Chapter 12 Reporting and Interpreting the Statement of Cash Flows 1© McGraw-Hill Ryerson. All rights reserved.

Business Activities and Cash Flows The Statement of Cash Flows shows each major type of business activity that caused a company's cash to increase or decrease. © McGraw-Hill Ryerson. All rights reserved.2 Operating Activities Investing Activities Financing Activities LO1

Classifying Cash Flows © McGraw-Hill Ryerson. All rights reserved.3 Cash flows related to day-to-day activities Cash flows related to long term assets Cash flows with lenders and investors Beginning and ending cash balance Statement of Cash Flows LO1

© McGraw-Hill Ryerson. All rights reserved.4 Operating Activities Cash flows from operating activities are related to components of net income. Investing Activities Cash flows from investing activities are related to the sale or purchase of investments and long-lived assets. Financing Activities Cash flows from financing activities are related to external financing sources (owners and lenders). LO1

Relationships to Other Financial Statements To prepare a Statement of Cash Flows, information is needed from: © McGraw-Hill Ryerson. All rights reserved.5 Comparative Balance Sheets A complete Income Statement Additional Data LO1

© McGraw-Hill Ryerson. All rights reserved.6 The basic balance sheet equation is: Assets = Liabilities + Shareholders' Equity Split Assets into Cash and Noncash Assets: Cash + Noncash Assets = Liabilities + Shareholders' Equity Move Noncash Assets to the Right: Cash = Liabilities + Shareholders' Equity – Noncash Assets Changes to Cash must be: Changes in Cash = Changes in (Liabilities + Shareholders' Equity – Noncash Assets) This equation says that changes in cash must be equal to changes in liabilities, shareholders’ equity and noncash assets. LO1

Preparing the Statement of Cash Flows © McGraw-Hill Ryerson. All rights reserved.7 1 Determine the change in each balance sheet account. 2 Identify the cash flow category or categories for each account. 3 Create schedules that summarize operating, investing, and financing cash flows. LO1

The Direct Method reports the components of cash flows from operating activities as gross receipts and gross payments. The Indirect Method present the operating activities sections of the cash flow statement by adjusting net income to compute cash flows from operating activities. © McGraw-Hill Ryerson. All rights reserved.8 The result will be the same. LO1

© McGraw-Hill Ryerson. All rights reserved.9 LO2 Cash Flow Statement Preparation Consider the following information to be used to prepare a Cash Flow Statement:

© McGraw-Hill Ryerson. All rights reserved.10 1 Determine the change in each Balance Sheet Account 2 Determine the related Cash Flow section; Operating, Investing or Financing LO2

Operating Cash Flows Indirect Method © McGraw-Hill Ryerson. All rights reserved.11 Net Income +/- Items included in net income that do not involve cash + Amortization + Losses on disposal of long-term assets or retirement of long-term debt – Gains on disposal of long-term assets or retirement of long-term debt +/- Changes in current assets and current liabilities + Decreases in current assets – Increases in current assets – Decreases in current liabilities + Increases in current liabilities = Net Cash Flow provided by (used in) Operating Activities LO2

© McGraw-Hill Ryerson. All rights reserved.12 Operating Cash Flows Starting point, from the Income Statement Amortization is a non-cash expense Cash collections greater than sales on account Cash payments greater than accrued expenses Cost of Goods Sold greater than purchases Prepayments greater than related expenses Payments to suppliers greater than purchases Overall increase in cash from operations LO2

Investing Cash Flows © McGraw-Hill Ryerson. All rights reserved.13 LO3 Property, Plant, and Equipment Purchase of property, plant and equipmentOutflow of Cash Sale of property, plant and equipment for cashInflow of Cash Intangible Assets Purchase of intangible assetsOutflow of Cash Sale of intangible assetsInflow of Cash Payment of cash for equipment Payment of cash for intangibles Overall decrease in cash from investing activities

Financing Cash Flows © McGraw-Hill Ryerson. All rights reserved.14 LO4 Notes Payable Borrowing cash from bankInflow of Cash Repayment of loan principalOutflow of Cash Bonds Payable Issuance of bonds for cashInflow of Cash Repayment of bond valueOutflow of Cash Contributed Capital Issuance of shares for cashInflow of Cash Repurchase of shares with cashOutflow of Cash Retained Earnings Payment of cash dividendOutflow of Cash Cash received when new loan obtained Cash paid on loan principal Overall increase in cash from financing activities Cash received from shareholders for new shares

© McGraw-Hill Ryerson. All rights reserved.15 Supplemental Disclosures include interest and taxes and show investing and financing transactions that did not affect cash flow. The Statement of Cash Flows shows cash inflows and outflows from operating, investing and financing activities. LO4

Let’s try it E12-4 E12-8 © McGraw-Hill Ryerson. All rights reserved.16

Evaluating Cash Flows © McGraw-Hill Ryerson. All rights reserved.17 LO5 Quality of Income Ratio Net Cash Flow from Operating Activities Net Income The Quality of Income ratio indicates whether operating cash flows and net income are in sync. A ratio near 1.0 is good. Deviation reasons can include: 1.Seasonality 2.The corporate life cycle 3.Changes in revenue and expense recognition 4.Changes in working capital management Quality of Income deteriorates prior to bankruptcy.

© McGraw-Hill Ryerson. All rights reserved.18 LO5 Capital Acquisitions Ratio Net Cash from Operations Cash Paid for PPE The Capital Acquisitions ratio indicates whether operating cash flows are sufficient to pay for property, plant, and equipment purchases. A higher ratio means less need for external financing. This ratio should only be compared within the same industry.

Operating Cash Flows Direct Method The Direct Method provides detailed information about each operating cost component. © McGraw-Hill Ryerson. All rights reserved.19 LO6 Converting Sales Revenues to Cash Inflows Sales may be collected in cash or on account. To determine the amount of cash inflows:

© McGraw-Hill Ryerson. All rights reserved.20 LO6 Converting Cost of Goods Sold to Cash Outflows Purchases may be paid in cash or on account; and inventory may increase or decrease. To determine the amount of cash outflows: Converting Operating Expenses to Cash Outflows Some operating expenses may be prepaid or accrued. To determine the amount of cash outflows:

© McGraw-Hill Ryerson. All rights reserved.21 Operating Activities presented using the Direct Method There is no change in the presentation of Investing and Financing Activities LO6

Supplement 12A Reporting Sales of Property, Plant, and Equipment (Indirect Method) © McGraw-Hill Ryerson. All rights reserved.22 S-12A The amount of cash received from the sale of property, plant and equipment does not equal the gain or loss from the sale, which was included in net income.

© McGraw-Hill Ryerson. All rights reserved.23 Under Armour sold old equipment for $7 million. The equipment originally cost $15 million and had $10 million of accumulated amortization. 2 Record 1 Analyze Because the $2 million was included in the calculation of net income, it must be deducted from the Operating Activities Section The $7 million cash received from the sale will be added to the Investing Activities Section S-12A