Chapter 14 Statement of Cash Flows

What does it do for us? The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its operating capacity, meet its financial obligations, and pay dividends. 2

Statement of Cash Flows Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities

4 7 (payments for treasury stock, dividends, and redemption of debt securities) Financing Financing (payments for expenses) Operating Operating Sources (increases) of Cash Uses (decreases) of Cash (receipts from sales of noncurrent assets) Investing Investing (receipts from issuing equity and debt securities) Financing Financing (payments for acquiring noncurrent assets) Investing Investing (receipts from revenues) Operating Operating Cash Flows

Direct vs. Indirect Cash receipts Cash disbursements Data is difficult to obtain/report on Same result as indirect Starts with Net Income Adjusts for rev/exp that don’t have anything to do with cash Most common b/c data is more available for reporting Same result as direct

Indirect Method

7 23 Comparative Balance Sheet (Continued) 14-2

8 Comparative Balance Sheet (Concluded)

9 25 Retained Earnings The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year. ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance202, Dec.31Net income108, , Cash dividends28, ,

10 26 ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance202, Dec.31Net income108, , Cash dividends28, , The net income of $108,000 is entered on the statement (or working papers). To statement 14-2

11 Next, we need to determine depreciation expense for the year. If it isn’t given in the income statement, sometimes it can be found by analyzing the various accumulated depreciation accounts. Depreciation 14-2

12 29 ACCOUNT Accumulated Depreciation—Building ACCT. NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance58, Dec.31Depr. for year7, , to statement The comparative balance sheet (Exhibit 4: Slides 23 and 24) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry. 14-2

13 Gain on Sale of Land The ledger or income statement of Rundell Inc. indicates that the sale of land resulted in a gain of $12,000. This gain increased net income by $12,000, yet cash flows was provided by an investing activity (selling land) rather than an operating activity, so the gain is deducted from net income on the statement of cash flows. 14-2

14 Next, select current assets and current liabilities that impact cash flows and determine their increases and decreases. Changes in Current Operating Assets and Liabilities 14-2

15 37 Adjustments to Net Income (Loss) Using the Indirect Method 14-2

16 38 Changes in Current Accounts Accounts Accounts receivable (net)$ 74,000$ 65,000 Inventories172,000180,000 Accounts payable (mdse.)43,50046,700 Accrued expenses payable26,50024,300 Income taxes payable7,9008,400 9,000 8,000* 3,200* 2, * December 31 Increase Decrease* Note that Cash and Dividends Payable are not included in this analysis. 14-2

17 Statement of Cash Flows— Indirect Method for Rundell Inc. (Operating Activities Section) 40 Same information as Slide 39, only in final form. 14-2

18 52 Building ACCOUNT Building ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance200,000 Dec.27Purchased for cash60,000260,000 By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash. 14-2

19 Land ACCOUNT Land ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance125,000 June8Sold for $72,000 cash60,00065,000 Oct.12Purchased for $15,000 cash15,00080,000 The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase

Cash Flows Used for Payment of Dividends ACCOUNT Dividends Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance10,000 10Cash paid10,000— June20Dividends declared14,00014,000 July 10Cash paid14,000— Dec. 20Dividends declared14,00014,000 Note that while $28,000 in dividends were declared, only $24,000 were paid during the year.

21 47 Common Stock Common Stock increased by $8,000. ACCOUNT Common Stock ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance16,000 Nov. 14,000 shares issued/cash8,00024,

22 48 ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance80,000 Nov. 14,000 shares issued/cash40,000120,000 Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,

23 50 Bonds Payable Bonds Payable decreased by $50,000. ACCOUNT Bonds Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance150,000 June 30Retired by payment of cash at face amount50,000100,

25 Financial Analysis and Interpretation Free cash flow is a measure of operating cash flow available for corporate purposes after providing sufficient fixed asset additions to maintain current productive capacity and dividends. 14-3

26 Cash flow from operations Less: Investments in fixed assets to maintain current production Free cash flow Free Cash Flow Positive free cash flow is considered favorable. A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and enjoy financial flexibility. 14-3