HUANGHUAI UNIVERSITY & BANGOR UNIVERSITY Lecture 9 Statement of Cash Flows DR. AZIZ JAAFAR

Statement of Cash Flows – Background Required presentation since 1987 Cash and cash equivalents Cash on hand Cash on deposit Investments in short-term, highly liquid securities

Statement Use Internal users External users Determine dividend policy Evaluate cash generated by operations Review investing and financing policy External users Assess firm’s ability to increase dividends Assess firm’s ability to pay debt from operations Assess firm’s relationship of cash from operations to total cash

Statement Structure Cash flows from operations + Cash flows from investing activities + Cash flows from financing activities = Change in cash + Beginning cash balance = Ending cash balance Supplemental disclosure: non-cash financing and investing activities

Operating Activities The cash effects of transactions and other events that enter into the determination of net income: Cash inflows from Sale of goods or services Returns on loans (interest) Return on equity securities (dividends) Cash outflows for Payments for acquisitions of inventory Payments to employees Payments for taxes Payments for interest Payments for other expenses

Investing Activities Lending money and collecting on those loans and acquiring and selling investments and productive long-term assets: Cash inflows from Receipts for loans collected Sales of debt or equity securities Sales of plant, property, and equipment Cash outflows for Loans to other entities Investment in debt or equity securities Purchase of plant, property, and equipment

Financing Activities Borrowing and repaying long-term loans; issuing equity securities; payment of dividends to shareholders: Cash inflows from Sale of equity securities Sale of bonds, mortgages, notes, and other short- and long-term borrowings Cash outflows for Payment of dividends Reacquisition of capital stock Payment of amounts borrowed

Cash Flows From Operations Alternative presentations: Direct method Presents the income statement on a cash basis Encouraged by FASB 95 Supplemental information required: reconciliation of net income to cash provided by operations Indirect method Adjusts net income for items that affected net income but did not affect cash Supplemental information required: cash paid for income taxes and for interest

Cash Flows From Operations: Direct Method Presents the income statement on a cash basis

Cash Flows From Operations: Indirect Method Adjusts net income for items that affected net income but did not affect cash

Cash Flows From Operations Direct Indirect

Cash Flows From Investing Activities

Cash Flows From Financing Activities

Statement of Cash Flows – Direct Method (supplemental disclosures not illustrated)

Statement of Cash Flows – Indirect Method (supplemental disclosures not illustrated)

Alternative Cash Flow Analysis

Financial Ratios and the Statement of Cash Flows Statement of cash flows is relatively new Required presentation began in 1987 Cash flow financial ratios were slowly developed Traditional ratios relate balance sheet to income statement

Operating Cash Flow/Current Maturities of Long-Term Debt and Current Notes Payable Indicates a firm’s abilities to meet its current maturities of debt Higher ratio indicates better liquidity

Operating Cash Flow to Total Debt Indicates a firm’s ability to cover total debt with the yearly operating cash flow Conservative approach is to include all possible balance sheet debt

Operating Cash Flow per Share A better indication of a firm’s ability to make capital expenditure decisions and pay dividends than is earnings per share Does not reflect firm’s profitability Firms are prohibited from reporting this statistic in financial statements or in the notes thereto

Operating Cash Flow to Cash Dividends Indicates a firm’s ability to cover cash dividends with the yearly operating cash flow

Alternative Cash Flow No standard definition of cash flow Alternative definition Net income plus depreciation expense Less useful than the net cash flow from operating activities

Procedures to Develop the Statement of Cash Flows Analyze all balance sheet accounts other than cash and cash equivalents. Increase Decrease Current assets Operating outflow Operating inflow Noncurrent assets Investing outflow Investing inflow Current liabilities Long-term liabilities Financing inflow Financing outflow Stockholders’ equity

Procedures to Develop the Statement of Cash Flows (cont’d) Determine change in cash and cash equivalents Compute the change in all other balance sheet accounts Classify as operating, investing, and financing

Procedures to Develop Direct Operating Cash Flows Operating section describes income statement accounts as receipts or payments Cash receipts From customers From other operating sources Cash payments For merchandise To employees For other operating expenses

Procedures to Develop Indirect Operating Cash Flows Begin with net income Eliminate gains and losses that relate to investing and financing activities Add back or deduct adjustments to change accrual-based net income to cash basis Current noncash assets Current liabilities