1. Module 11 Cash Flow

2. SAP 2007 / SAP University Alliances Introductory Accounting Learning Objectives Explain the purpose and importance of cash flow information.Distinguish among operating, investing, and financing activities.Identify and disclose non-cash investing and financing activities.Describe the format of a cash flow statement.Prepare a cash flow statement.Calculate cash flows from operating activities using the direct method.Determine cash flows from both investing and financing activities.Calculate cash flows from operating activities using the indirect methodRun an SAP demonstration.Practise preparing Cash Flow statements in SAP.

3. SAP 2007 / SAP University Alliances Introductory Accounting Cash Flow Statement Reports detailed information about the cash inflows and outflows during a period. Cash flows are classified as operating, investing, and financing activities. Helps users to evaluate the liquidity and solvency of a business and its ability to generate cash from internal sources.

4. SAP 2007 / SAP University Alliances Introductory Accounting Helps users answer questions such as: How does a company obtain its cash? Where does a company spend its cash? What is the change in the cash balance? Cash Flow Statement

5. SAP 2007 / SAP University Alliances Introductory Accounting Details the difference between the beginning and ending balances of cash and cash equivalents. Cash Flow Statement

6. SAP 2007 / SAP University Alliances Introductory Accounting Are investments that must be: Readily convertible to a known amount of cash, and Sufficiently close to maturity date so its market value is not significantly affected by changes in interest rates. Cash Equivalents

7. SAP 2007 / SAP University Alliances Introductory Accounting Operating Activities The principal revenue-producing activities of the enterprise. Classifications of Cash Flows

8. SAP 2007 / SAP University Alliances Introductory Accounting Operating ActivitiesInvesting Activities The acquisition and disposal of long-term assets and other investments that are not classified as cash equivalents. Classifications of Cash Flows

9. SAP 2007 / SAP University Alliances Introductory Accounting Operating ActivitiesInvesting ActivitiesFinancing Activities Those activities that affect a company’s owners and creditors. Classifications of Cash Flows

10. Outflows include: Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other. Outflows include: Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other. Inflows include: Receipts from customers. Cash dividends received. Interest from borrowers. Other. Inflows include: Receipts from customers. Cash dividends received. Interest from borrowers. Other. Operating Activities Cash Flows from Operating Activities SAP 2007 / SAP University Alliances Introductory Accounting

11. SAP 2007 / SAP University Alliances Introductory Accounting Outflows to: Purchase long-term productive assets. Purchase equity investments. Purchase debt investments. Make loans. Outflows to: Purchase long-term productive assets. Purchase equity investments. Purchase debt investments. Make loans. Cash Flows from Investing Activities Investing Activities Inflows from: Selling long-term productive assets. Selling equity investments. Collecting of principal on loans. Other. Inflows from: Selling long-term productive assets. Selling equity investments. Collecting of principal on loans. Other.

12. Financing Activities Inflows from: Issuing its own equity securities. Issuing bonds and notes. Issuing temporary and long- term liabilities. Inflows from: Issuing its own equity securities. Issuing bonds and notes. Issuing temporary and long- term liabilities. Outflows to: Pay dividends to shareholders. Purchase treasury shares. Repay cash loans. Cover withdrawals by owners. Outflows to: Pay dividends to shareholders. Purchase treasury shares. Repay cash loans. Cover withdrawals by owners. Cash Flows from Financing Activities SAP 2007 / SAP University Alliances Introductory Accounting

13. SAP 2007 / SAP University Alliances Introductory Accounting Non Cash Investing and Financing Activities Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred shares to common shares. Leasing of assets in a capital lease transaction.

14. Format of Statement of Cash Flows SAP 2007 / SAP University Alliances Introductory Accounting

15. SAP 2007 / SAP University Alliances Introductory Accounting Preparing the Cash Flow Statement Steps: 1. Calculate net increase or decrease in cash and cash equivalents. 2. Calculate and report net cash inflows (outflows) from: Operating activities. Investing activities. Financing activities. 3. Reconcile change in cash balance.

16. SAP 2007 / SAP University Alliances Introductory Accounting Operating Activities Cash flows may be calculated using either the direct method or the indirect method. The direct method is recommended by the CICA. However, the indirect method is used more frequently.

17. SAP 2007 / SAP University Alliances Introductory Accounting Direct Method of Reporting Operating Cash Flows Revenue or Expense Adjustments for Changes in Related Balance Sheet Accounts Cash Receipts or Cash Payments

18. SAP 2007 / SAP University Alliances Introductory Accounting Revenue or Expense Adjustments for Changes in Related Balance Sheet Accounts Cash Receipts or Cash Payments Cash received from customers =Sales { - Increase in A/R + Decrease in A/R

19. SAP 2007 / SAP University Alliances Introductory Accounting Cash Received from Customers Question: The balance in A/R was $40,000 on 1/1/05 and the balance was $52,000 on 12/31/05. If total sales revenue for 2005 was $800,000, then how much cash was received from customers? a. $800,000 b. $760,000 c. $812,000 d. $788,000

20. SAP 2007 / SAP University Alliances Introductory Accounting Answer: The balance in A/R was $40,000 on 1/1/05 and the balance was $52,000 on 12/31/05. If total sales revenue for 2005 was $800,000, then how much cash was received from customers? a. $800,000 b. $760,000 c. $812,000 d. $788,000 A/R increased $12,000 during 2005. Subtract increases in A/R during 2005 from total revenues to arrive at cash collected from customers. $800,000 - $12,000 = $788,000 Cash Received from Customers

21. SAP 2007 / SAP University Alliances Introductory Accounting This would appear in the operating section as follows: Cash flows from operating activities: Cash received from customers……………$788,000 Cash Received from Customers

22. SAP 2007 / SAP University Alliances Introductory Accounting Purchases =COGS { +Increase in inventory -Decrease in inventory Cash paid for merchandise =Purchases { +Decrease in A/P -Increase in A/P Step 1 Step 2 Cash Paid for Merchandise

23. SAP 2007 / SAP University Alliances Introductory Accounting Question: How much did the company pay for inventory in 2005? a.$900,000 b. $923,000 c.$947,000 d. $877,000 Cash Paid for Merchandise

24. SAP 2007 / SAP University Alliances Introductory Accounting Answer: How much did the company pay for inventory in 2005? a.$900,000 b. $923,000 c.$947,000 d. $877,000 Purchases for 2005 were $935,000. Purchases = $900,000 + $35,000 Cash Paid for Merchandise in 2005 was $923,000. Cash Paid = $935,000 - $12,000 Cash Paid for Merchandise

25. SAP 2007 / SAP University Alliances Introductory Accounting This would appear in the operating section as follows: Cash flows from operating activities: Cash paid for merchandise..……………$923,000 Cash Paid for Merchandise

26. SAP 2007 / SAP University Alliances Introductory Accounting The cash paid for wages and other operating expenses is affected by (1)whether the expense was prepaid, and (2) whether the expense was accrued. The cash paid for wages and other operating expenses is affected by (1)whether the expense was prepaid, and (2) whether the expense was accrued. {{ Cash paid for wages and other operating expenses = Wages and other operating expenses + Increase in prepaid expenses -Decrease in prepaid expenses + Decrease in accrued liabilities - Increase in accrued liabilities Wages and Operating Expenses

27. SAP 2007 / SAP University Alliances Introductory Accounting Interest Taxes Cash Paid = Interest Expense { +Decrease in interest payable -Increase in inventory Cash Paid = Income Tax Expense { +Decrease in taxes payable -Increase in taxes payable Cash Paid for Interest and Taxes

28. SAP 2007 / SAP University Alliances Introductory Accounting Amortization Expense Operating cash flows are not involved. Therefore, amortization is not disclosed in the Statement of Cash Flows using the direct method. Direct Method Amortization Expense

29. SAP 2007 / SAP University Alliances Introductory Accounting Steps: 1. Identify changes in investing related accounts. 2. Explain these changes using reconstruction analysis. 3. Report cash flow effects. Cash Flows from Investing Activities

30. SAP 2007 / SAP University Alliances Introductory Accounting Illustration: Cash flows from investing activities A company sells equipment costing $65,000 with accumulated amortization of $45,000 at a loss of $5,000. What is the cash receipt from the sale and how would this be reported on the statement of cash flows? Loss on Disposal Net Book ValueProceeds =- $5,000 = ($65,000 - $45,000) - Proceeds Proceeds = $15,000

31. SAP 2007 / SAP University Alliances Introductory Accounting Illustration: Cash flows from investing activities This would appear in the investing section as follows: Cash flows from investing activities: Cash received from sale of equipment……$15,000

32. SAP 2007 / SAP University Alliances Introductory Accounting Steps: 1. Identify changes in notes payable, non-current liabilities, and equity accounts. 2. Analyze these changes to determine the effects on cash. 3. Report cash flow effects. Cash Flows from Financing Activities

33. SAP 2007 / SAP University Alliances Introductory Accounting Illustration: Cash flows from financing activities An analysis of the retained earnings account reveals that the company declared $27,000 in share dividends and paid $20,000 in cash dividends. Share dividends do not involve cash and are recorded as a transfer from retained earnings to contributed capital. The cash dividends do involve cash and appear on the statement of cash flows as follows: Cash flows from financing activities: Cash paid for dividends………………………$20,000

34. SAP 2007 / SAP University Alliances Introductory Accounting This method: Yields the same net cash inflows (outflows) from operating activities as the direct method. Does not report individual operating cash inflows or outflows. Adjusts net income to determine cash inflows (outflows) from operating activities. Cash Flows from Operating – Indirect Method

35. SAP 2007 / SAP University Alliances Introductory Accounting 1. Changes in non-cash current assets and current liabilities. 2. Operating items not providing or using cash. 3. Gains and losses resulting from investing and financing activities. This method begins with net income and makes adjustments for: Indirect Method

36. SAP 2007 / SAP University Alliances Introductory Accounting Non-cash Current Assets1. Decreases are added to net income. 2. Increases are subtracted from net income. Adjustments

37. SAP 2007 / SAP University Alliances Introductory Accounting A review of a company’s year-end financial statements revealed that Accounts Receivable was $123,000 in 2004 and $103,000 in 2005. Inventory was $290,000 in 2004 and $315,000 in 2005. Net income for 2005 was $250,000. Illustration: Changes in non-cash current assets This would be reported as: Cash flows from operating activities: Net income……………..………………………$250,000 Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable…………….20,000 Increase in inventory………………………….(25,000)

38. SAP 2007 / SAP University Alliances Introductory Accounting Non-cash Current LiabilitiesIncreases are added to net income.Decreases are subtracted from net income. Adjustments

39. SAP 2007 / SAP University Alliances Introductory Accounting A review of a company’s year-end financial statements revealed that Accounts Payable was $150,000 in 2004 and $132,000 in 2005. Interest payable was $20,000 in 2004 and $36,000 in 2005. Net income for 2005 was $250,000. Illustration: Changes in Non-cash Current Liabilities This would be reported as: Cash flows from operating activities: Net income……………..………………………$250,000 Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts payable…………..….(18,000) Increase in interest payable…………………. 16,000

40. SAP 2007 / SAP University Alliances Introductory Accounting Operating Items Not Providing or Using Cash Expenses with no cash outflows are added back to net income. Revenues with no cash inflow are subtracted from net income. Adjustments

41. SAP 2007 / SAP University Alliances Introductory Accounting Amortization expense is an non-cash expense that is used in the computation of net income. In order to compute cash from operating activities we must add it to net income. Assume a company has a net income of $189,000 and amortization expense of $57,000. Illustration: Operating items not providing or using cash This would be reported as: Cash flows from operating activities: Net income……………..………………………$189,000 Adjustments to reconcile net income to net cash provided by operating activities: Amortization expense………..…………..…..57,000

42. SAP 2007 / SAP University Alliances Introductory Accounting Non-Operating Items Non-operating losses are added back to net income. Non-operating gains are subtracted from net income. Adjustments

43. SAP 2007 / SAP University Alliances Introductory Accounting Net income may include gains or losses that are not operating activities. These items are removed from the operating section. Assume a company reported net income of $98,000 which included a $12,000 loss on the sale of a piece of equipment. Illustration: Non-operating items This would be reported as: Cash flows from operating activities: Net income……………..……………………….$98,000 Adjustments to reconcile net income to net cash provided by operating activities: Loss on the sale of equipment…………..….12,000