1. Cash flow CH 2

2. Learning Objective 1 Identify cash flows arising from operating, investing, and financing activities. 12-2

3. Operations Cash received and paid for day-to-day activities with customers, suppliers, and employees. Investing Cash paid and received from buying and selling long-term assets. Financing Cash received and paid for exchanges with lenders and stockholders. Business Activities and Cash Flows The Statement of Cash Flows focuses attention on: 12-3

4. Cash Checking and Savings Accounts Cash Equivalents Highly liquid short-term investments within three months of maturity. Business Activities and Cash Flows Currency 12-4

5. Classifying Cash Flows 12-5

6. Cash inflows and outflows that directly relate to revenues and expenses reported on the income statement. Operating Activities 12-6

7. Direct and Indirect Reporting of Operating Cash Flows We will concentrate on the indirect method for now, and we will look at the direct method again later in the chapter. Same result 12-7

8. Investing Activities Under Armour’s 2008 Investing Activities 12-8

9. Financing Activities Under Armour’s 2008 Financing Activities 12-9

10. Relationships Between Classified Balance Sheet and Statement of Cash Flow (SCF) Categories 12-10

11. Relationship to Other Financial Statements Information needed to prepare a statement of cash flows: Comparative Balance Sheets. Income Statement. Additional details concerning selected accounts. 12-11

12. Relationship to Other Financial Statements Recall that the basic Balance Sheet equation is: We can recast the equation as follows: The following equation is true: From this basic Balance Sheet equation, we develop our model to solve for the change in cash : 12-12

13. Learning Objective 2 Report cash flows from operating activities, using the indirect method. 12-13

14. Cash Flows from Operating Activities - Indirect Method Net Income Cash Flows from Operating Activities - Indirect Method Changes in current assets and current liabilities. + Losses and - Gains + Noncash expenses such as depreciation and amortization. The indirect method adjusts net income by analyzing noncash items. 12-14

15. Use this table when adjusting Net Income to Operating Cash Flows using the indirect method. Relationships to the Balance Sheet and the Income Statement Change in account balances during the year 12-15

16. Use the following financial statements for Under Armour, Inc. and prepare the Statement of Cash Flows for the year ended December 31, 2008. Statement of Cash Flows Indirect Method Example 12-16

17. Statement of Cash Flows Indirect Method Example 12-17

18. Statement of Cash Flows Indirect Method Example 12-18

19. The Statement of Cash Flows using the indirect method will begin with Under Armor, Inc.’s net income from the Income Statement. Statement of Cash Flows Indirect Method Example 12-19

20. Direct and Indirect Reporting of Operating Cash Flows When using the indirect method, start with accrual basis net income and adjust it for: 1.items that are included in net income but do not involve cash, and 2.items that are not included in net income but do involve cash. 12-20

21. Next, adjust for the non-cash items included in net income. For Under Armour, the only non-cash adjustment is for depreciation. 12-21

22. Accumulated Depreciation increased by $16, from $31 in the 2007 Balance Sheet to $47 in the 2008 Balance sheet. The same $16 is shown as Depreciation in the 2008 Income Statement. To complete the cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period. 12-22

23. Statement of Cash Flows Indirect Method Example These five items were shown earlier in the current portions of Under Armour’s comparative Balance Sheets for 2007 and 2008 12-23

24. Learning Objective 3 Report cash flows from investing activities. 12-24

25. Reporting Cash Flows from Investing Activities We will need this additional data to prepare the investing portion of the statement. 1.No disposals or impairments of equipment or intangibles occurred 2.Equipment costing $36 million and intangibles costing $2 million were purchased with cash. 12-25

26. Under Armour, Inc., has two investing activities on the Statement of Cash Flows that required the use of cash: 1. Purchase of equipment, and 2. Purchase of intangible and other assets. Reporting Cash Flows from Investing Activities 12-26

27. Learning Objective 4 Report cash flows from financing activities. 12-27

28. Reporting Cash Flows from Financing Activities We will need this additional data to prepare the financing portion of the statement. 1.No dividends were declared or paid. 2.Long-term debt of $7 million was paid. 3.$16 million in new long-term loans were issued. 4.Shares of stock were issued for $12 million. 12-28

29. Reporting Cash Flows from Financing Activities Long-term debt increased because of $16 in new loans during the year. The long-term debt increase is a cash inflow. 12-29

30. Reporting Cash Flows from Financing Activities Payments on long-term debt resulted in a cash outflow of $7. The net effect of these two long-term debt transactions increased long-term debt by $9, from $14 on the 2007 Balance sheet to $23 on the 2008 Balance Sheet. 12-30

31. Reporting Cash Flows from Financing Activities The third financing activity is the issuance of common stock resulting in a cash inflow of $12. Contributed Capital increased from $163 in the 2007 Balance Sheet to $175 in the 2009 Balance Sheet. 12-31

32. Now we can reconcile the change in cash to the ending $102 cash balance that appears on the Balance Sheet. Reporting Cash Flows from Financing Activities 12-32

33. Noncash Investing and Financing Activities Required Supplemental Information: 1.Cash paid for taxes and interest. 2.Significant non-cash investing and financing activities. 12-33

34. Learning Objective 5 Interpret cash flows from operating, investing, and financing activities. 12-34

35. Operating cash flows must be positive over the long-run for a company to be successful. An upward trend in operating cash flows over time indicates growth and efficient operations. Evaluating Cash Flows 12-35

36. Quality of Income Ratio Net Cash Flow from Operating Activities Net Income = A measure for determining what portion of a company’s income was generated in cash. A ratio near 1.0 indicates a high likelihood that revenues are realized in cash and that expenses are associated with cash outflows. Evaluating Cash Flows Quality of Income Ratio 79 38 = = 2.08 for Under Armour in 2008 12-36

37. Capital Acquisitions Ratio Net Cash Flow from Operating Activities Cash Paid for Property, Plant, and Equipment = A measure for determining whether a company is generating enough cash internally to purchase long-term assets. A ratio greater than 1.0 indicates that outside financing was not needed to purchase long-term assets. Evaluating Cash Flows Capital Acquisitions Ratio 79 36 = = 2.19 for Under Armour in 2008 12-37

38. Learning Objective 6 Report and interpret cash flows from operating activities using the direct method. 12-38

39. Reporting Operating Cash Flows with the Direct Method Provides more detailed information Identifies cash inflows and outflows relationships Prepared by adjusting accrual basis to cash basis Investing and financing sections for the two methods are identical 12-39

40. When we prepared the operating section using the indirect method, we also arrived at net cash inflow of $79. Let’s see how we arrive at these cash flows. Direct Method Operating Activities 12-40

41. With the direct method, we convert each revenue and expense on the income statement to a cash flow. Direct Method Operating Activities 12-41

42. Supplement 12A Reporting Sales of Property, Plant, and Equipment (Indirect Method)

43. Depreciation Expense Loss on Sale of PPE A loss on the sale of PPE is added back to net income just as depreciation expense is added back. Adding these noncash items restores net income to what it would have been had depreciation and the loss not been subtracted at all. Just the opposite is true for a gain on the sale of PPE. Subtracting the gain reverses the effect of the gain having been added to net income. Gain on Sale of PPE Reporting Sales of Property, Plant, and Equipment (PPE) (Indirect) 12-43

44. Supplement 12B Spreadsheet Approach (Indirect Method)

45. A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked. Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be reported. Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides. Spreadsheet Approach (Indirect Method) 12-45

46. We begin by entering the beginning and ending balances for each account on the comparative balance sheets. The cash inflows and outflows columns will be used later to explain the changes in each account balance. 12-46

47. Changes in balance sheet accounts are analyzed in terms of debits and credits in the top half of the spreadsheet and recorded as cash inflows and outflows in the bottom half of the spreadsheet. We will begin with operating activities. 12-47

48. 12-48 Changes in balance sheet accounts are analyzed in terms of debits and credits in the top half of the spreadsheet and recorded as cash inflows and outflows in the bottom half of the spreadsheet. Now we will complete the analysis with investing and financing activities. 12-48

49. The top of the completed spreadsheet is shown here. Spreadsheet Approach (Indirect Method) 12-49

50. Spreadsheet Approach (Indirect Method) The bottom of the completed spreadsheet is shown here. 12-50

51. Chapter 12 Solved Exercises E12-2, E12-3, E12-4, E12-5, E12-6, E12-7

52. End of Chapter 12