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The Cash Flow Statement

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Presentation on theme: "The Cash Flow Statement"— Presentation transcript:

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2 The Cash Flow Statement
Reporting of cash flows Purpose and content of the cash flow statement Preparing the cash flow statement Operating activities Investing activities Financing activities The cash flow statement Using financial statement information Free cash flow Copyright John Wiley & Sons Canada, Ltd.

3 CHAPTER 17: The Cash Flow Statement
Describe the purpose and content of the cash flow statement. Prepare a cash flow statement using either the indirect or direct method. Analyze the cash flow statement. Copyright John Wiley & Sons Canada, Ltd. 3

4 Purpose of the Cash Flow Statement
Gives information about: Cash receipts and payments Net change in cash during a period Helps investors, creditors and others understand a company’s: Ability to generate future cash flows Ability to pay dividends and meet obligations Investing and financing transactions during the period Cash provided (used) by operating activities, and how it differs from profit Copyright John Wiley & Sons Canada, Ltd.

5 Content of Cash Flow Statement: Definition of Cash
Cash flow statement is prepared using cash and cash equivalents: Highly liquid investments readily convertible to cash, and Very near maturity (usually three months) Companies must give a clear definition of “cash” as it is used in the statement Copyright John Wiley & Sons Canada, Ltd.

6 Content of Cash Flow Statement: Classification of Cash Flows
Operating activities: cash effect of transactions that: Create revenues and expenses Relate to changes in noncash current assets and liabilities Investing activities: affect non-current assets: Acquiring and disposing of non-trading investments and long-lived assets, and Lending money and collecting the loans Financing activities: affect non-current liability and shareholders’ equity accounts: Proceeds from issuing and repayment of debt Proceeds from shareholders and payment of dividends Copyright John Wiley & Sons Canada, Ltd.

7 Content of Cash Flow Statement: Significant Noncash Activities
Significant investing and financing activities not affecting cash are not reported in cash statement Reported in a separate note instead Examples: Issue of debt to purchase assets Issue of common shares to purchase assets Conversion of debt or preferred shares to common shares Exchanges of property, plant and equipment Copyright John Wiley & Sons Canada, Ltd.

8 CHAPTER 17: The Cash Flow Statement
Describe the purpose and content of the cash flow statement. Prepare a cash flow statement using either the indirect or direct method. Analyze the cash flow statement. Copyright John Wiley & Sons Canada, Ltd. 8

9 Preparation of the Cash Flow Statement
Cash flow statement is prepared differently from other financial statements Not prepared from the adjusted trial balance Information usually comes from three sources: Comparative balance sheet Current income statement Additional information, including transaction data Accrual concept is not used, since cash flow statement deals with cash receipts and payments Copyright John Wiley & Sons Canada, Ltd.

10 Four Steps to Preparing the Cash Flow Statement
Determine net cash provided (used) by: Operating activities: convert profit from accrual basis to cash basis Investing activities: analyze changes in non-current asset accounts Financing activities: analyze changes in non-current liability and equity accounts Then: 4. Prepare cash flow statement and determine net increase (decrease) in cash Copyright John Wiley & Sons Canada, Ltd.

11 Step 1: Operating Activities
Convert profit from accrual to cash basis Some revenues and expenses have not been realized or paid in cash, therefore cannot be included in cash statement Two methods to convert: indirect and direct: Indirect (more popular): total profit is converted Direct: individual revenues and expenses are converted Both methods arrive at the same total amount; difference is in the amount of disclosure Copyright John Wiley & Sons Canada, Ltd.

12 Step 1: Operating Activities Indirect Method
Add non-cash expenses (e.g. depreciation) Add losses and deduct gains from investing and financing activities Changes in noncash current assets and liabilities: Add: decreases in current assets and increases in current liabilities Deduct: increases in current assets and decreases in current liabilities Copyright John Wiley & Sons Canada, Ltd.

13 Step 1: Operating Activities Indirect Method 2
Bonds payable: amortization of: Discount – added to profit Premium – deducted from profit Long-term investments in bonds: amortization of: Discount – deducted from profit Premium – added to profit Changes in trading investments: Trading investments are classified as an operating activity Increases – deducted from profit Decreases – added to profit Copyright John Wiley & Sons Canada, Ltd.

14 Step 1: Operating Activities Indirect Method 3
Copyright John Wiley & Sons Canada, Ltd.

15 Step 1: Operating Activities Summary of Indirect Method
Starting with profit, add and deduct these items to arrive at net cash provided (used) by operations: Noncash expenses Gains and losses, and Changes in noncash current asset and liability accounts Copyright John Wiley & Sons Canada, Ltd.

16 Step 1: Operating Activities Direct Method
Each revenue and expense item is adjusted from accrual basis to cash basis By adjusting for changes in the related asset and liability accounts Only major classes of receipts and payments are reported Copyright John Wiley & Sons Canada, Ltd.

17 Step 1: Operating Activities Direct Method 2
Copyright John Wiley & Sons Canada, Ltd.

18 Step 1: Operating Activities Direct Method: Cash Receipts
Cash Receipts from Customers: Decrease in receivables: cash collected Increase in receivables: cash receipts lower than revenues Cash Receipts from Interest and Dividends: Any accrued amounts must be adjusted Copyright John Wiley & Sons Canada, Ltd.

19 Step 1: Operating Activities Direct Method: Cash Payments
Cash Payments to Suppliers: First determine cost of goods purchased = cost of goods sold ± changes in inventory Then determine cash payments by adjusting cost of goods purchased for changes in accounts payable Copyright John Wiley & Sons Canada, Ltd.

20 Step 1: Operating Activities Direct Method: Cash Payments 2
Cash Payments for Operating Expenses: Increase in prepaid expenses and decrease in accrued liabilities: more cash paid Decrease in prepaid expenses and increase in accrued liabilities: less cash paid Copyright John Wiley & Sons Canada, Ltd.

21 Step 1: Operating Activities Direct Method: Cash Payments 3
Cash Payments for Interest: Change in interest payable must be added to or deducted from interest expense to determine amount paid Amortization of bond discount is deducted from interest expense Amortization of bond premium is added to interest expense Copyright John Wiley & Sons Canada, Ltd.

22 Step 1: Operating Activities Direct Method: Cash Payments 4
Cash Payments for Income Tax: Change in income tax payable must be added to/deducted from income tax expense to determine amount paid Copyright John Wiley & Sons Canada, Ltd.

23 Step 1: Operating Activities Direct Method Summary
After all revenues and expenses have been adjusted to a cash basis, the operating activities section can be completed: Copyright John Wiley & Sons Canada, Ltd.

24 Step 2: Investing Activities
Analyze changes in non-current asset and investment accounts Review transactions in these accounts to determine the effect on cash; exclude noncash transactions Cash purchases of long-lived assets Cash proceeds from disposals of long-lived assets Changes in investment accounts that indicate purchase and sales of investments Note exceptions (Also must analyze short-term investments or notes receivable from non-trade transactions) Copyright John Wiley & Sons Canada, Ltd.

25 Step 3: Financing Activities
Analyze changes in non-current liability and equity accounts Review transactions in these accounts to determine the effect on cash Exclude noncash transactions Note exceptions (nontrade short-term notes payable) Bonds payable: issue and redemption Share capital: issue and reacquisition of shares Retained earnings: dividends paid Copyright John Wiley & Sons Canada, Ltd.

26 Step 4: The Cash Flow Statement
Indirect Method Operating activities provided $172,000 of cash Investing activities used $141,000 of cash Financing activities used $9,000 of cash Significant noncash activity for $110,000 Copyright John Wiley & Sons Canada, Ltd.

27 Step 4: The Cash Flow Statement
Direct Method Operating activities provided $172,000 of cash Investing activities used $141,000 of cash Financing activities used $9,000 of cash Significant noncash activity for $110,000 Copyright John Wiley & Sons Canada, Ltd.

28 CHAPTER 17: The Cash Flow Statement
Describe the purpose and content of the cash flow statement. Prepare a cash flow statement using either the indirect or direct method. Analyze the cash flow statement. Copyright John Wiley & Sons Canada, Ltd. 28

29 Using the Information in the Financial Statements
Cash flow statement gives information about financial health not found in other statements Shows the generation of cash and how it is being used Shows whether a company is having difficulties with cash flow (liquidity) All financial statements must be read together in order to assess the overall financial health of a company Copyright John Wiley & Sons Canada, Ltd.

30 Copyright John Wiley & Sons Canada, Ltd.
Free Cash Flow Describes the cash remaining from operating activities after cash outlays for non-expansionary capital expenditures Not readily available, so net cash from investing activities is substituted Shows how much cash is available to expand, repay debt or pay dividends Copyright John Wiley & Sons Canada, Ltd.

31 Copyright John Wiley & Sons Canada, Ltd.
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (the Canadian copyright licensing agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these files or programs or from the use of the information contained herein. Prepared by: A. Davis, MSc, BComm, CA, CFE Copyright John Wiley & Sons Canada, Ltd.


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