Presentation on theme: "Categories of Cash Flows"— Presentation transcript:
1 Categories of Cash Flows Inflows and outflows that result from transactionsCash account must increase or decreaseOperating activitiesCash receipts and cash disbursements from revenues and expensesInvolve current assets and current liabilitiesInvesting activitiesCash receipts and disbursements that result from purchasing or selling long-term assets or investments in other firmsFinancing activitiesCash receipts and disbursements from long-term debt and equity transactions
2 Categories of Cash Flows Financing activitiesDebtIssuing debtRepaying debtInterest expense results from financing activities because it arises from debt financing. Why is it reported in the operating section?EquityReceiving contributions from ownersPaying dividends to owners
3 Accrual-basis vs. Cash-basis Must convert from accrual-basis accounting (GAAP) to cash-basis accounting to prepare statement of cash flowsAccrual-basis accountingRevenues recorded when earned and expenses recorded when incurredTiming of cash receipt is irrelevantCash-basis accountingRevenues recorded when cash received and expenses recorded cash paidTiming of revenue and expense recognition is irrelevantConvert from accrual basis to cash basisAccounts payable (assume for inventory)Beg bal $1,200; End bal $400; purch $36,300Compute cash paid
4 Operating activities Direct method Indirect method Cash inflows and outflows explicitly identifiedAnalyzes every item on income statementIndirect methodReconciles net income and cash flowStarts with net incomeMakes adjustments for income statement items that do not affect cashAdjust for changes in current assets and current liabilitiesEnds with net cash flow
5 Investing and financing activities Same presentation for both direct and indirect methodsCash flows for each activity directly identifiedUsed by 90% of companies.Financial statements neededCurrent year income statementBeginning and ending balance sheet
6 Steps to Calculate Operating Cash Flows Start with net incomeAdd back non-cash expenses such as depreciationUndo the effect of non-cash expensesAdjust for changes in current assetsIncrease (decrease) in account should be subtracted from (added to) net income to arrive at cash balance.Adjust for changes in current liabilitiesIncrease (decrease) in account should be added to (subtracted from) net income to arrive at cash balance.
15 Investing and Financing Activities Investing cash flowsEquipment purchases/disposals require the following accountsAsset account (beg & end)Accumulated depreciation (beg & end)Depreciation expense (current)Financing cash flowsDebt financingNeed to analyze changes in long-term liability accountsEquity financingAdditional capital contributionsCommon and preferred stock accountsDividendsRetained earnings and current net income
17 Preparing the Statement of Cash Flows Prepare operating, investing, and financing sectionsSupplementary disclosuresNoncash financing and investing activitiesCash paid for interest expense and income taxesBroken out in supplementary disclosures because usually part of subtotals
19 Free Cash Flow Net cash from operating activities - Cash dividends - Capital expenditures _Free cash flow
20 Cash Flow Adequacy Ratio Measures the firm’s ability to generate enough cash from operating activities to pay for its capital expendituresNet cash from operating activities _Cash required for investing activitiesCash paid for capital expenditures and acquisitions minus cash proceeds from disposal of capital assets
21 Cash Needed to Pay Current Liabilities Current cash debt coverage ratioMeasures a firm’s ability to generate the cash it needs in the short-runA liquidity measureNet Cash Provided by OperationsAverage Current Liabilities
22 Business Risk, Control, and Ethics Investors’ risks associated with statement of cash flowsInvestors look for positive cash flows from operationsHow could a company manipulate operating cash flows?