© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 21 Statement of Cash Flows Revisited

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-2 Investing ActivitiesOperating ActivitiesFinancing Activities Sale of operational assets Sale of investments Collections of loans Cash received from revenues Issuance of stock Issuance of bonds and notes CASH INFLOWS Business CASH OUTFLOWS Purchase of operational assets Purchase of investments Loans to others Cash paid for expenses Payment of dividends Repurchase of stock Repayment of debt

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-3 Cash and Cash Equivalents Resources immediately available to pay obligations. Short-term, highly liquid investments. So near maturity that there is insignificant risk of market value fluctuation from interest rate changes. Maturity of 3 months or less

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-4 Cash Equivalents Treasury bill 100,000 Cash 100,000 Inflow or outflow of cash? Neither – moves $100,000 from one cash account to another “cash” account

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-5 Primary Classifications in the Statement of Cash Flows

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-6 Cash flows from operating activities: Cash inflows: From customers$98 From investment revenue 3 Cash outflows: To suppliers of goods(50) To employees(11) For interest (3) For insurance (4) For income taxes (11) Net cash flows from operating activities$22 Cash flows from investing activities: Purchase of land($30) Purchase of short-term investment (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities(19) Cash flows from financing activities: Sale of common shares$26 Retirement of bonds payable(15) Payment of cash dividends (5) Net cash flows from financing activities 6 Net increase in cash $9 Cash balance, January 1 20 Cash balance, December 31$29

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-7 Cash Flows From Operating Activities Cash flows from operating activities are both inflows and outflows of cash that result from activities reported on the income statement.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-8 Income StatementCash Flows from Operating Activities Revenues:Cash inflows: Sales and service revenue Cash received from customers Investment revenue Cash revenue received Noncash revenues and gains (e.g., gain on sale of assets) [Not reported] Less: Expenses:Less: Cash outflows: Cost of goods sold Cash paid to suppliers Salaries expense Cash paid to employees Noncash expenses and losses (depreciation, amortization, bad debts, loss on sale of assets) [Not reported] Interest expense Cash paid to creditors Other operating expenses Cash paid for expenses Income tax expense Cash paid to the government Net incomeNet cash flows from operating activities

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-9 CASH FLOWS FROM OPERATING ACTIVITIES Direct Method  Cash flows from operating activities are the elements of net income, but reported on a cash basis. Cash flows from operating activities: Cash inflows: From customers$98 From investment revenue 3 Cash outflows: To suppliers of goods(50) To employees(11) For interest (3) For insurance (4) For income taxes(11) Net cash flows from operating activities $22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM OPERATING ACTIVITIES Indirect Method Derived indirectly by starting with reported net income and working backwards to convert that amount to a cash basis. Cash flows from operating activities: Net income$12 Adjustments for noncash effects: Gain on sale of land (8) Depreciation expense 3 Loss on sale of equipment 2 Changes in operating assets and liabilities: Increase in accounts receivable (2) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Discount on bonds payable 2 Decrease in prepaid insurance 3 Decrease in income tax payable (2) Net cash flows from operating activities $22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM INVESTING ACTIVITIES Related to the acquisition and disposition of assets, other than (a) inventory and (b) assets classified as cash equivalents. Included in this classification are cash payments to acquire:  Property, plant and equipment and other productive assets [except inventories].  Investments in securities [except cash equivalents].  Nontrade receivables. When these assets later are liquidated, any cash receipts from their disposition also are classified as investing activities. Cash Flows from Investing Activities: Purchase of land$(30) Purchase of short-term investments (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities (19)

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM FINANCING ACTIVITIES Inflows and outflows of cash resulting from the external financing of a business, including cash inflows from:  The sale of common and preferred stock  The issuance of bonds and other debt securities Subsequent transactions related to these financing transactions are also classified as financing activities, such as:  The repurchase of common or preferred stock (retirement or treasury stock)  The repayment of debt  The payment of cash dividends to shareholders Cash Flows from Financing Activities: Sale of common stock$26 Retirement of bonds payable(15) Payment of cash dividends (5) Net cash flows from financing activities 6

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Significant Noncash Activities Common noncash activities include: Retiring bonds by issuing stock. Retiring debt by transferring noncash assets. Acquiring an asset by issuing a note payable. Acquiring an asset by capital lease.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cash Flows from Operating Activities

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Now, let’s look at the Indirect Method for presenting the Cash Flows from Operating Activities section.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide INDIRECT METHOD  By the indirect method, the net cash increase or decrease from operating activities is derived indirectly by starting with reported net income and "working backwards" to convert that amount to a cash basis. Net income$12 Adjustments for noncash effects: Increase in accounts receivable (2) Gain on sale of land (8) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Depreciation expense 3 Discount on bonds payable 2 Decrease in prepaid insurance 3 Loss on sale of equipment 2 Decrease in income tax payable (2) Net cash flows from operating activities$22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Net Income Adjustments for Noncash Components Amounts that were increases in net income Gains Subtract from net income Amounts that were reductions of net income Depreciation, depletion, and amortization Losses Add back to net income

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Net Income Adjustments for Changes in Assets and Liabilities IncreaseDecrease Asset - + Liability + -