understanding financial statements seventh edition

Understanding Understanding Financial Statements Financial Statements Seventh Seventh EDITIONEDITION

Lyn M. Fraser Lyn M. Fraser

Aileen OrmistonAileen Ormiston Insert BOOK COVER

(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.

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Statement of Cash FlowsStatement of Cash Flows

Chapter 4

“Joan and Joe: A Tale of Woe”Joe added up profits and went to see Joan,Assured of obtaining a much-needed loan.

When Joe arrived, he announced with good cheer:“My firm has had an outstanding year,

And now I need a loan from your bank.”Eyeing the statements, Joan’s heart sank.

“Your profits are fine,” Joan said to Joe.But where, oh where, is your company’s cash flow?

I’m sorry to say: the answer is ‘no’.” --L. Fraser


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The Statement of Cash The Statement of Cash FlowsFlows

Provides information about cash Provides information about cash inflows and outflows during an inflows and outflows during an accounting period accounting period


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The Statement of Cash Flows The Statement of Cash Flows Con’t.Con’t.

Required by SFAS #95 Required by SFAS #95 Replaced the Statement of Changes Replaced the Statement of Changes

in Financial Position in 1988in Financial Position in 1988 Can be developed from Balance Can be developed from Balance

Sheet and Income Statement dataSheet and Income Statement data


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The Statement of Cash Flows The Statement of Cash Flows Con’t.Con’t.

“ “A positive net income on the income A positive net income on the income statement is ultimately statement is ultimately insignificant unless a company insignificant unless a company can translate its earnings into can translate its earnings into cash, and the only source in cash, and the only source in financial statement data for financial statement data for learning about the generation of learning about the generation of cash from operations is the cash from operations is the statement of cash flows”statement of cash flows”

Why is it important???


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Objectives of the ChapterObjectives of the Chapter

To explain how the statement of To explain how the statement of cash flows is preparedcash flows is prepared

To interpret the information To interpret the information presented in the statement presented in the statement


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Preparing a Preparing a Statement of Cash FlowsStatement of Cash Flows

Begins with a return to the Begins with a return to the balance sheetbalance sheet

Is prepared by calculating Is prepared by calculating changes in all of the balance changes in all of the balance sheet accounts sheet accounts


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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued

1.1. CashCash

2.2. Operating activitiesOperating activities

3.3. Investing activitiesInvesting activities

4.4. Financing activitiesFinancing activities

Four parts of a statement of cash flows:


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Cash & Cash equivalents:Cash & Cash equivalents:

Cash include

T-BillsT-Bills NotesNotes

CertificatesCertificatesBondsBondsCDsCDs

Commercial paperCommercial paper


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Short-term investments:Short-term investments:

Classified as investing activities

Cash include


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Delivering or producing goods Delivering or producing goods for sale and providing servicesfor sale and providing services

The cash effects of transactions The cash effects of transactions and other events that enter and other events that enter into the determination of into the determination of incomeincome

Operating Activities includeOperating Activities include


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Cash flows resulting from sales Cash flows resulting from sales of goods of goods

Purchase of inventories,Purchase of inventories, Payment of operating expensesPayment of operating expenses

Operating Activities ExamplesOperating Activities Examples


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Acquiring/disposing of securities Acquiring/disposing of securities that are not cash equivalentsthat are not cash equivalents

Acquiring/disposing of Acquiring/disposing of productive assetsproductive assets

Lending money/collecting on Lending money/collecting on loans loans

Investing Activities include


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Borrowing from Borrowing from creditors/repaying the principalcreditors/repaying the principal

Obtaining resources from Obtaining resources from ownersowners

Providing owners with a return Providing owners with a return on investment on investment

Financing Activities include


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How Cash Flows During an Accounting Period

Total Inflows less Total Outflows = Change in cash for the accounting period

Operating Activities

Investing Activities

Financing Activities

Inflows

Outflows


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Look at changes in balance sheet Look at changes in balance sheet accounts from beginning to end accounts from beginning to end of accounting periodof accounting period

First First Step::


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Transfer the account changes to the Transfer the account changes to the appropriate area of a statement appropriate area of a statement of cash flows of cash flows

Next Step: Step:


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InflowInflow OutflowOutflow

- Asset account- Asset account + Asset account+ Asset account

+ Liability + Liability accountaccount

- Liability account- Liability account

+ Equity account+ Equity account - Equity account- Equity account


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Calculating Cash Flow Calculating Cash Flow from Operating Activitiesfrom Operating Activities

Direct MethodDirect MethodIndirect Method Indirect Method

Firms may use one of two methods prescribed by the FASB:


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Calculating Cash Flow Calculating Cash Flow from Operating Activitiesfrom Operating Activities ContinuedContinued

Shows cash collections from Shows cash collections from customers, interest and dividends customers, interest and dividends collected, other operating cash collected, other operating cash receipts, cash paid to suppliers receipts, cash paid to suppliers and employees, interest paid, and employees, interest paid, taxes paid and other operating taxes paid and other operating cash paymentscash payments

The Direct Method


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Calculating Cash Flow Calculating Cash Flow from Operating Activitiesfrom Operating Activities ContinuedContinued

Starts with net income and adjusts Starts with net income and adjusts for deferrals; accruals; noncash for deferrals; accruals; noncash items, such as depreciation and items, such as depreciation and amortization; and nonoperating amortization; and nonoperating items, such as gains and losses items, such as gains and losses on asset sales on asset sales

The Indirect Method


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Analyzing the Analyzing the Statement of Cash FlowsStatement of Cash Flows

Is an important analytical tool for Is an important analytical tool for creditors, investors and other creditors, investors and other users of financial statement users of financial statement data data


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Analyzing the Analyzing the Statement of Cash FlowsStatement of Cash Flows Con’t.Con’t.

Firm’s ability to generate cash Firm’s ability to generate cash flows in the futureflows in the future

Firm’s capacity to meet cash Firm’s capacity to meet cash obligationsobligations

Firm’s future external financing Firm’s future external financing needsneeds

Indicates


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Analyzing the Analyzing the Statement of Cash FlowsStatement of Cash Flows Con’t.Con’t.

Firm’s success in productively Firm’s success in productively managing investing activitiesmanaging investing activities

Firm’s effectiveness in Firm’s effectiveness in implementing financing and implementing financing and investing strategiesinvesting strategies

Indicates


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Cash Flow from Cash Flow from OperationsOperations

Pay dividends or invest in new Pay dividends or invest in new equipmentequipment

Service debt Service debt

It is possible for a firm to be It is possible for a firm to be highly profitable and not be able to:highly profitable and not be able to:


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Cash Flow from OperationsCash Flow from Operations ContinuedContinued

It is also possible for a firm to be It is also possible for a firm to be highly profitable and go bankrupt highly profitable and go bankrupt


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Cash Flow from Operations Cash Flow from Operations ContinuedContinued

How?How?

The problem is cash The problem is cash


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Cash Flow from Operations Cash Flow from Operations ContinuedContinued

The ongoing operation of any The ongoing operation of any business depends upon its business depends upon its success in generating cash success in generating cash from operations from operations


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Statement of Cash FlowsStatement of Cash Flows

Cash flow from operating Cash flow from operating activitiesactivities

Cash inflowsCash inflows Cash outflowsCash outflows

Should, at a minimum cover analysis ofShould, at a minimum cover analysis of


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Statement of Cash FlowsStatement of Cash Flows ContinuedContinued

The success or failure of the firm The success or failure of the firm in generating cash from in generating cash from operationsoperations

The underlying causes of the The underlying causes of the positive or negative operating positive or negative operating cash flow cash flow

Analyst Concerns:Analyst Concerns:


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Statement of Cash FlowsStatement of Cash Flows ContinuedContinued

The magnitude of positive or The magnitude of positive or negative operating cash flownegative operating cash flow

Fluctuations in cash flow from Fluctuations in cash flow from operations over timeoperations over time

Analyst Concerns:Analyst Concerns:


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Summary Analysis of the Summary Analysis of the Statement of Cash FlowsStatement of Cash Flows

Provides an approach to analyzing Provides an approach to analyzing a statement of cash flows that a statement of cash flows that can be used for any firm that can be used for any firm that provides comparative cash flow provides comparative cash flow datadata

The Summary TableThe Summary Table


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Summary Analysis of the Summary Analysis of the Statement of Cash FlowsStatement of Cash Flows Con’t.Con’t.

The information underlines the The information underlines the importance of internal cash importance of internal cash generation—from operations—generation—from operations—and the implications for and the implications for investing and financing investing and financing activities when this does and activities when this does and does not occur does not occur

The Summary TableThe Summary Table


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Analysis of Cash InflowsAnalysis of Cash Inflows

Capital expenditures and expansionCapital expenditures and expansionRepayments of debtRepayments of debt

Payments of dividends Payments of dividends

Generating cash from operations is Generating cash from operations is the preferred method for obtaining the preferred method for obtaining excess cash to finance:excess cash to finance:


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Analysis of Cash InflowsAnalysis of Cash Inflows Con’t.Con’t.

When analyzing the cash outflows, When analyzing the cash outflows, the analyst should consider the the analyst should consider the necessity of the outflow and necessity of the outflow and how the outflow was financedhow the outflow was financed


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The Journey The Journey Through the Maze Through the Maze ContinuesContinues

Ch. 5:Ch. 5: The Analysis of Financial The Analysis of Financial StatementsStatements

understanding financial statements seventh edition

Documents

statement of cash flowswhy

statement of cash flowsbegins

cash inflows

prentice hall

generation of cash

statement c

statement of changes

companys cash flow