1 © Copyright Doug Hillman 2000 Statement of Cash Flows

2 © Copyright Doug Hillman 2000 Purpose of Statement of Cash Flows l Provide information about cash receipts and payments during an accounting period l Helps us see how financial position changes during an accounting period l Only statement that collects and shows in one statement the causes of changes in cash during a financial reporting period

3 © Copyright Doug Hillman 2000 Cash and Cash Equivalents l Cash includes currency on hand and demand deposits l Cash equivalents are short-term, highly liquid investments that are

4 © Copyright Doug Hillman 2000 Cash and Cash Equivalents l Cash includes currency on hand and demand deposits l Cash equivalents are short-term, highly liquid investments that are »Readily convertible to known amounts of cash

5 © Copyright Doug Hillman 2000 Cash and Cash Equivalents l Cash includes currency on hand and demand deposits l Cash equivalents are short-term, highly liquid investments that are »Readily convertible to known amounts of cash »So near maturity that they are not likely to change in value due to changes in interest rates

6 © Copyright Doug Hillman 2000 Classification of Cash Receipts and Cash Payments l Operating activities l Investing activities l Financing activities

7 © Copyright Doug Hillman 2000 Operating Activities l Transactions that generally involve producing and delivering goods and providing services l Inflows »selling goods and services, interest and dividend revenue l Outflows »inventory, salary exp, interest exp

8 © Copyright Doug Hillman 2000 Investing Activities l Buying and selling plant assets and securities, and making loans and collecting on them l Inflows »sale of plant assets and investment securities, collecting loans l Outflows »purchasing plant assets, investment securities

9 © Copyright Doug Hillman 2000 Financing Activities l Obtaining resources from owners and providing return, and obtaining resources from creditors and repaying principal l Inflows »issuing stock, bonds, other short and long-term borrowing l Outflows »purchasing treasury stock, repaying principal, cash dividends

10 © Copyright Doug Hillman 2000 Other Cash Flow Considerations l Generally, information on gross receipts and payments more relevant »When issuing long-term debt to retire other debt, show both l Noncash investing and financing »Acquiring plant assets by issuing notes payable »Converting bonds payable into common stock

11 © Copyright Doug Hillman 2000 Basic Interpretation of Statement of Cash Flows l Overall, how successful has management been in generating and investing cash flows? l How does accrual basis net income compare with cash basis?

12 © Copyright Doug Hillman 2000 Basic Interpretation of Statement of Cash Flows l What cash uses have been made for investing activities, and to what extent has cash from operations been sufficient to pay for these investments? l What sources and uses have been generated from financing activities?

13 © Copyright Doug Hillman 2000 Direct versus Indirect Method for Operating Activities l Direct shows major classes of gross cash receipts and cash payments »Difference is net cash provided by, used in, operating activities l Indirect starts with net income (loss) and adjusts for revenues and expenses that did not cause changes in cash l FASB encourages use of the direct method

14 © Copyright Doug Hillman 2000 Direct Method l Goal to convert each income statement item from accrual to cash basis l First, identify the balance sheet account(s) that relate to each income statement item l Next, combine the change in the balance sheet account with the income statement amount

15 © Copyright Doug Hillman 2000 Cash Receipts from Customers l Cash receipts from customers relates sales to change in accounts receivable l If accounts receivable decreased during the period, we collected more cash than amount reported as sales revenue l If accounts receivable increased during the period, we collected less cash that amount reported as sales revenue

16 © Copyright Doug Hillman 2000 Cash Receipts from Customers l Take sales amount and »Add decrease in accounts receivable »OR »Subtract increase in accounts receivable

17 © Copyright Doug Hillman 2000 Cash Payments to Suppliers l Cash Payments to Suppliers relates cost of goods sold to change in merchandise inventory and change in accounts payable l First use cost of goods sold and change in inventory to calculate purchases l If inventory increased during the period, we purchased more goods than we sold l If inventory decreased during the period, we purchased fewer goods than we sold

18 © Copyright Doug Hillman 2000 Cash Payments to Suppliers l To calculate purchases, take cost of goods sold amount and »Add increase in inventory »OR »Subtract decrease in inventory l This gives us accrual purchases

19 © Copyright Doug Hillman 2000 Cash Payments to Suppliers l Second use purchases and change in accounts payable to calculate cash payments to suppliers l If accounts payable increased during period, we paid less cash than purchases l If accounts payable decreased during period, we paid more cash than purchases

20 © Copyright Doug Hillman 2000 Cash Payments to Suppliers l To calculate cash payments to suppliers, take purchases amount and »Add decrease in accounts payable »OR »Subtract increase in accounts payable

21 © Copyright Doug Hillman 2000 Other Expenses That Affect Cash l Cash payments for expenses relate the expense to a change in an accrued expense account or a prepaid expense »Cash payments for wages relates wages expense and change in wages payable »Cash payments for office supplies relates office supplies expense and changes in office supplies

22 © Copyright Doug Hillman 2000 Other Expenses That Affect Cash l To calculate cash payments for expenses, take the expense amount and »Add decrease in accrued expense »OR »Subtract increase in accrued expense »OR »Add increase in prepaid expense »OR »Subtract decrease in prepaid expense

23 © Copyright Doug Hillman 2000 Other Revenues That Affect Cash l Cash receipts for revenues relate the revenue to a change in an unearned revenue account or accrued revenue »Cash receipts from interest relates interest revenue and change in interest receivable »Cash receipts from subscriptions relates subscriptions revenue and changes in unearned subscriptions

24 © Copyright Doug Hillman 2000 Other Revenues That Affect Cash l To calculate cash receipts from revenues, take the revenue amount and »Add decrease in accrued revenue »OR »Subtract increase in accrued revenue »OR »Add increase in unearned revenue »OR »Subtract decrease in unearned revenue

25 © Copyright Doug Hillman 2000 Indirect Method for Operating Activities l Starts with net income(loss) from the income statement. l Adjusts for revenues and expenses that did not cause a change in cash l Results in same total as direct method l FASB encourages use of direct l Believes that reconciliation of net income to cash provided by operations is useful information

26 © Copyright Doug Hillman 2000 Indirect Method Step 1 l Net income l Add »Expenses that did not use cash and losses on sale of noncurrent assets l Subtract »Gains on sales of noncurrent assets

27 © Copyright Doug Hillman 2000 Indirect Method Step 2 l Add »Decreases in operating current assets »Increases in operating current liabilities l Subtract »Increases in operating current assets »Decreases in operating current liabilities

28 © Copyright Doug Hillman 2000 Cash Flows from Investing Activities l Analyze changes in nonoperating current assets and noncurrent assets »If equipment increased, there was a purchase of new equipment »If equipment decreased, there was a disposal of old equipment l If there was more than one change, analyze each separately l Identify the cash flow from each transaction

29 © Copyright Doug Hillman 2000 Cash Flows from Financing Activities l Analyze changes in nonoperating current liabilities, noncurrent liabilities, paid-in capital, and nonoperating changes to retained earnings(dividends) »If bonds increased, there was an issuance of bonds »If paid-in capital increased, there was an issuance of stock

30 © Copyright Doug Hillman 2000 Cash Flows from Financing Activities l If dividends were declared, combine amount declared with change in dividends payable to get cash dividends l If there was more than one change, analyze each separately l Identify the cash flow from each transaction

31 © Copyright Doug Hillman 2000 Steps in Preparing Statement of Cash Flows l Compute the net change in cash and cash equivalents l Compute the amount of net cash provided by (used in) operating activities by direct method l Prepare the reconciliation of net income to net cash provided by (used in) operating activities by indirect method

32 © Copyright Doug Hillman 2000 Steps in Preparing Statement of Cash Flows l Compute the amount of net cash provided by (used in) investing and financing activities l Prepare the statement of cash flows

33 © Copyright Doug Hillman 2000 Interpretation of Information in Statement of Cash Flows l Overall, how successful has management been in generating and investing cash flows during the period? l How does accrual net income compare with cash net income?

34 © Copyright Doug Hillman 2000 Interpretation of Information in Statement of Cash Flows l What cash uses have been made for investing activities and to what extent has cash from operations been sufficient to pay for these investments? l What sources and uses have been generated from financing activities?