Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto Chapter 22 Statement of Cash Flows Chapter 22 Statement of Cash Flows

2 Statement of Cash Flows Introduction to the Statement of Cash Flows Usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/Private Enterprise GAAP Comparison Comparison of IFRS and private enterprise GAAP Looking ahead Preparing a Statement of Cash Flows Sources of information Steps in the process First illustration – Tax Consultants Inc. Second illustration – Eastern Window Products Limited Third illustration – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative examples Interpreting the statement of cash flows Free cash flow

3 Statement of Cash Flows Introduction to the Statement of Cash Flows Usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/Private Enterprise GAAP Comparison Comparison of IFRS and private enterprise GAAP Looking ahead Preparing a Statement of Cash Flows Sources of information Steps in the process First illustration – Tax Consultants Inc. Second illustration – Eastern Window Products Limited Third illustration – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative examples Interpreting the statement of cash flows Free cash flow

4 Usefulness of the Statement of Cash Flows The information may help users (investors, creditors, and others) assess the following: 1.Liquidity and solvency – i.e. the entity’s ability to generate future cash flows and its needs for cash resources 2.The amounts, timing, and uncertainty of future cash flows 3.The reasons why net income and net cash flow from operating activities differ

5 Cash and Cash Equivalents Cash Cash on hand Demand deposits Cash Equivalents Investments that are –Short term, –Highly liquid, and –Easily converted to a known amount of cash –Subject to an insignificant risk of change in value All references to Cash include Cash Equivalents when discussing the Statement of Cash Flows

6 The Cash Flow Statement The cash flow statement provides information about: the cash receipts (cash inflows), and uses of cash (cash outflows) during the year Inflows and outflows are reported for: operating activities investing activities, and financing activities during the year

7 Cash Flow Classifications 1.Operating Activities The cash flows resulting from the primary revenue- producing activities of the business, such as Collections from customers Payments to suppliers Payments to employees Payments to CRA for tax Cash flow provided by operating activities necessary for long term sustainability of the business (i.e. to take advantage of new investment opportunities, to pay dividends without seeking external financing etc.)

8 Cash Flow Classifications 2.Investing Activities The acquisition and disposal of long term assets and long-term investments Examples include: Purchase/disposal of capital assets Acquiring an interest in another corporation Cash flow generated by investing activities shows if the business is investing in additional long term assets that will generate profits and increase cash flows in the future

9 Cash Flow Classifications 3.Financing Activities Changes in long-term debt or equity capital Examples include: Issuing debt, or repayment of debt Issuing new shares, or repurchase of currently outstanding shares Provides information to assess potential for future claims to entity’s cash, extent of debt and increased interest charges

10 Statement of Cash Flows: Concept Operatingactivities Investingactivities Financingactivities Inflows CashPool Operatingactivities Investingactivities Financingactivities Outflows

11 Classification of Cash Flows -IFRS requirements relating to classification of cash flows are similar to accounting standards for private enterprises (ASPE) -Under ASPE, interest and dividends included in determining net income are classified as operating flows while those charged against retained earnings are reported as financing flows -Under IFRS, a choice is allowed for interest and dividends -Interest and dividends (paid and received) could be classified as operating flows -Interest and dividends paid could also be classified as financing outflow -Interest and dividends received could also be considered investment flows

12 Significant Noncash Transactions Transactions that do not involve the direct receipt or disbursement of cash in the period Examples: –Asset purchased, paid for by assuming debt, or issuance of shares –Exchanges of non-monetary assets –Conversion of debt to equity Noncash transactions are not reported on the Statement of Cash Flows If material, they are reported as notes to the statement or in a supplementary schedule to the financial statements

13 Preparing a Statement of Cash Flows Two methods of preparing the operating cash flow section of the Statement of Cash Flows: 1.Indirect method 2.Direct method Indirect method derives operating cash flows from accrual basis income statement Direct method determines operating cash flows directly for each operating source or use of cash

14 In favour of Direct Method Is more consistent with objective of a statement of cash flows Knowing specific sources of cash inflows and purposes of cash outflows helps in estimating future cash flows Lending officers and other investors prefer direct method Both IFRS and PE GAAP encourage the use of direct method as it provides additional information

15 Cash Flow from Operations: Indirect Method – Concept Net Income + - EarnedRevenues ExpensesIncurred Operating cash flow Eliminate non-cash revenues Eliminate non-cash charges

16 The Statement of Cash Flows: Indirect Method Accrual Basis StatementsCash Flow Statement Income Statement items and changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals, non-cash charges and non- operating gains/losses Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and outflows for purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions

17 Format of the Statement of Cash Flows (Indirect Method) Cash flows from operating activities: Net Income (Loss) $ XXX Adjustments (List individual adjustments) $ XX Net cash flow from operating activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Change in cash $ XXX

18 Format of the Statement of Cash Flows (Direct Method) Cash flows from operating activities: Cash receipts (individually): Inflows $ XXX Cash payments (separately): outflows ($ XXX) Net cash flow from operating activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Change in cash $ XXX

19 Cash Flows from Operations: Direct Method OutflowsInflows Received from customers for cash sales and on account Cash receipts from other revenue sources To suppliers for cash purchases and payments on account To employees for salaries and wages paid To government for taxes paid

20 Statement of Cash Flows Introduction to the Statement of Cash Flows Usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/Private Enterprise GAAP Comparison Comparison of IFRS and private enterprise GAAP Looking ahead Preparing a Statement of Cash Flows Sources of information Steps in the process First illustration – Tax Consultants Inc. Second illustration – Eastern Window Products Limited Third illustration – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative examples Interpreting the statement of cash flows Free cash flow

21 Indirect Method: Example Tax Consultants Inc. began operations on January 1, The income statement and balance sheet for year 2011 follow. Income Statement Revenues $ 125,000 Less: Operating expenses 85,000 Income before Tax 40,000 Less: Income Tax 6,000 Net Income $ 34,000 A dividend of $14,000 was declared during year.

22 Indirect Method: Example Balance Sheet Dec 31, 2011 Jan 1, 2011 Assets: Cash$ 49,000$-0- Accounts Receivable 36, Total $ 85,000$-0- Liabilities and Shareholders’ Equity: Accounts Payable$ 5,000$-0- Common Shares 60, Retained Earnings 20, Total $85,000$-0-

23 Operating Activities Net Income $34,000 Accounts Receivable +$ 36,000 Accounts Payable +$ 5,000 Accrual Basis Net Income $34,000 Less: Increase in A/R $ 36,000 Add: Increase in A/P $ 5,000 Cash Flow Changes between beginning and ending balances Operations: Net Inflow $3,000 See explanations next slide

24 Operating Activities Accounts Receivable Increased by $36,000 Cash collections are less than revenue recognized Reduce net income by $36,000 to derive cash flows from operations

25 Operating Activities Accounts Payable Increased by $5,000 Cash paid for purchases is less than expenses reported Increase net income by $5,000 to derive cash flows from Operations; net income for the year increases by $5,000

26 Investing and Financing Activities Accrual Basis Common Stock + $60,000 Retained Earnings + $20,000 Beg Bal:$ 0 Net Income: 34,000 less: Dividends (14,000) End Balance:$20,000 Cash Flow Financing Activities: Issue of Shares: $60,000 Dividends paid: ( 14,000) Inflow 46,000

27 Cash Flow Statement: (Indirect Method) - Summary Cash provided by operating activities: $ 3,000 Cash used by investing activities: -0- Cash provided by financing activities: 46,000 Net inflow for the year $ 49,000 Beginning cash balance: $ -0- Cash, end of year $ 49,000

28 Other Items Income statement gains and losses on disposal of long-term assets must be adjusted in determining cash from operations. Why? These result from investing activities, not operating activities and The amount of the cash flow is the proceeds on disposal, not the gain or loss

29 Other Items Income statement gains and losses on redemption of long-term debts must be adjusted in determining cash from operations. Why? These result from financing activities, not operating activities and The amount of the cash flow is the amount paid to redeem the debt, not the gain or loss

30 Cash From Operations: Direct Method Cash receipts from customers: = Revenue from credit sales – Increase in A/R balances = $125,000 – $36,000 = $89,000 Cash payments to suppliers: = cost of goods sold = $85,000 – $5,000 = $80,000 Refer to Tax Consultant Inc. the data for the indirect method.

31 Direct Method: Operating Activities Operating Activities: Cash receipts from customers $ Cash paid to suppliers (80,000) Cash paid for income taxes (6,000) Net cash inflow $ 3,000

32 Statement of Cash Flows Introduction to the Statement of Cash Flows Usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/Private Enterprise GAAP Comparison Comparison of IFRS and private enterprise GAAP Looking ahead Preparing a Statement of Cash Flows Sources of information Steps in the process First illustration – Tax Consultants Inc. Second illustration – Eastern Window Products Limited Third illustration – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative examples Interpreting the statement of cash flows Free cash flow

33 Disclosure Requirements IFRS and PE GAAP require similar disclosures on certain items, including the disclosure of: 1.Significant non-cash investing and financing transactions 2.Policy on what makes up cash and cash equivalents 3.Reconciliation of cash and cash equivalents to balance sheet accounts IFRS has more strict requirements relating to disclosure of some items, including: 1.Income taxes 2.Interest and dividends (paid and received) 3.Restrictions on cash and cash equivalents

34 Free Cash Flow Free cash flow (FCF) is a non-GAAP measure used by many companies to indicate discretionary cash available for new investments, paying dividends, retiring debt, repurchasing shares, or improving liquidity FCF is typically calculated as –Net operating cash flows –Less: capital expenditures to sustain current level operations As it is a non-GAAP measure, some companies calculate FCF differently

35 Statement of Cash Flows Introduction to the Statement of Cash Flows Usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/Private Enterprise GAAP Comparison Comparison of IFRS and private enterprise GAAP Looking ahead Preparing a Statement of Cash Flows Sources of information Steps in the process First illustration – Tax Consultants Inc. Second illustration – Eastern Window Products Limited Third illustration – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative examples Interpreting the statement of cash flows Free cash flow

36 Looking Ahead Significant changes are expected from the FASB-IASB Financial Statement Presentation project Both IAS 1 Presentation of Financial Statements and IAS 7 Statement of Cash Flows are expected to be replaced with a new standard

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