Financial Accounting: Tools for Business Decision Making, 4th Ed.
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1 Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, KiesoCHAPTER 12Prepared byEllen L. SweattGeorgia Perimeter College
2 STATEMENT OF CASH FLOWS Chapter 12STATEMENT OF CASH FLOWS
3 Chapter 12 Statement of Cash Flows After studying Chapter 12, you should be able to:Indicate the usefulness of the statement of cash flows.Distinguish among operating, investing, and financing activities.Explain the impact of the product life cycle on a company's cash flows.Prepare a statement of cash flows using the indirect method.Use the statement of cash flows to evaluate a company.
4 The Primary Purpose of the Statement of Cash Flows Is... To provide information about:cash receipts,cash payments, andthe net change in cash resulting from:operating,investing, andfinancing activities of a company during a period.
6 Why Report the Causes of Changes in Cash? Because investors, creditors, and other interested parties want to know what is happening to a company’s most liquid asset,CASH
7 Usefulness of the Statement of Cash Flow 111Usefulness of the Statement of Cash FlowThe entity’s ability to generate future cash flows.The entity’s ability to pay dividends and meet obligations.The reason for the difference between net income and net cash provided (used) by operating activities.The cash investing and financing transactions during the period.
8 Involve Income Statement Items 112Operating Activities...Include:The cash effects of transactions that create revenues and expenses andEnter into determination of net income.Involve Income Statement Items
9 Involve Investments and Noncurrrent Asset Items Investing Activities...Include:Purchasing and disposing of investments and productive long-lived assets using cash andLending money and collecting the loans.Involve Investments and Noncurrrent Asset Items
10 Involve Noncurrent Liability and Stockholders’ Equity Items Financing Activities...Include:Obtaining cash from issuing debt and repaying the amounts borrowed andObtaining cash from stockholders, repurchasing shares, and paying dividends.Involve Noncurrent Liability and Stockholders’ Equity Items
11 Types of Cash Flows - Operating Activities Cash inflows:From sale of goods or servicesFrom return on loans (interest received) and on equity securities (dividends received)Cash outflows:To suppliers for inventoryTo employees for servicesTo government for taxesTo lenders for interestTo others for expenses
12 Types of Cash Flows - Investing Activities Cash inflows:From sale of property, plant, and equipmentFrom sale of debt or equity securities of other entitiesFrom collection of principal on loans to other entitiesCash outflows:To purchase property, plant, and equipmentTo purchase debt or equity securities of other entitiesTo make loans to other entities
13 Types of Cash Flows - Financing Activities Cash inflows:From sale of equity securities (company's own stock)From issuance of debt (bonds and notes)Cash outflows:To stockholders as dividendsTo redeem long-term debt or reacquire capital stock
14 Operating Activities - ALERT Some cash flows relating to investing or financing activities are classified as operating activities. For example...Receipts of investment revenue (interest and dividends) andPayments of interest to lenders are classified as operating activities because these items are reported in the income statement.
15 Significant Noncash Activities... That do NOT affect cash are NOT reported in the body of the statement of cash flows.Are reported:In a separate schedule at the bottom of the statement of cash flows orIn a separate note or supplementary schedule to the financial statements.
16 Significant Noncash Activities... 1. Issuance of common stock to purchase assets.2. Conversion of bonds into common stock.3. Issuance of debt to purchase assets.4. Exchanges of plant assets.
17 Review Which is an example of a cash flow from an operating activity? Payment of cash to lenders for interest.Receipt of stock from the sale of capital stockPayment of cash dividends to the company’s stockholdersSale of old equipment.
18 Review Which is an example of a cash flow from an operating activity? Payment of cash to lenders for interest.Receipt of stock from the sale of capital stockPayment of cash dividends to the company’s stockholdersSale of old equipment.
19 Format of the Statement of Cash Flows Three parts:operatinginvestingfinancingPlus significant noncash investing and financing activities in separate schedule or at bottom of the statement of cash flows.
21 The Product Life Cycle 3 A series of phases all products go through 113A series of phases all products go throughThe phases are often referred to as the:introductory phasegrowth phasematurity phasedecline phase.The phase a company is in affects its cash flows.
22 Introductory PhaseTo support asset purchases the company may issue stock or debt. Expect:cash from operations to be negativecash from investing to be negative.cash from financing to be positive.
23 Growth PhaseThe company is striving to expand its production and sales.Expect:small amounts of cash to be generated from operations.cash from investing to be negative.cash from financing to be positive.
24 Maturity Phase Sales and production level-off Expect: cash from operations to exceed investing needs.cash from investing to be neutral.cash from financing to be negative.
25 Decline Phase Sales and production decline Expect: cash from operations to declinecash from investing to possibly become positive.cash from financing to possibly become negative
27 Statement of Cash Flows Helps Users Evaluate 1. The entity's ability to generate future cash flows2. The entity's ability to pay dividends and meet obligations3. The reasons for the difference between net income and net cash provided (used) by operating activities4. The investing and financing transactions during the period
28 Statement of Cash Flows Helps Answer the Following Questions How did cash increase when there was a net loss for the period?How were the proceeds of the bond issue used?How was the expansion in the plant and equipment financed?Why were dividends not increased?How was the retirement of debt accomplished?How much money was borrowed during the year?Is cash flow greater or less than net income?
29 Sources of Information for the Statement of Cash Flows Comparative balance sheetCurrent income statementAdditional information
30 Major Steps in Preparing Statement of Cash Flows
31 Major Steps in Preparing Statement of Cash Flows In order to perform step a company MUST convert net income from a cash to accrural basis.Over Ninety-eight (98.8)% of companies use the indirect method, so will we.
32 Comparative Balance Sheet 114Comparative Balance SheetIndicates the amount of changes in assets, liabilities, and stockholders' equities from the beginning to the end of the period.
36 Indirect and Direct Methods Convert net income from an accrual basis to a cash basis.This conversion may be done by two methods:indirectdirect
37 Indirect and Direct Methods Both methods arrive at the same total amount for “Net cash” provided by operating activities.The methods differ in disclosing the items that make up the total amount.The choice of methods affects only the operating activities section; the investing and financing activities sections are the same.
38 Indirect MethodMost companies favor the indirect method for the following reasons:it is easier to prepareit focuses on the differences between net income and net cash flow from operating activitiesit tends to reveal less company information to competitors.
39 3 Steps to Convert Net Income to Net Cash from Operations
40 Adjustment of Depreciation Adjustment of Loss on Equipment
46 Free Cash Flow115In the statement of cash flows, cash from operations is intended to indicate the cash-generating capability of the company.Statement of Cash flows fails to take into account that a company must invest in new fixed assets to maintain its current level of operations and it must maintain dividends at current levels to satisfy investors.
47 Free Cash Flow Cash Provided By Operations – Capital Expenditures – Dividends PaidFree Cash Flow
48 The ratios are cash-based instead Assessing Liquidity and Solvency UsingCash FlowsRather than using numbers from the income statement for assessment purposes, we use numbers from the statement of cash flows.The ratios are cash-based insteadof accrual-based.
49 Cash-Based MeasuresAccrual-based measures allows too much management discretion.One disadvantage to the cash-based measures is no readily available published industry averages for comparison.
50 LiquidityLiquidity is the ability of a business to meet its immediate obligations.One measure of liquidity is the current ratio.A disadvantage of the current ratio is that it uses year-end balances of current assets and current liabilities (may not be representative of a company's position during most of the year.)
51 Current Cash Debt Coverage Ratio A ratio that partially corrects this is the current cash debt coverage ratio.Cash provided by operationsAverage current liabilitiesSince cash from operations involves the entire year rather than a balance at one point in time, it is often considered a better representation of liquidity on the average day.
52 Cash Provided By Operations Average Total Liabilities SolvencySolvency is the ability of a firm to survive over the long term.One measure of solvency is the debt to total assets ratio.A measure of solvency that uses cash figures is the cash debt coverage ratio.Cash Provided By OperationsAverage Total LiabilitiesThis ratio measures a company's ability to repay its liabilities from cash generated from operations.