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© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-1 Reporting the Statement of Cash Flows Chapter 16.

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Presentation on theme: "© The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-1 Reporting the Statement of Cash Flows Chapter 16."— Presentation transcript:

1 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-1 Reporting the Statement of Cash Flows Chapter 16

2 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-2 Learning objectives 1.Basics of Cash flow reporting 2.Cash flow from operating 3.Cash flow from investing 4.Cash flow from financing 5.Interpretation of Statement of Cash flow 6.Decision analysis: Cash flow on total assets

3 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-3 How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? 1.Basics of Cash flow reporting - Purpose of the Statement of Cash Flows

4 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-4 How did the business fund its operations? Did the business borrow any funds or repay any loans? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? 1.Basics of Cash flow reporting - Importance of Cash Flows

5 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-5 Cash Currency Cash Equivalents Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes. Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes. 1.Basics of Cash flow reporting - Measurement of Cash Flows

6 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-6 The Statement of Cash Flows includes the following three sections:  Operating Activities  Investing Activities  Financing Activities 1.Basics of Cash flow reporting - Classifying Cash Flows

7 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-7 Outflows Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other. Outflows Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other. Inflows Receipts from customers. Cash dividends received. Interest from borrowers. Other. Inflows Receipts from customers. Cash dividends received. Interest from borrowers. Other. Operating Activities

8 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-8 Outflows Purchasing long-term productive assets. Purchasing equity investments. Purchasing debt investments. Other. Outflows Purchasing long-term productive assets. Purchasing equity investments. Purchasing debt investments. Other. Inflows Selling long-term productive assets. Selling equity investments. Collecting principal on loans. Other. Inflows Selling long-term productive assets. Selling equity investments. Collecting principal on loans. Other. Investing Activities

9 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-9 Outflows Pay dividends. Purchasing treasury stock Repaying cash loans. Paying owners’ withdrawals. Outflows Pay dividends. Purchasing treasury stock Repaying cash loans. Paying owners’ withdrawals. Inflows Issuing its own equity securities. Issuing bonds and notes. Issuing short- and long-term liabilities. Inflows Issuing its own equity securities. Issuing bonds and notes. Issuing short- and long-term liabilities. Financing Activities

10 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-10 Items requiring separate disclosure include:  Retirement of debt by issuing equity securities.  Conversion of preferred stock to common stock.  Leasing of assets in a capital lease transaction. Items requiring separate disclosure include:  Retirement of debt by issuing equity securities.  Conversion of preferred stock to common stock.  Leasing of assets in a capital lease transaction. 1.Basics of Cash flow reporting - Noncash Investing and Financing

11 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-11 1.Basics of Cash flow reporting - Format of SCF

12 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-12 There are two acceptable methods to determine Cash Flows from Operating Activities: Direct Method Indirect Method 2. Cash flow from Operating - Two methods

13 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-13 Let’s look at the Direct Method for preparing the Cash Flows from Operating Activities section.

14 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-14 Analyzing the Cash Account Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows under the Direct Method.

15 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-15

16 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-16 Let’s look at the Indirect Method for preparing the Cash Flows from Operating Activities section.

17 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-17 Net Income Cash Flows from Operating Activities 97.5% of all companies use the indirect method. Changes in current assets and current liabilities. + Losses and – Gains from Non- operating activities + Noncash expenses such as depreciation and amortization. 2. Cash Flow from Operating - Indirect Method

18 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-18 Use this table when adjusting Net Income to Operating Cash Flows. Indirect Method of Reporting Operating Cash Flows

19 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-19 East, Inc. reports $125,000 net income for the year ended December 31, 2005. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2005, East reported $12,500 of Depreciation Expense. East, Inc. reports $125,000 net income for the year ended December 31, 2005. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2005, East reported $12,500 of Depreciation Expense. What is East, Inc.’s Operating Cash Flow for 2005? Indirect Method Example

20 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-20 Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities For the indirect method, start with net income. Indirect Method Example

21 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-21 Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense. Indirect Method Example

22 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-22 Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Indirect Method Example

23 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-23 Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Indirect Method Example

24 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-24 Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ Indirect Method Example If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

25 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-25 Let’s prepare a Statement of Cash Flows for B&G Company using the Indirect Method.

26 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-26

27 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-27

28 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-28  Additional Information for 2005: Net income was $38,000. a. The accounts payable balances result from merchandise inventory purchases. b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.  Additional Information for 2005: Net income was $38,000. a. The accounts payable balances result from merchandise inventory purchases. b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.

29 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-29 Add noncash expenses and losses. Subtract noncash revenues and gains. Add noncash expenses and losses. Subtract noncash revenues and gains. Start with accrual-basis net income. Then, analyze the changes in current assets and current liabilities.

30 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-30

31 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-31 2. Cash Flow from operation - reconciliation with direct method

32 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-32 Cash received from customer Vs. Accounts receivable Accounts Receivable Beg Bal: 40,000 End Bal: 60,000 Sales 590,000Cash receipts 570,000 Increase in A/R balance from 40,000 to 60,000 indicates that the company collects $20,000 less cash from customer than is reported in sales, i.e. Cash received from customer $570,000

33 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-33 Purchase Vs. Merchandise Inventory Merchandise inventory Beg Bal: 70,000 End Bal: 84,000 Purchases 314,000 Cost of goods sold 300,000 Increase in merchandise inventory balance from 70,000 to 84,000 indicates that the company has $14,000 higher purchase than cost of goods sold, i.e. Purchase during the period $314,000 (not the cash paid to supplier)

34 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-34 Prepaid expense Beg Bal 4,000 Prepaid expense End Bal 6,000 Cash payment 218,000 Wages and other operating exp 216,000 Increase in prepaid expense balance from 4,000 to 6,000 indicates the company pay $2,000 less cash than operating expense, i.e. Cash payment for wage and other operating expense $218,000

35 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-35 Cash paid for merchandise Vs. Accounts payable  The decrease in A/P balance from 40,000 to 35,000 indicates that company pay $5,000 more cash than purchases for the period, i.e. Cash paid for merchandise $319,000 Accounts payable Cash payment 319,000 Beg Bal 40,000 Purchases 314,000 End Bal 35,000

36 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-36 Interest payable  The decrease in interest payable balance from 4,000 to 3,000 indicates that company pay $1,000 more cash than interest expense, i.e. Cash paid for interest $8,000 Interest payable Cash paid for interest 8,000 Beg Bal 4,000 Interest expense 7,000 End Bal 3,000

37 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-37 Income tax payable  The increase in income tax payable balance from 12,000 to 22,000 indicates that company pay $10,000 less cash than reported income tax, i.e. Cash paid for Tax $5,000 Income tax payable Beg Bal 12,000 Income tax expense 15,000 Cash paid for taxes 5,000 End Bal 22,000

38 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-38  Additional Information for 2005: b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.  Additional Information for 2005: b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. 3. Cash flow from Investing

39 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-39 Now, let’s complete the investing section.

40 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-40 3. Cash Flow from Investing - Reconstruction analysis

41 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-41 3. Cash Flow from Investing - Reconstruction analysis b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.

42 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-42 Beg. Bal 48,000 Sale 12,000 End Bal. 60,000 Dep. Expense 24,000 Accumulated Depreciation Plant Assets Beg Bal 210,000 Purchase 70,000 Sale 30,000 End Bal 250,000

43 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-43  Additional Information for 2005: d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.  Additional Information for 2005: d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000. 4. Cash flow from Financing

44 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-44 Now, let’s complete the financing section.

45 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-45 4. Cash Flow from Financing - Reconstruction analysis

46 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-46 4. Cash Flow from Financing - Reconstruction analysis d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.

47 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-47 Beg. Bal 64,000 Retired bond 34,000 End Bal. 90,000 Issue bonds 60,000 Bond Payable Retained Earning Beg Bal 88,000 Cash dividend 14,000Net Income 38,000 End Bal 112,000 Common Stock Beg Bal 80,000 Issue stock 15,000 End Bal 95,000 4. Cash Flow from Financing - Reconstruction analysis

48 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-48 5. Interpretation of SCF - Analyzing Cash Sources and Uses

49 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-49 5. Interpretation of SCF - Analyzing Cash Sources and Uses

50 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-50 5. Interpretation of SCF - Analyzing Cash Sources and Uses

51 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-51 Used, along with income-based ratios, to assess company performance. Cash Flow on Total Assets = Operating cash flows Average total assets 6. Decision Analysis: - Cash Flow on Total Assets

52 © The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin 16-52 End of Chapter 16


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