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1 Chapter 13 STATEMENT OF CASH FLOWS. 2 Questions the Statement of Cash Flow Answers.

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Presentation on theme: "1 Chapter 13 STATEMENT OF CASH FLOWS. 2 Questions the Statement of Cash Flow Answers."— Presentation transcript:

1 1 Chapter 13 STATEMENT OF CASH FLOWS

2 2 Questions the Statement of Cash Flow Answers

3 The Primary Purpose of the Statement of Cash Flows Is... To provide information about: –cash receipts, –cash payments, and –the net change in cash resulting from: operating, investing, and financing activities of a company during a period.

4 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, CASH

5 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 6 Operating Activities... Include: –The cash effects of transactions that create revenues and expenses and –Enter into determination of net income. Involve Income Statement Items

7 7 Cash inflows: –From sale of goods or services –From return on loans (interest received) and on equity securities (dividends received) Cash outflows: –To suppliers for inventory –To employees for services –To government for taxes –To lenders for interest –To others for expenses Operating Activities… Types of Cash Flows

8 8 Investing Activities... Include: –Purchasing and disposing of investments and productive long-lived assets using cash and –Lending money and collecting the loans. Involve Investments and Noncurrrent Asset Items

9 9 Cash inflows: –From sale of property, plant, and equipment –From sale of debt or equity securities of other entities –From collection of principal on loans to other entities Cash outflows: –To purchase property, plant, and equipment –To purchase debt or equity securities of other entities –To make loans to other entities Investing Activities... Types of Cash Flows

10 10 Financing Activities... Include: –Obtaining cash from issuing debt and repaying the amounts borrowed and –Obtaining cash from stockholders and paying dividends. Involve Noncurrent Liability and Stockholders’ Equity Items

11 11 Cash inflows: –From sale of equity securities (company's own stock) –From issuance of debt (bonds and notes) Cash outflows: –To stockholders as dividends –To redeem long-term debt or reacquire capital stock Financing Activities... Types of Cash Flows

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) and Payments 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 or –In a separate note or supplementary schedule to the financial statements.

14 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 Question Which 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.

16 Question Which 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 Plus significant noncash investing and financing activities in separate schedule or at bottom of the. Body of Statement

18 Major Steps in Preparing Statement of Cash Flows

19 In order to perform step 1 a company MUST convert net income from a cash to accrual basis. Over Ninety-eight (98.8)% of companies use the indirect method. Can used the Direct Method or 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 because –Noncash 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 Example: Inventory is purchased on credit from a supplier. It is implied that cash was used to acquire the inventory. Increases in noncash asset accounts imply uses of cash. Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts

24 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. Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts

25 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. Increases in liability accounts imply sources of cash. Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts

26 Decreases in liability accounts imply uses of cash. When the company makes the payment, cash decreases. I.O.U. Example: The company made a payment on a note payable held by a creditor. Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts

27 Question Which of the following would be considered a "use" of cash for purposes of constructing a statement of cash flows? a.an increase in accounts payable. b.an increase in prepaid expenses. c.an increase in accrued liabilities. d.an increase in accumulated depreciation.

28 Question Which of the following would be considered a "use" of cash for purposes of constructing a statement of cash flows? a.an increase in accounts payable. b.an increase in prepaid expenses. c.an increase in accrued liabilities. d.an increase in accumulated depreciation.

29 Operating Activities Net Income (Loss)$ XXX Add:Decr. in Current Noncash Assets XXX Incr. in Current LiabilitiesXXX Depreciation ChargesXXX LossesXXX Less:Incr. in Current Noncash Assets(XXX) Decr. in Current Liabilities(XXX) Gains(XXX) Net Cash Flows from Operating Activities$ XXX Includes those activities that enter into the determination of net income

30 Add:Proceeds from sale of land, buildings, equipment, or other noncurrent assets$ XXX Receipt of principal from investmentsXXX Less:Payments to acquire land, buildings, equipment, or other noncurrent assets(XXX) Payments to acquire investments(XXX) Net Cash Flows from Investment Activities$ XXX Includes transactions that involve the acquisition or disposal of noncurrent assets. Investing Activities

31 Add:Proceeds from borrowings$ XXX Proceeds from issuing capital stockXXX Proceeds from sale of bondsXXX Less:Principal payments on borrowed funds(XXX) Payments related to bond maturities(XXX) Dividend payments(XXX) Net Cash Flows from Investment Activities$ XXX Includes transactions involving receipts from or payments to creditors and owners. Financing Activities

32 Question Which is an example of a cash flow from a financing activity? a. Receipt of cash from sale of land. d. None of the above. c. Purchase of equipment for cash. b. Issuance of debt for cash.

33 Question Which is an example of a cash flow from a financing activity? a. Receipt of cash from sale of land. d. None of the above. c. Purchase of equipment for cash. b. Issuance of debt for cash.

34 Question An 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.a source of cash of $1,000 in Operating Activities. b.a use of cash of $1,000 in Operating Activities. c.a source of cash of $1,000 in Investing Activities. d.a use of cash of $1,000 in Financing Activities.

35 Question An 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.a source of cash of $1,000 in Operating Activities. b.a use of cash of $1,000 in Operating Activities. c.a source of cash of $1,000 in Investing Activities. d.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 Method The 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 Technology Services Company Statement of Cash Flows--Direct Method (Partial) For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers $ 765,000 Cash payments To supplier$550,000 For operating expenses 158,000 For income taxes 48,000 756,000 Net 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 Indirect Method Net income is reconciled to cash flow from operating activities. No supplemental schedule is required. Used by 98.8% of companies. Direct Method or Indirect Method? Direct Method Net 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 phase –growth phase –maturity phase –decline phase The 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 The 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. Growth Phase

46 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. Maturity Phase

47 47 Sales and production decline. Expect: cash from operations to decline. cash from investing to possibly become positive. cash from financing to possibly become negative. Decline Phase

48 48 Impact of Product Life Cycle on Cash Flows

49 Free Cash Flow In 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 Cash Provided By Operations – Capital Expenditures – Dividends Paid Free Cash Flow

51 The 2008 statement of cash flows of Microsoft Corporation provides information for the computations of these measures. MICROSOFT CORPORATION STATEMENT OF CASH FLOWS (PARTIAL) 2008 Cash flows from operations $21,612 Additions to property, plant, and equipment$ (3,182) Acquisition of companies (8,053) Sales of investments, net of purch. 6,648 Cash used by investing activities (4,587) Using Cash Flows to Evaluate a Company

52 MICROSOFT CORPORATION STATEMENT OF CASH FLOWS (Partial) 2008 Cash flows from operations 21,612 Less: Expenditures on property, plant, and equipment 3,182 Dividends 4,015 Free Cash Flow14,415

53 53 In addition to using numbers from the income statement for assessment purposes, we often use numbers from the statement of cash flows. Assessing Liquidity, Solvency, and Profitability Using Cash Flows The ratios are cash-based instead of accural-based.

54 Accrual-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. Cash-Based Measures

55 Liquidity Liquidity 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 operations Average current liabilities Since 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 Solvency Solvency 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 Operations Average Total Liabilities This 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 Liabilities Cash Debt Cash Provided by Operations =. Coverage Ratio Average Total Liabilities

59 Profitability Profitability 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 Question The data given below are from the accounting records of the Kuhn Company: Net Income (accrual basis)....................... $45,000 Depreciation Expense............................... $ 9,000 Decrease in Accounts Payable.................. $ 2,500 Decrease in Merchandise Inventory........ $ 3,000 Increase in Long-term Liabilities............ $10,000 Sale of Capital Stock for cash.................. $30,000 Increase in Accounts Receivable.............. $ 4,500 Based on this information, the cash provided by operating activities using the indirect method would be: a.$55,000. b.$50,000. c.$58,000. d.$60,000.

61 End of Chapter 13 Now, this is what I call CA$H FLOW!


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