Copyright © 2006 McGraw-Hill Ryerson. 1 Reporting and Interpreting Cash Flows

Copyright © 2006 McGraw-Hill Ryerson. 2 Business Background Positive cash flows permit a company to... expand its operations replace needed assets take advantage of market opportunities pay dividends to owners Financial analysts consider cash flow an important indicator of a company’s financial health.

Copyright © 2006 McGraw-Hill Ryerson. 3 Classifications on the Cash Flow Statement The Cash Flow Statement must include the following three sections:  Operating  Operating Activities  Investing  Investing Activities  Financing  Financing Activities The Cash Flow Statement must include the following three sections:  Operating  Operating Activities  Investing  Investing Activities  Financing  Financing Activities

Copyright © 2006 McGraw-Hill Ryerson. 4 Cash Flow From Operating Activities – 2 Methods Direct Method Use cash received and cash paid Indirect Method Start with Net Income Eliminate all non-cash items to get “Net Cash Inflow (Outflow) from Operating Activities”

Copyright © 2006 McGraw-Hill Ryerson. 5 Cash Flows from Operating Activities - Indirect Method Net Income Cash Flows from Operating Activities: Indirect Method Changes in current assets and current liabilities + Losses and - Gains + Non-cash expenses such as amortization The indirect method adjusts net income by eliminating non-cash items, essentially converting it from accrual- based to cash-based net income.

Copyright © 2006 McGraw-Hill Ryerson. 6 Cash Flows from Operating Activities Changes in Current Assets Assume for ABC Co. that: l Accounts Receivable increases l Typically if A/R increases, Sales also increases l Therefore ABC Co. recorded revenue that they didn’t collect the cash for l Therefore, to convert to cash basis, reduce revenue (reduce Net Income)

Copyright © 2006 McGraw-Hill Ryerson. 7 Cash Flows from Operating Activities Changes in Current Assets Therefore if: l Current Assets Increase l Reduce Net Income

Copyright © 2006 McGraw-Hill Ryerson. 8 Cash Flows from Operating Activities Changes in Current Liabilities Assume for ABC Co. that: l Payables increase l Typically if payables increase, expenses also increase (ie wages payable & wages expense) l Therefore they recorded the expense, but haven’t paid for the expense yet in cash (wages) l To convert to cash basis, take out the expense that has not been paid in cash (decrease expenses, increase Net Income)

Copyright © 2006 McGraw-Hill Ryerson. 9 Cash Flows from Operating Activities Changes in Current Liabilities Therefore if: l Current Liabilities Increase l Increase Net Income

Copyright © 2006 McGraw-Hill Ryerson. 10 Cash Flows from Operating Activities Changes in CA & CL Increase in an Asset (decrease in a Liability)  SUBTRACT it from Net Income to convert to cash basis Decrease in an Asset (increase in a Liability) ADD it to Net Income to convert to cash basis

Copyright © 2006 McGraw-Hill Ryerson. 11 Cash Flows from Investing Activities + _ Inflows from: Sale or disposal of property, plant, and equipment. Sale or maturity of investments in securities. Inflows from: Sale or disposal of property, plant, and equipment. Sale or maturity of investments in securities. Outflows to: Purchase property, plant, and equipment. Purchase investments in securities. Outflows to: Purchase property, plant, and equipment. Purchase investments in securities.

Copyright © 2006 McGraw-Hill Ryerson. 12 Cash Flows from Financing Activities + _ Inflows from: Borrowing on notes, mortgages, bonds, etc. from creditors Issuing equity securities to shareholders Inflows from: Borrowing on notes, mortgages, bonds, etc. from creditors Issuing equity securities to shareholders Outflows to: Repay principal to creditors (excluding interest) Repurchase equity securities from owners Pay dividends to shareholders Outflows to: Repay principal to creditors (excluding interest) Repurchase equity securities from owners Pay dividends to shareholders