McGraw-Hill/Irwin Slide 1 McGraw-Hill/Irwin Slide 1 How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? PURPOSE OF THE STATEMENT OF CASH FLOWS C 1

McGraw-Hill/Irwin Slide 2 McGraw-Hill/Irwin Slide 2 How did the business fund its operations? Did the business borrow any funds or repay any loans? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? IMPORTANCE OF CASH FLOWS C 1

McGraw-Hill/Irwin Slide 3 McGraw-Hill/Irwin Slide 3 Cash Currency Cash Equivalents  Short-term, highly liquid investments.  Readily convertible into cash.  Sufficiently close to maturity so that market value is unaffected by interest rate changes. MEASUREMENT OF CASH FLOWS C 1

McGraw-Hill/Irwin Slide 4 McGraw-Hill/Irwin Slide 4 CLASSIFICATION OF CASH FLOWS The Statement of Cash Flows includes the following three sections:  Operating Activities  Investing Activities  Financing Activities C 2

McGraw-Hill/Irwin Slide 5 McGraw-Hill/Irwin Slide 5 Outflows  Salaries and wages  Payments to suppliers  Taxes and fines  Interest paid to lenders  Other Outflows  Salaries and wages  Payments to suppliers  Taxes and fines  Interest paid to lenders  Other Inflows  Receipts from customers  Cash dividends received  Interest from borrowers  Other. Inflows  Receipts from customers  Cash dividends received  Interest from borrowers  Other. OPERATING ACTIVITIES C 2

McGraw-Hill/Irwin Slide 6 McGraw-Hill/Irwin Slide 6 Outflows  Purchasing long-term productive assets  Purchasing equity investments  Purchasing debt investments  Other Outflows  Purchasing long-term productive assets  Purchasing equity investments  Purchasing debt investments  Other Inflows  Selling long-term productive assets  Selling equity investments  Collecting principal on loans  Other Inflows  Selling long-term productive assets  Selling equity investments  Collecting principal on loans  Other INVESTING ACTIVITIES C 2

McGraw-Hill/Irwin Slide 7 McGraw-Hill/Irwin Slide 7 Outflows  Pay dividends  Purchasing treasury stock  Repaying cash loans  Paying owners’ withdrawals Outflows  Pay dividends  Purchasing treasury stock  Repaying cash loans  Paying owners’ withdrawals Inflows  Issuing its own equity securities  Issuing bonds and notes  Issuing short- and long-term liabilities  Contributions by owners Inflows  Issuing its own equity securities  Issuing bonds and notes  Issuing short- and long-term liabilities  Contributions by owners FINANCING ACTIVITIES C 2

McGraw-Hill/Irwin Slide 8 McGraw-Hill/Irwin Slide 8 NONCASH INVESTING AND FINANCING Items requiring separate disclosure include:  Retirement of debt by issuing equity securities.  Conversion of preferred stock to common stock.  Leasing of assets in a capital lease transaction. Items requiring separate disclosure include:  Retirement of debt by issuing equity securities.  Conversion of preferred stock to common stock.  Leasing of assets in a capital lease transaction. C 3

McGraw-Hill/Irwin Slide 9 McGraw-Hill/Irwin Slide 9 FORMAT OF THE STATEMENT OF CASH FLOWS C 4

McGraw-Hill/Irwin Slide 10 McGraw-Hill/Irwin Slide 10 There are two acceptable methods to determine Cash Flows from Operating Activities:  Direct Method  Indirect Method FORMAT OF THE STATEMENT OF CASH FLOWS While each method uses a different format to arrive at Net Cash Provided (Used) by Operating Activities, the end result is the same under each method. C 4

McGraw-Hill/Irwin Slide 11 McGraw-Hill/Irwin Slide 11 Let’s look at the Indirect Method for preparing the Cash Flows from Operating Activities section. PREPARING THE STATEMENT OF CASH FLOWS Nearly all companies use the indirect method. P 1

McGraw-Hill/Irwin Slide 12 McGraw-Hill/Irwin Slide 12 PREPARING THE STATEMENT OF CASH FLOWS Preparing a statement of cash flows involves five steps: 1.Compute the net increase or decrease in cash; 2.Compute and report net cash provided or used by operating activities; 3.Compute and report net cash provided or used by investing activities; 4.Compute and report net cash provided or used by financing activities; 5.Compute the net cash flow by combining net cash provided or used by operating, investing, and financing activities and then prove it by adding it to the beginning cash balance to show that it equals the ending cash balance. Preparing a statement of cash flows involves five steps: 1.Compute the net increase or decrease in cash; 2.Compute and report net cash provided or used by operating activities; 3.Compute and report net cash provided or used by investing activities; 4.Compute and report net cash provided or used by financing activities; 5.Compute the net cash flow by combining net cash provided or used by operating, investing, and financing activities and then prove it by adding it to the beginning cash balance to show that it equals the ending cash balance. P 1

McGraw-Hill/Irwin Slide 13 McGraw-Hill/Irwin Slide 13 Net Income Cash Flows from Operating Activities Changes in current assets and current liabilities. + Losses and - Gains + Noncash expenses such as depreciation and amortization. INDIRECT METHOD P 2

McGraw-Hill/Irwin Slide 14 McGraw-Hill/Irwin Slide 14 Use this table when adjusting Net Income to Operating Cash Flows. INDIRECT METHOD P 2

McGraw-Hill/Irwin Slide 15 McGraw-Hill/Irwin Slide 15 INDIRECT METHOD EXAMPLE  East, Inc. reports $125,000 net income for the year ended December 31,  Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.  During 2009, East reported $12,500 of Depreciation Expense.  East, Inc. reports $125,000 net income for the year ended December 31,  Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.  During 2009, East reported $12,500 of Depreciation Expense. What is East, Inc.’s Operating Cash Flow using the indirect method for 2009? P 2

McGraw-Hill/Irwin Slide 16 McGraw-Hill/Irwin Slide 16 Net income125,000 Net income125,000$ INDIRECT METHOD EXAMPLE For the indirect method, start with net income. P 2

McGraw-Hill/Irwin Slide 17 McGraw-Hill/Irwin Slide 17 Net income125,000 Add: Depreciation expense12,500 Net income125,000$ Add: Depreciation expense12,500 Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense. INDIRECT METHOD EXAMPLE P 2

McGraw-Hill/Irwin Slide 18 McGraw-Hill/Irwin Slide 18 Net income125,000 Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) INDIRECT METHOD EXAMPLE P 2

McGraw-Hill/Irwin Slide 19 McGraw-Hill/Irwin Slide 19 Net income125,000 Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating INDIRECT METHOD EXAMPLE P 2

McGraw-Hill/Irwin Slide 20 McGraw-Hill/Irwin Slide 20 Net income125,000 Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000 Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities. INDIRECT METHOD EXAMPLE P 2

McGraw-Hill/Irwin Slide 21 McGraw-Hill/Irwin Slide 21 Now let’s prepare a complete Statement of Cash Flows for B&G Company using the indirect method. INDIRECT METHOD EXAMPLE P 2

McGraw-Hill/Irwin Slide 22 McGraw-Hill/Irwin Slide 22 P 2

McGraw-Hill/Irwin Slide 23 McGraw-Hill/Irwin Slide 23 Additional Information for 2010:  Net income was $105,000.  Cash dividends declared and paid were $40,000.  Bonds payable of $50,000 were redeemed for $50,000 cash.  Common stock was issued for $35,000 cash. INDIRECT METHOD EXAMPLE P 2

McGraw-Hill/Irwin Slide 24 McGraw-Hill/Irwin Slide 24 Add noncash expenses and losses. Subtract noncash revenues and gains. Add noncash expenses and losses. Subtract noncash revenues and gains. Start with accrual-basis net income. Then, analyze the changes in current assets and current liabilities. P 2

McGraw-Hill/Irwin Slide 25 McGraw-Hill/Irwin Slide 25 P 2

McGraw-Hill/Irwin Slide 26 McGraw-Hill/Irwin Slide 26 Now, let’s complete the investing section. P 2

McGraw-Hill/Irwin Slide 27 McGraw-Hill/Irwin Slide 27 Now, let’s complete the financing section. P 3

McGraw-Hill/Irwin Slide 28 McGraw-Hill/Irwin Slide 28 P 3

McGraw-Hill/Irwin Slide 29 McGraw-Hill/Irwin Slide 29 Let’s briefly compare the direct method with the indirect method for B&G. Remember that the only difference is in the operating activities section of the statement. PREPARING THE STATEMENT OF CASH FLOWS – DIRECT METHOD P 5

McGraw-Hill/Irwin Slide 30 McGraw-Hill/Irwin Slide 30 ANALYZING THE CASH ACCOUNT Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows using the Direct Method. P 5

McGraw-Hill/Irwin Slide 31 McGraw-Hill/Irwin Slide 31 PREPARING THE STATEMENT OF CASH FLOWS – DIRECT METHOD P 5