The Statement of Cash Flows 15

Overview of the Statement of Cash Flows OBJECTIVE 1: Describe the principal purposes and uses of the statement of cash flows, and identify its components.

Figure 1: Classification of Cash Inflows and Cash Outflows

Exhibit 1: Consolidated Statement of Cash Flows

Overview of the Statement of Cash Flows The statement of cash flows is a major financial statement.

Overview of the Statement of Cash Flows Purposes of the statement of cash flows –The statement of cash flows provides information that is not provided by the other three statements.

Overview of the Statement of Cash Flows Purposes of the statement of cash flows (cont.) –The statement of cash flows shows the effects on cash and cash equivalents of operating, investing, and financing activities. Cash equivalents are short-term, highly liquid investments. Marketable securities are not cash equivalents. –The statement of cash flows provides information about a company’s cash receipts and cash payments.

Overview of the Statement of Cash Flows Uses of the statement of cash flows –The statement of cash flows also provides information about a company’s investing and financing activities.

Overview of the Statement of Cash Flows Uses of the statement of cash flows (cont.) –Investors, creditors, and management use the statement of cash flows for many reasons: To assess a company’s ability to generate positive future cash flows To assess a company’s ability to pay debts To assess a company’s ability to pay dividends To assess a company’s need for additional financing To plan for investing idle cash

Overview of the Statement of Cash Flows Classification of cash flows –Operating activities include cash received from customers; interest and dividends received; sales of trading securities; and cash paid for wages, goods, services, interest, taxes, and purchases of trading securities.

Overview of the Statement of Cash Flows Classification of cash flows (cont.) –Investing activities involve long-term asset and marketable-security transactions and loans made and collected. –Financing activities involve stock, bond, and note transactions, as well as dividends paid. A schedule of noncash investing and financing transactions should accompany the statement of cash flows.

Overview of the Statement of Cash Flows In the statement of cash flows, individual cash inflows and outflows are shown separately in their respective categories.

Overview of the Statement of Cash Flows Unethical means of falsely enhancing cash flows range from failing to fully disclose financial transactions to misclassifying payments and expenses.

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Analyzing Cash Flows OBJECTIVE 2: Analyze the statement of cash flows.

Analyzing Cash Flows Many companies put their cash to good use, but sometimes shareholders suffer when management is too conservative and keeps cash in low-yielding assets.

Analyzing Cash Flows Cash-generating efficiency is the ability of a company to generate cash from operations. –Cash flow yield is the quotient of net cash flows from operating activities divided by net income. –Cash flows to sales is the quotient of net cash flows from operating activities divided by net sales.

Analyzing Cash Flows Cash-generating efficiency is the ability of a company to generate cash from operations. (cont.) –Cash flows to assets is the quotient of net cash flows from operating activities divided by average total assets.

Analyzing Cash Flows To interpret a statement of cash flows, it is important to know the right questions to ask. –Why did cash flow from operating activities differ from net income? –What investing activities are important other than capital expenditures? –How did the company manage it’s financing activities during the fiscal year?

Analyzing Cash Flows Free cash flow is net cash flows from operating activities less dividends and investments in plant assets plus proceeds from the sale of plant assets.

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Operating Activities OBJECTIVE 3: Use the indirect method to determine cash flows from operating activities.

Exhibit 2: Income Statement

Exhibit 3: Comparative Balance Sheets Showing Changes in Accounts

Figure 2: Indirect Method of Determining Net Cash Flows from Operating Activities

Exhibit 4: Schedule of Cash Flows from Operating Activities: Indirect Method

Operating Activities Under the indirect method, cash flows from operating activities equal net income adjusted by items that increase or decrease cash flow from operations. –Items to be added back to net income: Depreciation expense, amortization expense, and depletion expense Losses

Operating Activities Under the indirect method, cash flows from operating activities equal net income adjusted by items that increase or decrease cash flow from operations. (cont.) –Items to be added back to net income: Decreases in accounts receivable, inventory, and prepaid expenses Increases in accounts payable, accrued liabilities, and income taxes payable

Operating Activities Under the indirect method, cash flows from operating activities equal net income adjusted by items that increase or decrease cash flow from operations. (cont.) –Items to be deducted from net income: Gains Increases in accounts receivable, inventory, and prepaid expenses Decreases in accounts payable, accrued liabilities, and income taxes payable

Operating Activities The direct and indirect methods produce the same results, and both are GAAP.

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Investing Activities OBJECTIVE 4: Determine cash flows from investing activities.

Investing Activities Investing activities include the following: –Purchase and sale of long-term assets –Purchase and sale of short-term investments

Investing Activities Gains and losses under the indirect approach. –deducted from and added back to net income to arrive at net cash flows from operating activities –full cash proceeds are entered into the cash flows from investing activities section of the statement of cash flows Upon a sale, the full cash proceeds are entered into the statement of cash flows.

Investing Activities Upon a purchase, the full cash outflows are entered into the statement of cash flows.

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Financing Activities OBJECTIVE 5: Determine cash flows from financing activities.

Exhibit 5: Statement of Cash Flows: Indirect Method

Financing Activities Financing activities include the following: –Short- and long-term borrowing (notes and bonds) and repayment –Issuance and repurchase of capital stock Changes in retained earnings are explained through analyses of net income and dividends declared.

Financing Activities The direct and indirect methods differ only in the cash flows from operating activities section of the statement of cash flows. Exhibit 5 shows a completed indirect method statement of cash flows. –The essence of the indirect approach is the conversion of net income to net cash flows from operating activities.

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