3 The Primary Purpose of the Statement of Cash Flows Is... To provide information about:cash receipts,cash payments, andthe net change in cash resulting from:operating,investing, andfinancing activities of a company during a period.
4 Why Report the Causes of Changes in Cash? Because investors, creditors, and other interested parties want to know what is happening to a company’s most liquid asset,CASHFollow the cash to know what’s really happening in the business!
5 Usefulness of the Statement of Cash Flow The entity’s ability to generate future cash flows.The entity’s ability to pay dividends and meet obligations.The reason for the difference between net income and net cash provided (used) by operating activities.The cash investing and financing transactions during the period.
6 Involve Income Statement Items Operating Activities...Include:The cash effects of transactions that create revenues and expenses andEnter into determination of net income.Involve Income Statement Items
7 Operating Activities… Types of Cash FlowsCash inflows:From sale of goods or servicesFrom return on loans (interest received) and on equity securities (dividends received)Cash outflows:To suppliers for inventoryTo employees for servicesTo government for taxesTo lenders for interestTo others for expenses
8 Involve Investments and Noncurrrent Asset Items Investing Activities...Include:Purchasing and disposing of investments and productive long-lived assets using cash andLending money and collecting the loans.Involve Investments and Noncurrrent Asset Items
9 Investing Activities... Types of Cash Flows Cash inflows:From sale of property, plant, and equipmentFrom sale of debt or equity securities of other entitiesFrom collection of principal on loans to other entitiesCash outflows:To purchase property, plant, and equipmentTo purchase debt or equity securities of other entitiesTo make loans to other entities
10 Involve Noncurrent Liability and Stockholders’ Equity Items Financing Activities...Include:Obtaining cash from issuing debt and repaying the amounts borrowed andObtaining cash from stockholders and paying dividends.Involve Noncurrent Liability and Stockholders’ Equity Items
11 Financing Activities... Types of Cash Flows Cash inflows:From sale of equity securities (company's own stock)From issuance of debt (bonds and notes)Cash outflows:To stockholders as dividendsTo redeem long-term debt or reacquire capital stock
12 Operating Activities - ALERT Some cash flows relating to investing or financing activities are classified as operating activities. For example...Receipts of investment revenue (interest and dividends) andPayments of interest to lenders are classified as operating activities because these items are reported in the income statement.
13 Significant Noncash Activities... That do NOT affect cash are NOT reported in the body of the statement of cash flows.Are reported:In a separate schedule at the bottom of the statement of cash flows orIn a separate note or supplementary schedule to the financial statements.
14 Significant Noncash Activities... 1. Issuance of common stock to purchase assets.2. Conversion of bonds into common stock.3. Issuance of debt to purchase assets.4. Exchanges of plant assets.
15 QuestionWhich is an example of a cash flow from an operating activity?a. Payment of cash to lenders for interest.b. Receipt of cash from the sale of capital stock.c. Payment of cash dividends to the company’s stockholders.d. None of the above.
16 QuestionWhich is an example of a cash flow from an operating activity?a. Payment of cash to lenders for interest.d. None of the above.c. Payment of cash dividends to the company’s stockholders.b. Receipt of cash from the sale of capital stock.
17 Format Three parts: Operating Investing Financing Body ofStatementPlus significant noncash investing and financing activities in separate schedule or at bottom of the.
18 Major Steps in Preparing Statement of Cash Flows
19 Major Steps in Preparing Statement of Cash Flows In order to perform step a company MUST convert net income from a cash to accrual basis.Can used the Direct Method or Indirect MethodOver Ninety-eight (98.8)% of companies use the indirect method.
20 Indirect Method The indirect method is used extensively in practice. Most companies favor the indirect method for the following reasons:it is easier to prepare.it focuses on the differences between net income and net cash flow from operating activities.it tends to reveal less company information to competitors.
21 Statement Of Cash Flows Indirect Method Start with Net Income
22 Determine Net Cash Provided/Used By Operating Activities Adjust net income for items that did not affect cash.Net income must be converted becauseNoncash expenses, such as depreciation must be added back.Earned revenues may include credit sales that have not been collected in cash.Expenses incurred that may not have been paid.
23 Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts Increases in noncash asset accounts imply uses of cash.Example: Inventory is purchased on credit from a supplier.It is implied that cash was used to acquire the inventory.
24 Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts Decreases in noncash assets accounts imply sources of cash.Example: Accounts receivable decreases when a customer pays their bill.When the customer pays his bill, the company’s cash increases.
25 Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts Increases in liability accounts imply sources of cash.Example: Inventory is purchased on credit from a supplier.It is implied that an increase in a payable has the effect of increasing cash available for other uses.
26 Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts Decreases in liability accounts imply uses of cash.Example: The company made a payment on a note payable held by a creditor.I.O.U.When the company makes the payment, cash decreases.
27 QuestionWhich of the following would be considered a "use" of cash for purposes of constructing a statement of cash flows?an increase in accounts payable.an increase in prepaid expenses.an increase in accrued liabilities.an increase in accumulated depreciation.
28 QuestionWhich of the following would be considered a "use" of cash for purposes of constructing a statement of cash flows?an increase in accounts payable.an increase in prepaid expenses.an increase in accrued liabilities.an increase in accumulated depreciation.
29 Operating Activities Net Income (Loss) $ XXX Add: Decr. in Current Noncash AssetsXXXIncr. in Current LiabilitiesDepreciation ChargesLossesLess:Incr. in Current Noncash Assets(XXX)Decr. in Current LiabilitiesGainsNet Cash Flows from Operating ActivitiesIncludes those activities that enter into the determination of net income
30 Investing ActivitiesAdd:Proceeds from sale of land,buildings, equipment, or othernoncurrent assets$ XXXReceipt of principal frominvestmentsXXXLess:Payments to acquire land,(XXX)Payments to acquireNet Cash Flows from Investment ActivitiesIncludes transactions that involve the acquisition or disposal of noncurrent assets.
31 Financing ActivitiesAdd:Proceeds from borrowings$ XXXProceeds from issuing capitalstockXXXProceeds from sale of bondsLess:Principal payments onborrowed funds(XXX)Payments related to bondmaturitiesDividend paymentsNet Cash Flows from Investment ActivitiesIncludes transactions involving receipts from or payments to creditors and owners.
32 Question Which is an example of a cash flow from a financing activity? a. Receipt of cash from sale of land.b. Issuance of debt for cash.c. Purchase of equipment for cash.d. None of the above.
33 Question Which is an example of a cash flow from a financing activity? a. Receipt of cash from sale of land.b. Issuance of debt for cash.c. Purchase of equipment for cash.d. None of the above.
34 QuestionAn increase in the Interest Payable account of a company from $0 at the beginning of the year, to $1,000 at the end of the year, would be shown on the company's statement of cash flows prepared under the indirect method as:a source of cash of $1,000 in Operating Activities.a use of cash of $1,000 in Operating Activities.a source of cash of $1,000 in Investing Activities.a use of cash of $1,000 in Financing Activities.
35 QuestionAn increase in the Interest Payable account of a company from $0 at the beginning of the year, to $1,000 at the end of the year, would be shown on the company's statement of cash flows prepared under the indirect method as:a source of cash of $1,000 in Operating Activities.a use of cash of $1,000 in Operating Activities.a source of cash of $1,000 in Investing Activities.a use of cash of $1,000 in Financing Activities.
36 Indirect and Direct Methods Both methods arrive at the same total amount for “Net cash provided by Operating Activities”.The methods differ in disclosing the items that make up the total amount.The choice of methods affects only the operating activities section; the investing and financing activities sections are the same.
37 Direct MethodThe FASB prefers the direct method but allows the use of either method.When the direct method is used, the net cash flow from operating activities as computed using the indirect method must also be reported in a separate schedule.
38 Cash flows from operating activities Technology Services CompanyStatement of Cash Flows--Direct Method (Partial)For the Year Ended December 31, 2008Cash flows from operating activitiesCash receipts from customers $ 765,000Cash paymentsTo supplier $550,000For operating expenses ,000For income taxes , ,000Net cash provided by operating activities $ 9,000
39 Formula to Compute Cash Receipts from Customers-Direct Method
40 Formula to Compute Cash Payment to Suppliers - Direct Method
41 Formula to Compute Cash Payments for Operating Expenses-Direct Method
42 Direct Method or Indirect Method? Net income is reconciled to cash flow from operating activities.No supplemental schedule is required.Used by 98.8% of companies.Direct MethodNet income is reconstructed on a cash basis.Requires a supplemental reconciliation of net income to cash flow from operating activities.Used by 1.2% of companies.
43 Product Life Cycle A series of phases all products go through The phases are often referred to as the:introductory phasegrowth phasematurity phasedecline phaseThe phase a company is in affects its cash flows.
44 Introductory Phase To support asset purchases the company may issue stock or debt. Expect:cash from operations to be negative.cash from investing to to be negative.cash from financing to be positive.
45 Growth PhaseThe company is striving to expand its production and sales.Expect:small amounts of cash to be generated from operations.cash from investing to be negative.cash from financing to be positive.
46 Maturity Phase Sales and production level-off. Expect: cash from operations to exceed investing needs.cash from investing to be neutral.cash from financing to be negative.
47 Decline Phase Sales and production decline. Expect: cash from operations to decline.cash from investing to possibly become positive.cash from financing to possibly become negative.
49 Free Cash FlowIn the Statement of Cash Flows, cash from operations is intended to indicate the cash- generating capability of the company.Statement of Cash flows fails to take into account that a company must invest in new fixed assets to maintain its current level of operations and it must maintain dividends at current levels to satisfy investors.
50 Free Cash Flow Cash Provided By Operations – Capital Expenditures – Dividends PaidFree Cash Flow
51 Using Cash Flows to Evaluate a Company The 2008 statement of cash flows of Microsoft Corporation provides information for the computations of these measures.MICROSOFT CORPORATIONSTATEMENT OF CASH FLOWS (PARTIAL)2008Cash flows from operations $21,612Additions to property, plant,and equipment $ (3,182)Acquisition of companies (8,053)Sales of investments, net of purch ,648Cash used by investing activities (4,587)
52 STATEMENT OF CASH FLOWS (Partial) MICROSOFT CORPORATIONSTATEMENT OF CASH FLOWS (Partial)2008Cash flows from operations 21,612Less: Expenditures on property, plant,and equipment ,182Dividends ,015Free Cash Flow 14,415
53 Assessing Liquidity, Solvency, and Profitability Using Cash Flows In addition to using numbers from the income statement for assessment purposes, we often use numbers from the statement of cash flows.The ratios are cash-based insteadof accural-based.
54 Cash-Based MeasuresAccrual-based measures allow too much management discretion.One disadvantage to the cash-based measures is no readily available published industry averages for comparison are available.
55 LiquidityLiquidity is the ability of a business to meet its immediate obligations.One measure of liquidity is the current ratio.A disadvantage of the current ratio is that it uses year-end balances of current assets and current liabilities. (May not be representative of a company's position during most of the year.)Also, it is subject to some “window dressing” such as paying down payables prior to Y/E.
56 Current Cash Debt Coverage Ratio A ratio that partially corrects this is the current cash debt coverage ratio.Cash provided by operationsAverage current liabilitiesSince cash from operations involves the entire year rather than a balance at one point in time, it is often considered a better representation of liquidity on the average day.
57 SolvencySolvency is the ability of a firm to survive over the long term.One measure of solvency is the debt to total assets ratio.A measure of solvency that uses cash figures is the cash debt coverage ratio.Cash Provided By OperationsAverage Total LiabilitiesThis ratio measures a company's ability to repay its liabilities from cash generated from operations.
58 Current Cash Debt Coverage Ratio Cash Debt Coverage Ratio Current Cash Debt Cash Provided by Operations=Coverage Ratio Average Current LiabilitiesCash Debt Coverage RatioCash Debt Cash Provided by Operations=Coverage Ratio Average Total Liabilities
59 ProfitabilityProfitability refers to a company's ability to generate a reasonable return.Accrual-based ratios that measure profitability are the gross profit rate, profit rate margin, and return on assets.A cash-based measure of performance is the cash return on sales ratio.
60 QuestionThe data given below are from the accounting records of the Kuhn Company:Net Income (accrual basis) $45,000Depreciation Expense $ 9,000Decrease in Accounts Payable $ 2,500Decrease in Merchandise Inventory $ 3,000Increase in Long-term Liabilities $10,000Sale of Capital Stock for cash $30,000Increase in Accounts Receivable $ 4,500Based on this information, the cash provided by operating activities using the indirect method would be:$55,000.$50,000.$58,000.$60,000.
61 Now, this is what I call CA$H FLOW! End of Chapter 13Now, this is what I call CA$H FLOW!