Presentation on theme: "Statement of Cash Flows- First Approach"— Presentation transcript:
1 Statement of Cash Flows- First Approach Appendix 6- Introduction to preparation of the Statement of Cash Flows
2 Cash Flow Statement Flow statement Periodic Provides information regarding the liquidity of a firmexplains the reasons for increase or decrease in cash balance from one balance sheet date to the nextclassifies the reasons for the change as an operating, investing or financing activity.amount of net income in a period is usually different than the amount of increase in cash in the same periodreconciles net income with cash flow from operations.
3 Classification of Cash Flows Operations -- cash flows related to selling goods and services; that is, the principle business of the firm.Investing -- cash flows related to the acquisition or sale of noncurrent assets.Financing -- long term and short term cash flows related to liabilities and owners’ equity; dividends are a financing cash outflow.
4 What is Cash? Cash includes cash and cash equivalents treasury bills maturing in 90 days or less;investment funds;foreign currency on hand;checking account and free savings account
5 External Uses of CFSTo assess the ability of a firm to manage cash flowsTo assess the ability of a firm to generate cash through its operationsTo assess the company’s ability to meet its obligations and its dividend policyTo provide information about the effectiveness of the firm to convert its revenues to cashTo provide information to estimate or anticipate the company’s need for additional financing
6 Internal Uses of CFS Along side with cash budget CFS is used: To assess liquidityDetermine if short-term financing is necessaryTo determine dividend policyDecide to distribute; or increase or decreaseTo evaluate the investment and financing decisions
7 Cash flow from operating activities Examples (IAS No.7):cash received from customers through sale of goods or services performed;cash received from non-operating activities such as dividends from investments, interest revenue, commissions, and fees;cash payments to suppliers or employees;cash payments for taxes and other expenses;In effect, the income statement is changed from accrual basis to cash basis
8 Investing Activities Examples of investing activities include: cash payments to acquire property, plant, and equipment (PPE), other tangible or intangible assets, and other long-term assets; and sale of such assetsloans extended to other companies; and collection of such loans;
9 Financing Activities Examples of financing activities are : cash received from issuing share capital;cash proceeds from issuing bonds, loans, notes, mortgages and other short or long-term borrowings;cash repayment of loans and other borrowings; andcash payments to shareholders as dividends.
10 Classification of Cash in-flows and outflows To wages salary paymentsTo suppliers for purchases of inventoriesTo other operating expensesTo interest paymentsTo tax paymentsTo advance payments to suppliersFrom sales of goods and services to customersFrom receipt of customer advancesFrom receipt of interest revenue or dividends or rent revenue or similar revenue itemsOperating ActivitiesFrom sale of PPE and other long-term assetsFrom collection of loansTo purchase PPE and other long-term assetsTo make loans and to collect such loansInvesting ActivitiesFrom sale of common or preferred stockFrom issuance of short or long term debtFinancing ActivitiesTo repay debtTo pay dividends
11 Format of the Cash Flow Statement Name of the CompanyCash Flow StatementFor the period …Cash from operating activities ACash from investing activities BCash from financing activities CNet Change in Cash D = (A+B+C) increase or (decrease)+ Beginning Cash balance CB, from the beginning balance sheetEnding Cash balance =CB + D should equal to ending cashbalance in the ending balance sheetNon-cash Investing and Financing Activities
12 Determination of Cash Flows From Operating Activities Direct MethodIncome Statement items are converted to cash flows individuallyIndirect MethodNet income or loss is adjusted for accruals such as accounts receivable and payable, and for non-cash expenses such as depreciationreconciliation of the accrual based and cash based accounting
13 Comparison of MethodsDirect method of presentation calculates cash flow from operations by subtracting cash disbursements to supplies, employees, and others from cash receipts from customers.The indirect method calculates cash flow from operations by adjusting net income for non-cash revenues and expenses.Most firms present their cash flows using the indirect method.Only operating activities section is different between the methods, investing and financing sections are the same.
14 How to prepare cash flow statement Firms could prepare their own cash flow statement directly from the cash account.however, we need two consecutive balance sheets and the income statement that covers the period between the two balance sheets
15 Algebraic Formulation* Assets = Liabilities + Shareholders’ Equityor A = L + SHEAssets are either cash (C) or not (Non-Cash)Thus reorganizingC + Non Cash Assets (NCA) = L + SE C + NCA = L + SEWhere means the change in the balance of the item from the previous period.Solving for change in cash: C = L + SE - NCABased on Stickney and Weil, 10th ed. Financial Accounting Slides
16 Algebraic Formulation (Cont.) C = L + SE - NCAThe change in cash, C, is the increase or decrease in the cash account.This amount must equal changes in liabilities plus changes in shareholders’ equity minus changes in assets other than cash.Thus, we can identify the causes in the change in the cash account by studying the changes in non-cash accounts.
17 Indirect Method – cash flow from operations Adjusting Net Income of the period (accrual) to cash basis incomeIncrease in non-cashassets shows that cashwas spent,so cash outflow.Decrease in non-cashassets shows thatthey provided cashso cash inflow.Increase in liabilitiescash savings;increase in SHE cashreceived;so cash inflowDecrease in liabilitiesor SHE showscash paid;so cash outflowAssetsLiabilitiesandShareholders’equityINCREASEDECREASE
18 Indirect Method- operating activities- Adjustments to net income + noncash expenses: depreciation, amortization, uncollectible account expense,etc+ loss on sale of asset+ increases in current liabilities+ decreases in current assets- gain on sale of asset- decrease in current liabilitiesincrease in current assets= Cashflow from operating activities
19 Noncash ExpensesNoncash expenses, such as depreciation expense, are added back – because they were deducted to measure net income but did not require any cash payment in the current periodThey are not truly sources of cash, even though they are associated with cash inflows but reversal of an accrued expense
25 Effects of a Sale of a Long-Term Assets on Cash Flows A few transactions complicate the derivation of a cash flow statement from a comparative balance sheet, for example, the sale of a long-term (or fixed) asset.Recall the journal entry for the sale of an asset:Cash nnnnAccumulated Depreciation nnnnAsset nnnnGain (or loss) on sale nnnn
26 Sale of an AssetEach of the four parts of the above journal entry require an adjustment in the cash flow statement.The first line, cash, adds a line to the investing section.The second line, a debit to accumulated depreciation, increases the depreciation expense above the change in the change in the accumulated depreciation account.The third line, a credit to the asset, increases the amount of cash invested in long-lived assets above the change in the fixed asset accounts.The fourth line, a gain or loss, is reversed out in the operating sections since this is not a cash flow.
27 Comparison of Cash Flow to Net Income Net income is an accrual based concept and purports to show the long-term.Cash flows purport to show the short term.Consider the outlook for both short-term and long-term and consider that each is either good or poor.A strong growing firm would show both good long-term and good short-term outlooks.A failing firm would show both poor long-term and poor short term outlooks.What about a firm with good cash flows (short-term) but poor net income (long-term)?What about a firm with poor cash flows (short-term) but good net income (long-term)?