Chapter 16 The Statement of Cash Flows 16-1

What Is the Statement of Cash Flows? The statement of cash flows reports on a business’s cash receipts and cash payments for a specific period. This statement does the following: – Reports on the cash flows of a business. – Reports why cash increased or decreased during the period. – Covers a span of time and is dated the same as the income statement. 16-2

Purpose of the Statement of Cash Flows The statement of cash flows explains why net income as reported on the income statement does not equal the change in the cash balance. The statement of cash flows helps: – Predict future cash flows. – Evaluate management. – Predict ability to pay debts and dividends. 16-3

Classification of Cash Flows There are three basic types of cash flows, and the statement of cash flows has a section for each: – Operating activities – Investing activities – Financing activities 16-4

Operating Activities Operating activities is the first section on the statement of cash flows. This section reports on activities that create revenue or expense in the entity’s business. This is often the most important category. 16-5

Investing Activities Investing activities is the second category listed on the statement of cash flows. This section reports cash receipts and cash payments that increase or decrease long-term assets. It includes the cash inflow from selling and the cash outflow from purchasing long- term assets. 16-6

Financing Activities Financing activities is the last category listed on the statement of cash flows. Financing activities include cash inflows and outflows involved in long-term liabilities and equity. Financing activities include: – Issuing stock. – Paying dividends. – Buying and selling treasury stock. 16-7

Classification of Cash Flows 16-8

Non-cash Investing and Financing Activities Companies make investments that do not require cash. Such transactions are called non-cash investing and financing activities. These activities appear as a separate schedule at the bottom of the statement of cash flows or in the notes to the financial statements. 16-9

Non-cash Investing and Financing Activities 16-10

Two Formats for Operating Activities Indirect method Starts with accrual income and adjusts to net cash Uses account relationships to determine changes in cash Direct method Restates the income in terms of cash Shows actual cash receipts and cash payments 16-11

How Is the Statement of Cash Flows Prepared Using the Indirect Method? Items needed: – Income statement for the current year. – Balance sheet for current year. – Balance sheet from prior year. – Additional information based on review of transactions

How Is the Statement of Cash Flows Prepared Using the Indirect Method? Prepare in five steps: 1.Complete the cash flows from operating activities. 2.Complete the cash flows from investing section. 3.Complete the cash flows from financing section. 4.Compute the change in cash. 5.Prepare a schedule for non-cash activities

How Is the Statement of Cash Flows Prepared Using the Indirect Method? 16-14

How Is the Statement of Cash Flows Prepared Using the Indirect Method? 16-15

How Is the Statement of Cash Flows Prepared Using the Indirect Method? 16-16

Cash Flows from Operating Activities When using the indirect method, the operating activities section begins with accrual-basis net income or loss, which needs to be adjusted to a cash number. For example: – Sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. – Accrued expenses decrease net income, but the company has not yet paid cash

Depreciation, Depletion, and Amortization Expenses Depreciation, depletion, and amortization expenses are added back to net income to reconcile net income to net cash flow from operating activities

Gains and Losses on the Disposal of Long-Term Assets Disposals from long-term assets create a gain or loss that must be removed from net income, which is in the operating activities section

Changes in Current Assets and Current Liabilities Most current assets and current liabilities result from operating activities

Evaluating Cash Flows from Operating Activities The operating activities section starts with accrual net income, and then adjustments are made to reconcile net income to net cash

Evaluating Cash Flows from Operating Activities 16-22

Cash Flows from Investing Activities Investing activities affect long-term assets, such as: – Plant assets – Investments – Notes receivable It is helpful to evaluate the T-accounts for each long-term asset to determine if there was an acquisition or disposal

Cash Flows from Investing Activities Use the information available to determine the cash received from an asset disposal: 16-24

Cash Flows from Investing Activities 16-25

Cash Flows from Financing Activities Financing activities affect the long-term liability and equity accounts: – Long-Term Notes Payable – Bonds Payable – Common Stock – Retained Earnings 16-26

Cash Flows from Financing Activities If the amount of cash dividend payments is not readily available, the Retained Earnings account can be used to determine dividend payments

Cash Flows from Financing Activities 16-28

Net Change in Cash and Cash Balances 16-29

Non-cash Investing and Financing Activities The last step is to prepare the non-cash investing and financing activities section

How Do We Use Free Cash Flow to Evaluate Business Performance? Investors want to know how much cash a company can “free up” for new opportunities. Free cash flow is the amount of cash available from operating activities after paying for planned investments in long- term assets and after paying dividends

ShopMart expects net cash provided by operations of $200,000. It plans to spend $160,000 to modernize its retail facilities and pays $15,000 in cash dividends. ShopMart’s free cash flow is $25,000: ($200,000 ‒ $160,000 ‒ $15,000) How Do We Use Free Cash Flow to Evaluate Business Performance? 16-32

How Is the Statement of Cash Flows Prepared Using the Direct Method? The Financial Accounting Standards Board (FASB) prefers the direct method of reporting cash flows from operating activities. This method provides clearer information about the sources and uses of cash than the indirect method. Only the operating section differs between the two methods

Cash Flows from Operating Activities Cash collections from customers: 16-34

Payments to Suppliers Cash paid for inventory is calculated as follows: Cash paid for operating expenses is calculated as follows: 16-35

Payments to Suppliers 16-36

Net Cash Provided by Operating Activities To calculate net cash provided by operating activities using the direct method, we add all the cash receipts and cash payments. Net cash provided by operating activities is $70,000, which is the same amount found under the indirect method

Net Cash Provided by Operating Activities 16-38

How Is the Statement of Cash Flows Prepared Using the Indirect Method and a Spreadsheet? Most companies use a spreadsheet to prepare the statement of cash flows. This statement starts with the beginning balance sheet and concludes with the ending balance sheet. Columns labeled “Transaction Analysis” hold the data for the statement of cash flows

16-40 How Is the Statement of Cash Flows Prepared Using the Indirect Method and a Spreadsheet?

16-41 How Is the Statement of Cash Flows Prepared Using the Indirect Method and a Spreadsheet?