2 Learning ObjectivesDescribe the circumstances in which the cash flow statement is a particularly important companion of the income statement.Outline the structure of and information reported in the three main categories of the cash flow statement: operating, investing, and financing.
3 Learning ObjectivesAppreciate the historical process involved in the development of the modern statement of cash flows.Compute cash flow from operations using either the direct or the indirect method.Prepare a complete statement of cash flows and provide the required supplemental disclosures.
4 Learning ObjectivesUnderstand the differences among cash flow statements prepared according to U.S. GAAP, U.K. GAAP, and International Accounting Standards.Assess a firm’s financial strength by analyzing the relationships among cash flows from operating, investing, and financing activities and by computing financial ratios based on cash flow data.
5 Learning ObjectivesUse knowledge of how the three primary financial statements tie together in order to prepare a forecasted statement of cash flows.EXPANDED MATERIALUse a T-account or work sheet approach to prepare a statement of cash flows.
6 What Good Is a Cash Flow Statement? Does a statement of cash flows tell us anything we don’t already know from other statements?
7 What Good Is a Cash Flow Statement? Finally, a statement of cash flows is an excellent forecasting tool.Yes, because there are situations where net income does not give us an accurate picture.Also, everything you want to know about a company is summarized in this one statement.
8 Purposes of Cash Flow Statement Statement of Cash Flows--The primary financial statement that summarizes an entity’s cash receipts and payments during a period.Predicts an entity’s ability to:generate positive future cash flows.meet current and long-term obligations.pay future dividends.32
9 Cash EquivalentIt must be readily convertible to cash and it must be so near to maturity that there is insignificant risks of changes in value due to changes in interest rate.It is a short-term, highly liquid investment.What is a cash equivalent?
10 Three Categories of Cash Flows Cash InflowsOperatingActivitiesInvestingFinancing35
11 Cash Flow CategoriesOperating Activities--Transactions and events that enter into the determination of net income.Investing Activities--Transactions and events that involve the purchase and sale of securities, property, plant, equipment, and other assets not generally held for resale, and the making and collecting of loans.Financing Activities--Transactions and events whereby cash is obtained from or repaid to owners and creditors.65
12 General Format of a Statement of Cash Flows Cash Provided by or Used in:Operating Activities $XXXInvesting Activities XXXFinancing Activities XXXNet Increase (Decrease) in Cash $XXXCash--Beginning of Year XXXCash--End of Year $XXX126
13 Operating Activities Cash Inflow Cash Outflow Cash Receipt of Sales Collection of ReceivablesInterest RevenueDividend RevenueCash OutflowInventory PaymentsInterest PaymentsWagesUtilitiesRent137
14 Investing Activities Cash Inflow Cash Outflow Sale of plant assets Sale of securities, other than trading securitiesCollection of principal on loansCash OutflowPurchase of plant assetsPurchase of securities, other than trading securitiesMaking of loans with other entities159
15 Financing Activities Cash Inflow Cash Outflow Issuance of own stock BorrowingsCash OutflowDividend paymentsRepayment of loansTreasury stock purchase1711
16 Noncash TransactionsNoncash Transactions--Investing and financing activities that do not affect an entity’s cash flow.Significant transactions should be disclosed separately.These transactions do not affect the statement of cash flows.1913
17 Reporting Operating Cash Flows Direct Method--A method of reporting net cash flows from operations that shows cash receipts and payments for a period of time. This method is more straight forward.Indirect Method--A method of reporting net cash flow from operations that involves reconciling net income to a cash basis. It shows how noncash flows affect net income.2014
18 The Direct MethodThis method reports directly the major classes of operating cash receipts and payments of an entity during a period.Accrual-basis revenues and expenses must be converted to equivalent cash receipts and payments.The amount of cash actually collected or paid is determined.3321
19 Example: Cash Receipts Sales and Cash Collected from Customers:Beginning accounts receivable $140+ Sales= Cash available for collection $190- Ending accounts receivable= Cash collected from customers $1306437
20 Example: Inventory Cost of Goods Sold and Cash Paid for Inventory: Ending inventory $ 75+ Cost of goods sold 80= Required inventory $155- Beginning inventory 100= Cash paid for inventory this year $ 55
21 Example: Wages Wages Expense and Cash Paid for Wages: Beginning wages payable $ 7+ Wages expense 25= Total obligation to employee $32- Ending wages payable 10 = Cash paid for wages $22
22 Indirect Method The indirect method makes the following adjustments: Adjustments for receivables and other current operating assets.Adjustments for payables and other current liabilities.Adjustments for depreciation and other noncash items.Adjustments for gains and losses.2115
23 Adjustments for Gains and Losses Gains or losses do not represent the cash effect of the transaction.Adjustment toAccount Net IncomeLossesGainsThese adjustments are made to net income since the sale of an investment is an investing activity, not an operating activity.3220
24 Adjustments for Receivables Changes in accounts directly affect revenues recorded on an accrual basis.Account Adjustment toAccount Change Net IncomeAccounts Receivable2517
25 Adjustments for Payables Changes in liabilities mean the reverse of changes in current operating asset accounts.Account Adjustment toAccount Change Net IncomeAccounts Payable2818
26 Noncash AdjustmentsDepreciation and similar noncash items do not affect cash and are not reported on the statement of cash flows.Any noncash item that reduces net income should be added back to net income in the indirect method.Any noncash item that increases net income should be subtracted from net income in the indirect method.2919
27 Relationship Between Net Income and Operating Cash Flow Business engages in operating activitiesCash is received and disbursedOperating cash flowNet incomeApply accrual accounting rules“Undo” accrual accounting to get back to cash flow16
28 Steps for Preparing a Cash Flow Statement Compute how much the cash balance changed during the year.Convert the income statement from an accrual-basis to a cash-basis summary of operations.a. Eliminate expenses that do not involve the outflow of cash, such as depreciation.b. Eliminate gains and losses associated with investing or financing activities.c. Adjust for changes in the balances of current assets and current liabilities.4922
29 Steps for Preparing a Cash Flow Statement Analyze the long-term assets to identify the cash flow effects of investing activities.Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions.Make sure that the total net cash flow from operating, investing, and financing activities is equal to the net increase or decrease in cash as computed in Step 1. Then, prepare a formal statement of cash flows.Prepare supplement disclosure of significant noncash transactions.
30 Example: Comparative Balance Sheet AssetsCash and Cash EquivalentsAccounts ReceivableInventoryEquipmentAccumulated DepreciationTotal Assets$ 82180170200(72)$560$ 40150200140(60)$470Liabilities and EquityAccounts PayableLong-Term Notes PayableCommon StockRetained EarningsTotal Liabilities and Equity$100100250110$560$ 805025090$4705023
31 Income Statement, 20X1 Sales Expenses: Cost of Goods Sold Selling and General ExpenseDepreciationInterest ExpenseOperating IncomeGain from Sale of EquipmentIncome before Income TaxesIncome Tax ExpenseNet Income$345$1205820$1455$14030$1105124
32 Step 1 Determine change in cash and cash equivalents: Cash 20X $ 40Cash 20XChange in Cash $ 425326
33 (T-account or work sheet entry) Step 2Convert from an accrual-basis to a cash-basis summary of operations:EXAMPLE: Eliminate depreciation expense, $44, because it does not require the use of cash.Cash Provided by Operations 44Accumulated Depreciation 44(T-account or work sheet entry)
34 Add back $5 to cash provided by operations. Step 2Convert from an accrual-basis to a cash-basis summary of operations:EXAMPLE: Eliminate the $5 gain from selling equipment.Cash 33Accumulated Depreciation 32Equipment 60Gain on Sale of Equipment 5Add back $5 to cash provided by operations.
35 Step 3Analyze the long-term assets to identify the cash flow effects of investing activities.Expenditures for Property, Plant, and Equipment:Beginning equipment $140- Equipment sold during the year= $ 80- Ending equipment= Expenditures for equipment duringyear $120
36 Step 4Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions:Expenditures for Long-Term Debt:Beginning L-T notes payable balance $ 50- Notes reacquired during the year= $ 50- Ending L-T notes payable balance= L-T notes payable issued during year $ 50
37 Step 4Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions:Payment of Dividends:Beginning retained earnings balance $ 90+ Net income 110= $200- Ending retained earnings balance= Dividends paid $ 90
38 Steps 5 and 6Steps 5 and 6 relate to actually preparing the formal and supplementary statements.
39 Operating Activities Section: Indirect Method Cash Flows from Operating Activities:Net Income $110Adjustments:Depreciation ExpenseGain on Sale of Equipment (5)Increase in Accounts Receivable (30)Decrease in InventoryIncrease in Accounts PayableNet Cash Provided by OperatingActivities $169Continued on slide 426134
40 Operating Activities Section: Direct Method 4040Cash Flows from Operating Activities:Cash Collected from Customers $ 414Cash Payments for:Inventory (155) Selling & General Expenses (58)Interest (2)Income Taxes (30) $(245)Net Cash Provided by OperatingActivities $169Continued on slide 426841
41 Investing and Financing Activities Sections The investing and financing sections are the same whether the direct or indirect approach is used.
42 Investing and Financing Activities Sections Cash Flows from Investing Activities:Proceeds from Sale of Equipment $ 33Purchase of equipment (120)Net Cash Provided by InvestingActivities $(87)Cash Flows from Financing Activities:Issuance of Long-Term Notes Payable 50Payment of Cash Dividends (90)Net Cash Used for Financing Activities $(40)Net Increase in Cash $ 42Cash, January 1,Cash, December 31, 2001 $ 82Continued from either slide 39 or 40