1. The Statement of Cash Flows
Chapter 13
The Statement of Cash Flows

2. Amazon.com
Founded in 1995, Amazon largest on-line merchandising company in the world
one of the 500 largest companies in the US
Strong cash flows to maintain growth and liquidity
Cash provided by operations more than doubled from 2006 to 2007
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3. LO1 Statement of Cash Flows
Shows how a company’s operating, investing, and financing activities have affected cash during an accounting period
Explains the net increase or decrease in cash
Cash may include:
Cash
Cash equivalents
Money market accounts
Commercial paper
U.S. Treasury bills
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4. How Is the Statement of Cash Flows Used?
Managers
Investors and creditors assess the company’s ability to
Evaluate financing decisions
Evaluate investment decisions
Determine dividend policy
Assess liquidity
Pay dividends and interest
Pay its liabilities
Generate positive future cash flows
Manage cash flows
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5. Classification of Cash Flows
The statement of cash flows classifies cash receipts and cash payments into categories
Operating Activities
Investing Activities
Financing Activities
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6. Operating Activities
Involve the cash inflows and outflows from activities that enter into the determination of net income
Cash Inflows
collect from customers
Interest and dividends
Cash Outflows
Payments for:
Purchase inventory
Other expenses
interest
taxes
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7. Investing Activities
purchase and sale of property, plant, and equipment and other long-term assets, including investments (short-term and long-term), and the making and collecting of loans
Cash Inflows
sell investments
Sell long-term assets
Collections on loans
Cash Outflows
purchase assets
Purchase investments
lend to borrowers
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8. Financing Activities
Sell stock and provide stockholders with a return on their investments, and obtaining resources from creditors and repaying the amounts borrowed
Cash Outflows
Repayments of loans (excluding interest)
cash dividends paid
Purchase of treasury stock
Cash Inflows
sell stock issues
borrowing
Sale of treasury stock
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9. Noncash Investing and Financing Transactions
Significant transactions that involve only long-term assets, long-term liabilities, or stockholders’ equity
Noncash examples:
Exchange long-term asset for long-term liability
convert debt to stock
Purchase long-term asset with long-term debt
Not reflected on the statement of cash flows; no cash inflows or outflows
Future cash flows are affected, so required to disclose these transactions in a separate schedule or at the bottom of the statement
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10. Format of the Statement of Cash Flows1
Operating Activities section
Indirect method starts with net
income and ends with cash flows
from operating activities 2
Investing Activities section
Cash transactions involving
capital expenditures 3
Financing Activities section
Debt, cash stock transactions, dividends, and treasury stock transactions 4
Reconciliation of beg. and end. balances of cash
Ties to cash balances of the
balance sheet
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11. Ethics and Cash Flows How might companies misrepresent cash flows?
Managers are are often tempted to manipulate the presentation of certain transactions to make cash flow look better.
By classifying payments of operating expenses as investments on the statement of cash flows, a company can show an improvement in cash flows from operations
How might companies misrepresent cash flows?
By not disclosing the financing of accounts receivables on the statement of cash flows, the company makes collections of account receivables look better than they actually are
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12. Discussion: Ethics on the Job
Boxcar Industries, a small upstart company, was having cash flow difficulties. Payroll was due to employees in one week, invoices were due to vendors, and there was not enough cash to cover both. The CEO considered telling employees that payroll would be late or slowing down payments to vendors. He also considered a more aggressive collection effort on the company’s accounts receivables.
Q. What do you think of the options? Do any of the options strike you as more or less ethical than others?
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13. Stop & Review
Q. The proceeds from trading securities should be categorized in which section of the statement of cash flows?
A. Operating activities
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14. Stop & Review
Q. In which section of the statement of cash flows would the payment of dividends be classified?
A. Financing activities
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15. Stop & Review Q. What are the three classifications of cash flows?
A. Operating activities, investing activities, financing activities
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16. LO2 Cash-Generating Efficiency (CGE)
Shows the company’s ability to generate cash from its current or continuing operations
used to calculate CGE:
Cash flow yield
Cash flows to sales
Cash flows to assets
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17. Cash Flow Yield
Shows how much of net income actually results in operating cash inflows
Amazon.com’s operating activities were generating about $3 of cash for every dollar of net income
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18. Amazon.com generated positive cash flows to
Cash Flows to Sales
Shows how much of net sales actually results in cash inflows *
* Rounded
Amazon.com generated positive cash flows to
sales of 9.5 percent or in other words that every dollar of sales generates 9.5 cents in cash
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19. Cash Flows to Assets
Shows how much cash is being generated by operations for each dollar of assets *
*Rounded
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20. Free Cash Flow
Amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level
Net Cash Flows from Operating Activities
– Dividends
– Purchases of Plant Assets
+ Sales of Plant Assets
Free Cash Flow
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21. Free Cash Flow analysis
If positive, the company
Has met all of its planned cash commitments
Has cash available to reduce debt or expand
If negative, to continue at its planned level of operation, the company will have to
Sell investments
Borrow money
Issue stock in the short term
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22. Stop & Review
Q. What does the cash flow yield ratio show? How is it calculated?
A. Shows how much of net income actually results in operating cash inflows. Divide net cash flows from operating activities by net income.
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23. Stop & Apply
Q. Trentco Company demonstrated a cash flow to sales ratio of 9.4 percent. What does this mean? What amounts were needed to calculate this ratio?
A. The company generated positive cash flows to sales of 9.4 percent. Net sales and net cash flows from operating activities were needed to make the calculation.
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24. Stop & Review Q. Why is positive free cash flow important?
The company has demonstrated that it can meet all planned cash commitments and has cash available to reduce debt or to expand.
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25. LO3 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 on the income statement to its cash equivalent
More easily understood by the average reader
The indirect method
Lists adjustments to net income to net cash flows
Superior from an analyst’s perspective
Used by most companies
Both methods produce the same net figure
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26. Depreciation expense added back to net income
Depreciation expense appears on the income statement, but involves no outlay of cash
Adjustment:
Depreciation expense added back to net income
for the period
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27. Gain/Losses subtracted and added to net income
Gains and Losses
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
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28. Treatment of Noncash Items
Add to or Deduct from Net Income
Depreciation Expense
Add
Amortization Expense
Depletion Expense
Losses
Gains
Deduct
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29. Changes in Current Assets
Example: Laguna Corporation’s Accounts Receivable decreased by $8,000 as illustrated below.
Accounts Receivable
Beg. Bal ,000
End. Bal ,000
Cash Receipts from Customers
Sales to
Customers
698,000
706,000
The $8,000 decrease in Accounts Receivable
should be added to net income on the statement of cash flows.
Changes Sales to collections from customers
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30. Change net income into cash income
Decreases in current liabilities are subtracted from net income
< >
Decreases in current assets are added to net income +
Increases in
current assets are subtracted from net income
< >
Increases in
current liabilities are added to net income +

31. Changes in Current Liabilities
Example: Laguna Corporation’s accounts payable increased by $7,000 as illustrated below.
Accounts Payable
Beg. Bal ,000
End. Bal ,000
547,000
Cash Payments to Suppliers
554,000
Purchases
The $7,000 increase in Accounts Payable should
be added to net income on the statement of cash flows because more money was paid out than COGS.
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32. Net Income versus Cash Flows from Operating Activities
A net income of $16,000, after adjustments, actually yielded $30,000 in positive cash flows from operating activities
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33. Adjustments for Changes in Current Assets and Liabilities
Add to
Net Income
Deduct from
Current Assets:
Accounts receivable (net)
Decrease
Increase
Inventory
Prepaid expenses
Current Liabilities:
Accounts payable
Accrued liabilities
Income taxes payable
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34. Stop & Review
Q. If New Horizons Company had a decrease in its Accounts Payable balance of $2,750, how should this amount be treated in the operating activities section of the statement of cash flows?
A. The amount should be deducted from net income.
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35. Stop & Review
Q. Why is depreciation expense added back to net income in the operating activities section of the statement of cash flows?
A. Depreciation expense is a noncash item that has reduced net income. Thus, it must be added back to arrive at a true amount for cash flows from operating activities.
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36. LO4 Examining Investment Transactions
To determine cash flows from investing activities, accounts involving cash receipts and cash payments from investing activities are examined individually
investments
Property, Plant & Equip
intangibles
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37. Investment Transactions Cash Flows Illustrated
Laguna Corporation’s purchases of investments totaled $78,000 during These transactions, caused a $78,000 decrease in cash flows (cash paid).
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 ,000
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38. Plant Asset Transactions Cash Flows Illustrated
Laguna Corporation purchased plant assets totaling $1200,000. These transactions, caused a $120,000 decrease in cash flows (cash paid).
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 $3,000 (cash received) .
Investing activities section, statement of cash flows:
Purchase of plant assets ($120,000)
Sale of plant assets ,000
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39. Cash Flows from Investing Activities
The transactions for Laguna Corporation we have examined are listed below on its statement of cash flows in the investing activities section:
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40. Noncash Transaction Illustrated
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.
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Schedule of Noncash Investing and
Financing Transactions:
Issue of bonds payable for plant assets $100,000
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41. Stop & Review
Q. What types of accounts should be examined when determining the cash flows related to investments?
A. Long-term investments, short-term investments, plant assets, investment gains or losses, depreciation accounts
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42. Stop & Apply
Q. If a company purchases a plant asset for $25,000, how will this be reflected on the statement of cash flows?
Investing activities section:
Purchase of plant asset ($ 25,000)
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43. LO5 Examining Financing Transactions
To determine cash flows from financing activities, accounts involving cash receipts and cash payments from financing activities are examined individually
Short-term borrowings
Long-term liabilities
Stockholders’ equity
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44. Bonds Payable Transactions Cash Flows Illustrated
Laguna Corporation repaid $50,000 of bonds at face value at maturity. This transaction caused a $50,000 decrease in cash flows (cash paid).
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Financing activities section, statement of cash flows:
Repayment of bonds ($50,000)
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45. Common Stock 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).
Financing activities section, statement of cash flows:
Issue of common stock $175,000
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46. Dividend Transactions Cash Flows Illustrated
Laguna Corporation paid cash
dividends in the amount of
$8,000. This amount decreased
Retained Earnings. This
transaction caused a $8,000
decrease in cash flows (cash
paid).
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Only the payment of dividends appears on the statement of cash flows, not the declaration of dividends.
Financing activities section, statement of cash flows:
Payment of dividends ($8,000)
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47. Treasury Stock Transactions Cash Flows Illustrated
Laguna Corporation purchased treasury stock for $25,000. This transaction created a cash outflow of $25,000.
Financing activities section, statement of cash flows:
Purchase of treasury stock ($25,000)
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48. Cash Flows from Financing Activities
The transactions of Laguna Corporation that we have examined are presented in the financing section of the statement of cash flows:
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49. Statement of Cash Flows
All three sections are presented in summary form here, followed by the net increase or decrease in cash:
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50. Stop & Review
Q. Name at least three types of transactions that would be considered financing activities.
A. Repayment of bonds payable, issuance of stock, purchase of treasury stock, payment of dividends
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51. Chapter Review Problem
Taylor Corporation had net income of $122,435 for the year ended Dec. 31, 20x7. The following data was taken from the company’s income statement: Depreciation expense, $1,400; Loss on sale of plant asset, $1,500. The general ledger reflected an increase in Accounts Payable of $4,000 and a decrease in Accounts Receivable of $1,200 during the year. Taylor sold a plant asset that cost $4,000 with accumulated depreciation of $500 for $2,000. The company also issued 5,000 shares of $5 par value common stock for $32,000. Cash and cash equivalents at the beginning of the year were $14,459.
Required: Prepare the statement of cash flows using the indirect method.
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52. Taylor Corporation Statement of Cash Flows for the Year Ended December 31, 20x7
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