WHAT’S UP WITH C&C’S CASH? Increases in sales and income, yet they still have to borrow cash to make it through the year Time lag between payments for raw materials and collections from customers The timing difference is causing C&C to run out of cash

NET INCOME VS. CASH FLOWS Income Statement Cash Flow Statement of Cash Flows / =

Generate cash receipts SOURCES OF CASH Generate cash receipts Collections from customers  Cash proceeds from sale of building  Payment of salaries Χ Gain on sale of investment Χ

Require cash disbursements USES OF CASH Require cash disbursements Payment of interest on a loan  Purchase of inventory on account Χ Payment of salaries  Declaring dividends Χ

CASH FLOWS ARE GENERATED BY… OPERATING ACTIVITIES Cash flows from activities that accomplish the organization’s business purposes INVESTING ACTIVITIES Cash flows from activities related to investing in assets other than current operating assets FINANCING ACTIVITIES Cash flows from activities related to external funding sources such as debt and equity © Stephen Dumayne/iStockphoto © Russell Tate/iStockphoto © pagadesign/iStockphoto

C&C’S STATEMENT OF CASH FLOWS Cash from operating activities Cash from investing activities Cash from financing activities

EXAMPLES OF SOURCES AND USES OF CASH

TWO METHODS TO REPORT OPERATING CASH FLOWS Direct Method Indirect Method Start with net income and add items to reconcile to cash flows provided by operating activities Most commonly used method in practice Report specific operating activities that generate and use cash Method preferred by FASB, but rarely used in practice

INDIRECT METHOD

TREATMENT OF NON-CASH EXPENSES Income Statement Sales $100,000 Expenses (30,000) Depreciation (10,000) Net income $60,000 Cash Flow from Operations $100,000 (30,000) $70,000 Depreciation expense is subtracted from revenue to calculate net income. But depreciation expense has no effect on cash flow.

TREATMENT OF NON-CASH EXPENSES Rule: When calculating cash flow from operations under the indirect method, add back all non-cash expenses that reduce net income. Cash Flow from Operations Sales $100,000 Expenses (30,000) $70,000 Net income $60,000 Depreciation 10,000 Cash flow $70,000 Therefore depreciation expense must be added back to net income when calculating cash flows under the indirect method.

TREATMENT OF GAINS & LOSSES Assume: A building with a book value of $115,000 is sold for $130,000 in cash Reported on statement of cash flows as investing activity Journal Entry: Cash $130,000 Building, net $115,000 Gain on sale $ 15,000 Reported on income statement

TREATMENT OF GAINS & LOSSES Income Statement Sales $80,000 Expenses (60,000) Gain on sale 15,000 Net income $35,000 Cash Flow from Operations $80,000 (60,000) $20,000 The gain is added to revenue to calculate net income. But the total cash received has been reported in cash flow from investing.

TREATMENT OF GAINS & LOSSES Rule: When calculating cash flow from operations under the indirect method, subtract all gains from net income. Cash Flow from Operations $80,000 (60,000) $20,000 Net income $35,000 Gain on sale (15,000) Cash flow $20,000 Therefore any gains must be subtracted from net income when calculating cash flows under the indirect method.

TREATMENT OF CHANGES IN CURRENT ASSETS Reported on income statement Sales $300,000 Collections (280,000) Change in A/R balance $ 20,000 Cash flow to report in cash flows from operations Therefore, actual cash collected is $20,000 less than the amount included in sales revenue, and thus, net income.

TREATMENT OF CHANGES IN CURRENT ASSETS Accounts Receivable Beg. Bal. 5,000 Credit sales 300,000 280,000 Cash collections End. Bal. 25,000 Change in Accounts Receivable: Ending Balance – Beginning Balance $25,000 - $5,000 = $20,000

TREATMENT OF CHANGES IN CURRENT ASSETS Reported on income statement Sales $300,000 Collections (280,000) Change in A/P balance $ 20,000 Cash flow to report in cash flows from operations Rule: If current assets increase, subtract the amount of the increase from net income. If current assets decrease, add the amount of the decrease to income.

TREATMENT OF CHANGES IN CURRENT LIABILITIES Reported on income statement Salaries expenses $75,000 Payments to employees (80,000) Change in A/P balance $( 5,000) Cash flow to report in cash flows from operations Therefore, actual cash payment is $5,000 more than the amount included in salaries expense, and thus, net income.

TREATMENT OF CHANGES IN CURRENT LIABILITIES Salaries Payable Beg. Bal. 8,000 Salaries expense 75,000 80,000 Payments to employees End. Bal. 3,000 Change in Salaries Payable: Ending Balance – Beginning Balance $3,000 - $8,000 = ($5,000)

TREATMENT OF CHANGES IN CURRENT LIABILITIES Reported on income statement Salaries expenses $75,000 Payments to employees (80,000) Change in A/R balance $( 5,000) Cash flow to report in cash flows from operations Rule: If current liabilities increase, add the amount of the increase from net income. If current liabilities decrease, subtract the amount of the decrease to net income.

CASH FLOWS FROM INVESTING ACTIVITIES All cash flows from investing in non-operating assets Marketable securities Land Buildings Equipment Other assets Analyze each of these balance sheet accounts for changes

MARKETABLE SECURITIES From the balance sheet 2010 2009 $100,000 $80,000 Sold securities with a book value of $30,000 for $28,000 in cash. All purchases were made with cash. Beginning Balance $80,000 Cash Source Sales: $28,000 Cash Use Purchases: $50,000 + Purchases ? + Purchases 50,000 - Sales (30,000) = Ending Balance $100,000

PLANT & EQUIPMENT Beginning Balance $1,050,000 + Purchases + Purchases From the balance sheet 2010 2009 $800,000 $1,050,000 Sold equipment with a book value of $100,000 for $110,000 in cash. Depreciation expense was $150,000. Beginning Balance $1,050,000 + Purchases + Purchases ? Cash Source Sales: $110,000 - Sales (100,000) - Depreciation (150,000) = Ending Balance $800,000

INVESTING SECTION Sale of marketable securities $28,000 Sale of equipment 110,000 Purchase of marketable securities (50,000) Net cash provided by investing activities $88,000

CASH FLOWS FROM FINANCING ACTIVITIES All cash flows from investing in non-operating liabilities and equities Short-term debt Bonds payable Common stock Retained earnings Analyze each of these balance sheet accounts for changes

The company paid off $20,000 of its bonds payable. From the balance sheet 2010 2009 $500,000 $520,000 The company paid off $20,000 of its bonds payable. Beginning Balance $520,000 + Bonds issued ? + Bonds issued Cash Use Payments: $20,000 - Bond payments (20,000) = Ending Balance $500,000

RETAINED EARNINGS Beginning Balance $700,000 + Net income 110,000 - From the balance sheet 2010 2009 $780,000 $700,000 Net income was $110,000. All declared dividends were paid in cash during the year. Beginning Balance $700,000 + Net income 110,000 Cash Use Payments: $30,000 - Dividends declared (30,000) - Dividends declared ? = Ending Balance $780,000

FINANCING SECTION Repayment of bond payable $(20,000) Dividends paid (30,000) Net cash provided by financing activities $(50,000)

GENERAL FORMAT Cash flows provided by operating activities + Cash flows provided by investing activities Cash flows provided by financing activities = Change in Case Cash, beginning balance Cash, ending balance

THINGS TO LOOK FOR Does the company generate cash from operations? How are the current asset accounts changing? Do these changes match with the company’s strategic direction? Is the company maintaining its productive capacity through acquisition of replacement equipment? How is the company choosing to finance its operations – debt or equity?

MAJOR OPERATING ACTIVITIES Collections from customers Payments to suppliers Payments to employees Payments for operating costs Payments for income taxes

COLLECTIONS FROM CUSTOMERS Use this information that is readily available from the balance sheet and income statement A/R, Beginning Balance $11,200 + Sales 1,050,000 - Collections from customers ? - Collections from customers (1,038,000) = A/R Ending Balance $23,200

PAYMENTS TO SUPPLIERS – STEP 1: PURCHASES Use this information that is readily available from the balance sheet and income statement Inventory, Beginning Balance $326,340 + Inventory Purchases 774,030 + Inventory purchases ? - Cost of Goods Sold (777,000) = Inventory, Ending Balance $323,370

PAYMENTS TO SUPPLIERS – STEP 2: PAYMENTS Use the results from step 1 and from this information that is readily available from the balance sheet and income statement A/P, Beginning Balance $162,200 + Inventory purchases 774,030 - Payments to suppliers (1,038,000) - Payments to suppliers ? = A/P Ending Balance $23,200

PAYMENTS TO EMPLOYEES Use this information that is readily available from the balance sheet and income statement Salaries Payable, Beg. Bal. $1,600 + Salaries Expense 92,400 - Payments to employees ? - Payments to employees (92,050) = Salaries Payable, End. Bal. $23,200

PAYMENTS FOR OPERATING COSTS Use this information that is readily available from the balance sheet and income statement Accrued Liabilities, Beg. Bal. $42,540 + Operating expenses 124,900 - Payments for operating costs ? - Payments for operating costs (122,220) = Accrued liabilities, End. Bal. $45,220

PAYMENTS FOR INCOME TAXES Use this information that is readily available from the balance sheet and income statement Income Taxes Payable, Beg. Bal. $12,000 + Income Tax expense 13,200 - Payments for income taxes ? - Payments for income taxes (12,000) = Income Taxes Payable, End. Bal. $45,220