13–1 Chapter 13 The Statement of Cash Flows

13–2 Copyright © Cengage Learning. All rights reserved. Statement of Cash Flows Shows how a company’s operating, investing, and financing activities have affected cash during an accounting period Explains the net increase or decrease in cash Statement of Cash Flows includes: Cash Cash equivalents  Money market accounts  Commercial paper  U.S. Treasury bills © Royalty Free PhotoDisc/ Getty Images

13–3 Copyright © Cengage Learning. All rights reserved. How Is the Statement of Cash Flows Used? Pay dividends and interest Pay its liabilities Generate positive future cash flows Manage cash flows Investors and creditors assess the company’s ability to Evaluate financing decisions Evaluate investment decisions Determine dividend policy Assess liquidity Managers

13–4 Copyright © Cengage Learning. All rights reserved. Classification of Cash Flows The statement of cash flows classifies cash receipts and cash payments into categories Operating Activities Investing Activities Financing Activities

13–5 Copyright © Cengage Learning. All rights reserved. Operating Activities Involve the cash inflows and outflows from activities that enter into the determination of net income Cash Inflows Receipts from sale of goods and services Receipts from sale of trading securities Interest and dividends Cash Outflows Payments for wages, inventory, expenses, taxes Payments for purchase of trading securities Trading securities are a type of marketable security that a company buys and sells for the purpose of making a profit in the near term.

13–6 Copyright © Cengage Learning. All rights reserved. Investing Activities Involve the acquisition and sale of property, plant, and equipment and other long-term assets, including long- term investments; the acquisition and sale of short- term marketable securities, other than trading securities, and the making and collecting of loans Cash Inflows Receipts from selling marketable securities and long-term assets Collections on loans Cash Outflows Expenditures on purchase of securities and assets Outflows of cash lent to borrowers

13–7 Copyright © Cengage Learning. All rights reserved. Financing Activities Obtaining resources from stockholders and providing them with a return on their investments, and obtaining resources from creditors and repaying the amounts borrowed (settling the obligations) Cash Inflows Proceeds from stock issues and from short- and long-term borrowing Sales of treasury stock Cash Outflows Repayments of loans (excluding interest) Payments to owners, including cash dividends Purchases of treasury stock

13–8 Copyright © Cengage Learning. All rights reserved. Noncash Investing and Financing Transactions Significant transactions that involve only long-term assets, long-term liabilities, or stockholders’ equity Noncash examples: Exchange of long-term asset for a long-term liability Settle a debt by issuing capital stock Take out a long-term mortgage to purchase real estate Not reflected on the statement of cash flows; no cash inflows or outflows Future cash flows are affected, so required to disclose these transactions in a separate schedule or at the bottom of the statement

13–9 Copyright © Cengage Learning. All rights reserved. Format of the Statement of Cash Flows SE1/HwkE3 Operating Activities section Investing Activities section Financing Activities section Reconciliation of beg. and end. balances of cash Indirect method begins with net income and ends with cash flows from operating activities Cash transactions involving capital expenditures Ties to cash balances of the balance sheet Debt, cash stock transactions, dividends, and treasury stock transactions

13–10 Copyright © Cengage Learning. All rights reserved. Analyzing Cash Flows © Royalty Free/ Corbis

13–11 Copyright © Cengage Learning. All rights reserved. Cash-Generating Efficiency (CGE) Shows the company’s ability to generate cash from its current or continuing operations Ratios used to calculate CGE: Cash flow yield Cash flows to sales Cash flows to assets

13–12 Copyright © Cengage Learning. All rights reserved. Cash Flow Yield Shows how much of net income actually results in operating cash inflows Amazon.com’s operating activities were generating about $3 of cash for every dollar of net income

13–13 Copyright © Cengage Learning. All rights reserved. Cash Flows to Sales Shows how much of net sales actually results in cash inflows Amazon.com generated positive cash flows to sales of 9.5 percent or in other words that every dollar of sales generates 9.5 cents in cash * * Rounded

13–14 Copyright © Cengage Learning. All rights reserved. Cash Flows to Assets Shows how much cash is being generated by operations for each dollar of assets * *Rounded

13–15 Copyright © Cengage Learning. All rights reserved. Free Cash Flow Amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level Net Cash Flows from Operating Activities – Dividends – Purchases of Plant Assets + Sales of Plant Assets Free Cash Flow

13–16 Copyright © Cengage Learning. All rights reserved. Free Cash Flow (continued) SE2-3/HwkE4 If free cash flow is positive, the company –Has met all of its planned cash commitments –Has cash available to reduce debt or expand If free cash flow is negative, the company will have to –Sell investments –Borrow money –Issue stock in the short term to continue at its planned level of operation

13–17 Copyright © Cengage Learning. All rights reserved. Determining Cash Flows from Operating Activities 1.The direct method Adjusts each item on the income statement to its cash equivalent More easily understood by the average reader There are two methods of converting the income statement from an accrual basis to a cash basis. Both methods produce the same net figure

13–18 Copyright © Cengage Learning. All rights reserved. Determining Cash Flows from Operating Activities 2. The indirect method Lists only necessary adjustments to convert net income to net cash flows Superior from an analyst’s perspective Used by most companies We will be using the indirect method for determining operating activity cash flows.

13–19 Copyright © Cengage Learning. All rights reserved. Using the Indirect Method We start with Net Income and then adjust for those income statement items that do not affect cash.

13–20 Copyright © Cengage Learning. All rights reserved. Using the Indirect Method Depreciation Depreciation expense appears on the income statement, but involves no outlay of cash Adjustment: Depreciation expense added back to net income for the period

13–21 Copyright © Cengage Learning. All rights reserved. Gains and Losses Do not affect cash flows from operating activities; should be removed from net income Adjustments: Gain/Losses subtracted and added to net income for the period

13–22 Copyright © Cengage Learning. All rights reserved. Treatment of Noncash Items Noncash ItemAdd to or Deduct from Net Income Depreciation ExpenseAdd Amortization ExpenseAdd Depletion ExpenseAdd LossesAdd GainsDeduct

13–23 Copyright © Cengage Learning. All rights reserved. Changes in Current Assets Decreases in current assets are added to net income Increases in current assets are deducted from net income Example: Laguna Corporation’s Accounts Receivable decreased by $8,000 as illustrated below. Accounts Receivable Beg. Bal. 55,000 End. Bal. 47, , ,000 Sales to Customers Cash Receipts from Customers The $8,000 decrease in Accounts Receivable should be added to net income on the statement of cash flows.

13–24 Copyright © Cengage Learning. All rights reserved. Changes in Current Liabilities Decreases in current liabilities are deducted from net income Increases in current liabilities are added to net income Example: Laguna Corporation’s accounts payable increased by $7,000 as illustrated below. The $7,000 increase in Accounts Payable should be added to net income on the statement of cash flows. Accounts Payable Beg. Bal. 43,000 End. Bal. 50, , ,000 Cash Payments to Suppliers Purchases

13–25 Copyright © Cengage Learning. All rights reserved. Net Income versus Cash Flows from Operating Activities A net income of $16,000, after adjustments, actually yielded $30,000 in positive cash flows from operating activities

13–26 Copyright © Cengage Learning. All rights reserved. Adjustments for Changes in Current Assets and Liabilities SE4-5/HwkE5-7 Add to Net Income Deduct from Net Income Current Assets: Accounts receivable (net) DecreaseIncrease InventoryDecreaseIncrease Prepaid expensesDecreaseIncrease Current Liabilities: Accounts payableIncreaseDecrease Accrued liabilitiesIncreaseDecrease Income taxes payableIncreaseDecrease

13–27 Copyright © Cengage Learning. All rights reserved. Examining Investment Transactions To determine cash flows from investing activities, accounts involving cash receipts and cash payments from investing activities are examined individually Long-term assetsShort-term investmentsInvestment gains and losses

13–28 Copyright © Cengage Learning. All rights reserved. Investment Transactions Cash Flows Illustrated 1.Laguna Corporation’s purchases of investments totaled $78,000 during These transactions, caused a $78,000 decrease in cash flows (cash paid). 2.Laguna sold investments that cost $90,000 for $102,000. This transaction resulted in a gain of $12,000 and caused an increase in cash flows of $102,000 (cash received). Investing activities section, statement of cash flows: Purchase of investments($78,000) Sale of investments 102,000

13–29 Copyright © Cengage Learning. All rights reserved. Plant Asset Transactions Cash Flows Illustrated Examine the Plant Assets account and the related Accumulated Depreciation account 1.Laguna Corporation purchased plant assets totaling $1200,000. These transactions, caused a $120,000 decrease in cash flows (cash paid). 2.Laguna sold plant assets that cost $10,000 and that had accumulated depreciation of $2,000 for $5,000. This transaction resulted in a loss of $3,000 and caused an increase in cash flows of $3,000 (cash received). Investing activities section, statement of cash flows: Purchase of plant assets($120,000) Sale of plant assets 5,000

13–30 Copyright © Cengage Learning. All rights reserved. Cash Flows from Investing Activities SE6/HwkE8-9 The transactions for Laguna Corporation we have examined are listed below on its statement of cash flows in the investing activities section:

13–31 Copyright © Cengage Learning. All rights reserved. Examining Financing Transactions To determine cash flows from financing activities, accounts involving cash receipts and cash payments from financing activities are examined individually Short-term borrowingsLong-term liabilitiesStockholders’ equity

13–32 Copyright © Cengage Learning. All rights reserved. Bonds Payable Transactions Cash Flows Illustrated Laguna Corporation repaid $50,000 of bonds at face value at maturity. This transaction caused a $50,000 decrease in cash flows (cash paid). Financing activities section, statement of cash flows: Repayment of bonds($50,000) © Royalty Free PhotoDisc/ Getty Images

13–33 Copyright © Cengage Learning. All rights reserved. Common Stock Transactions Cash Flows Illustrated Laguna Corporation issued 15,200 shares of $5 par value common stock for $175,000. The Common Stock account increased by $76,000, and the Additional Paid- in Capital account increased by $99,000. This transaction caused an $175,000 increase in cash flows (cash received). Financing activities section, statement of cash flows: Issue of common stock $175,000

13–34 Copyright © Cengage Learning. All rights reserved. Dividend Transactions Cash Flows Illustrated Laguna Corporation paid cash dividends in the amount of $8,000. This amount decreased Retained Earnings. This transaction caused a $8,000 decrease in cash flows (cash paid). Financing activities section, statement of cash flows: Payment of dividends ($8,000) Only the payment of dividends appears on the statement of cash flows, not the declaration of dividends. © Royalty Free PhotoDisc/ Getty Images

13–35 Copyright © Cengage Learning. All rights reserved. Treasury Stock Transactions Cash Flows Illustrated Laguna Corporation purchased treasury stock for $25,000. This transaction created a cash outflow of $25,000. Financing activities section, statement of cash flows: Purchase of treasury stock ($25,000)

13–36 Copyright © Cengage Learning. All rights reserved. Cash Flows from Financing Activities SE7/HwkE10 The transactions of Laguna Corporation that we have examined are presented in the financing section of the statement of cash flows:

13–37 Copyright © Cengage Learning. All rights reserved. Statement of Cash Flows HwkE11 All three sections are presented in summary form here, followed by the net increase or decrease in cash:

13–38 Copyright © Cengage Learning. All rights reserved. Noncash Transaction Illustrated Laguna Corporation issued bonds at face value ($100,000) for plant assets. There are no cash inflows or outflows, but it is a significant transaction. Schedule of Noncash Investing and Financing Transactions: Issue of bonds payable for plant assets $100,000 © Royalty Free/ Corbis