Statement of Cash Flows Lecture 11 (CHAPTER 5)

Learning Objectives (LO) After studying this chapter, you should be able to Identify the purposes of the statement of cash flows Classify activities affecting cash as operating, investing, or financing activities Compute and interpret cash flows from financing activities Compute and interpret cash flows from investing activities Use the direct method to calculate cash flows from operations

Learning Objectives (LO) After studying this chapter, you should be able to Use the indirect method to explain the difference between net income and net cash provided by (used for) operating activities Understand why we add depreciation to net income when using the indirect method for computing cash flow from operating activities Show how the balance sheet equation provides a conceptual framework for the statement of cash flows Identify free cash flow, and interpret information in statements of cash flow

LO 1 - Purpose of Cash Flow Statement The concept underlying the statement Same as statements of income and retained earnings Explains change in an account (cash) from the beginning to the end of the reporting period What is “cash” Money in bank accounts and on hand Cash equivalents (maturity less than 90 days and easily and quickly convertible into cash Money market funds Treasury bills Very low probability of change in value

LO 1 - Purpose of Cash Flow Statement Helps predict future cash flows Evaluates how management generates and uses cash Determines a company’s ability to pay interest, dividends, and debts when they are due Identifies specific increases and decreases in a firm’s productive assets

LO 1 - Purpose of Cash Flow Statement

LO 1 - Purpose of Cash Flow Statement What information may users find/derive from the statement? Past Why net income differs from cash flows Identifies specific increases and decreases in a firm’s productive assets Evaluates how management generated/used cash Present - determines a company’s ability to pay interest, dividends, and debts when they are due Future – helps predict future cash flows

LO 2 - Cash Flow Activities

LO 3 - Financing Cash Flows From two successive balance sheets, observe: Short/long term debt (related to borrowing) Increase Decrease Capital stock accounts Treasury Stock (Chapter 10) Meaning Cash inflow Cash outflow

LO 3 - Financing Cash Flows From this year’s retained earning statement, observe: Dividends Declared From two successive balance sheets, observe Dividends Payable Increased Decreased Meaning Cash outflow<dividends declared Cash outflow>dividends declared Sometimes some changes are related to noncash events such as purchasing a building by issuing new stock to the seller. In those cases the noncash amount would be reported in a separate schedule if the buying company felt it was “significant.”

LO 4 - Investing Cash Flows From two successive balance sheets, observe: Intangible Assets Increase Decrease Long-term Investments Loans to others Meaning Cash outflow Cash inflow

LO 4 - Investing Cash Flows From two successive balance sheets, observe: Plant, Property, Equipment Increase Decrease Meaning Cash outflow Cash inflow Depreciation complicates this Balance Sheet Income Statement Cash Equipment Accumulated Depreciation Depreciation Expense Loss on sale of Equipment 110 900 970 90 95 15 5 Your firm bought $110 of equipment, paying cash. How much cash was received from the sale of equipment? (Figures are taken from last and this years’ financial statements.

LO 4 - Investing Cash Flows From two successive balance sheets, observe: Plant, Property, Equipment Increase Decrease Meaning Cash outflow Cash inflow Depreciation complicates this Balance Sheet Income Statement Cash Equipment Accumulated Depreciation Depreciation Expense Loss on sale of Equipment 25 110 900 110 970 40 10 90 15 95 15 5 Your firm bought $110 of equipment, paying cash. How much cash was received from the sale of equipment? (Figures are taken from last and this years’ financial statements.)

LO 5 - Operating Cash Flows All cash flows other than investing and financing Cash flows with the normal operations of the business

LO 5 - Operating Cash Flows Cash can precede an income statement event Buy supplies before using them Receive cash before earning it An income statement event can precede a cash flow Sell goods on credit with collection next month Consume utilities before paying for them Cash/income statement event occur simultaneously Cash sale to customer Pay for advertising used this reporting period

LO 5 - Operating Cash Flows Operating Cash Flows – Two methods Direct method Operating cash inflows less operating cash outflows = operating cash flows Preferred method because it is easily understood If use this method, must also show indirect method Indirect Explains why net income is different from net operating cash flows Do not have to show the direct method Most commonly used method

LO 5 - Operating Cash Flows - Direct If have access to all cash flow information, just select and list operating cash flows Payments for inventory $(865,000) (next page) Collections from customers $1,500.000 Payments for interest $(15,000) Tax refund $20,000 Etc. ________ Operating Cash Flow $640,000

LO 5 - Operating Cash Flows - Direct Access only to statements other than cash flow Balance Sheet (000) Income Statement (000) Cash Inventory Accounts Payable Cost of Goods Sold 59.2 25.2 100 Payments for inventory $(865,000)

LO 5 - Operating Cash Flows - Direct Access only to statements other than cash flow Balance Sheet (000) Income Statement (000) Cash Inventory Accounts Payable Cost of Goods Sold 134 159.2 59.2 100 134 159.2 25.2 100 Payments for inventory $(134,000)