payable balance $ 50

- Notes reacquired during the year 0= $ 50- Ending L-T notes payable balance 100= L-T notes payable issued during year $ 50

37

Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions:

Step 4

Payment of Dividends: Beginning retained earnings balance $ 90

+ Net income 110= $200- Ending retained earnings balance 110= Dividends paid $ 90

38

Steps 5 and 6

Steps 5 and 6 relate to actually preparing the

formal and supplementary

statements.

Steps 5 and 6 relate to actually preparing the

formal and supplementary

statements.

39

Cash Flows from Operating Activities: Net Income $110 Adjustments: Depreciation Expense 44 Gain on Sale of Equipment (5) Increase in Accounts Receivable (30) Decrease in Inventory 30 Increase in Accounts Payable 20 Net Cash Provided by Operating Activities $169

Operating Activities Section: Indirect Method

Continued on slide 42

Cash Flows from Operating Activities: Cash Collected from Customers $ 414 Cash Payments for:

Inventory (155) Selling & General Expenses

(58) Interest (2) Income Taxes (30)

$(245)

Net Cash Provided by Operating Activities $169

Operating Activities Section: Direct Method

Continued on slide 42

40

41Investing and Financing Activities Sections

The investing and financing sections are the same whether the

direct or indirect approach is used.

The investing and financing sections are the same whether the

direct or indirect approach is used.

42Investing and Financing Activities Sections

Cash Flows from Investing Activities: Proceeds from Sale of Equipment $ 33

Purchase of equipment (120) Net Cash Provided by Investing

Activities $(87)Cash Flows from Financing Activities:

Issuance of Long-Term Notes Payable 50 Payment of Cash Dividends (90)

Net Cash Used for Financing Activities $(40)

Net Increase in Cash $ 42 Cash, January 1, 2001 40

Cash, December 31, 2001 $ 82

Continued from either slide 39 or 40

Continued from either slide 39 or 40

43

The EndThe End