©2009 The McGraw-Hill Companies, Inc.
Chapter 11
Statement of Cash Flows
©2009 The McGraw-Hill Companies, Inc.
Part A
Formatting the Statement of
Cash Flows
11-3
Statement of Cash Flows
Provides a summary of cash inflows and cash outflows
during the reporting period
E-Games, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2010
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
Increase in accounts receivable
(7,000)
Decrease in inventory
10,000
Increase in prepaid rent
(2,000)
Decrease in accounts payable
(5,000)
Increase in interest payable
Decrease in income tax payable
Net cash flows from operating activities
1,000
(2,000)
$50,000
11-4
Statement of Cash Flows (continued)
Cash Flows from Investing Activities
Purchase of investment
Sale of land
(35,000)
6,000
Net cash flows from investing activities
(29,000)
Cash Flows from Financing Activities
Issuance of common stock
5,000
Payment of cash dividends
(12,000)
Net cash flows from financing activities
(7,000)
Net increase (decrease) in cash
14,000
Cash at the beginning of the period
48,000
Cash at the end of the period
$62,000
Note: Noncash Activities
Purchased equipment by issuing a note payable
$20,000
11-5
LO1 Classification of Cash Flows
Categories of Cash Flows
Operating
activities
Investing
activities
Financing
activities
Include cash receipts
and cash payments for
transactions relating
to revenue and
expense activities
Include cash
transactions involving
the purchase and sale
of long-term assets
and current
investments
Inflows and outflows
of cash resulting from
the external financing
of a business
11-6
Classification of Cash Flows
Cash Flows from Operating Activities
Cash Inflows:
Sale of goods or services.
Receipt of interest and dividends.
Cash Outflows:
Purchase of inventory.
For operating expenses.
For interest.
For income taxes.
Cash Flows from Investing Activities
Cash Inflows:
Sale of investments.
Sale of PPE or intangibles.
Collection of notes receivable.
Cash Outflows:
Purchase of investments.
Purchase of PPE or intangibles.
Acceptance of notes receivable.
Cash Flows from Financing Activities
Cash Inflows:
Issuance of bonds or notes payable.
Issuance of stock.
Cash Outflows:
Repayment of bonds or notes payable.
Reacquisition of stock (treasury stock).
Payment of dividends.
11-7
Sources of Information
Sources
Explanation
1. Income statement The income statement provides important
information in the determination of cash flows
from operating activities.
2. Balance sheets
We look at the change in asset, liability, and
stockholders’ equity accounts from the end of
last period to the end of this period to find cash
flows from operating, investing, and financing
activities.
3. Additional
information
Sometimes we need additional information
from the accounting records to determine
specific cash inflows or cash outflows for the
period.
11-8
Relationship between Financial
Statements
11-9
Reporting Noncash Activities



Transactions that don’t increase or decrease cash
Excluded from the statement of cash flows
Reported in a separate note to the financial statements as
noncash activities
Examples:
Purchase of long-term assets
by issuing debt
Purchase of long-term assets
by issuing stock
Conversion of bonds payable
into common stock.
Exchange of long-term assets
11-10
Operating Activities – Indirect and
Direct Methods


Differ only in the presentation format for operating activities.
We report investing, financing, and noncash activities identically
under both methods.
Indirect Method



Begin with net income and
then list adjustments to net
income in order to arrive at
operating cash flows.
More popular method.
Easier and less costly.
Direct Method



Adjust the items on the
income statement to directly
show the cash inflows and
outflows from operations.
Conceptually better method.
More difficult and more costly.
©2009 The McGraw-Hill Companies, Inc.
Part B
Preparing the Statement of
Cash Flows
11-12
Steps in Preparing the Statement of
Cash Flows
1. Calculate net cash flows from operating activities using information
from the income statement and changes in current assets (other
than cash) and current liabilities from the comparative balance
sheets.
2. Determine the net cash flows from investing activities by analyzing
changes in long-term asset accounts from the comparative balance
sheets.
3. Determine the net cash flows from financing activities by analyzing
changes in long-term liabilities and stockholders’ equity accounts
from the comparative balance sheets.
4. Combine the operating, investing, and financing activities and make
sure the total agrees with the net increase (decrease) in cash.
11-13
Illustration
The income statement, balance sheets, and additional information for E-Games,
Inc., are provided in the following Illustration. We will use this information in
preparing the statement of cash flows following the four basic steps.
E-Games, Inc.
Income Statement
For the Year Ended December 31, 2010
Revenues
$ 1,012,000
Expenses:
Cost of goods sold
Operating expenses (salaries, rent, utilities)
$ 650,000
286,000
Depreciation expense
9,000
Loss on sale of land
4,000
Interest expense
5,000
Income tax expense
16,000
Total expenses
Net Income
970,000
$
42,000
11-14
Illustration (continued)
E-Games, Inc.
Balance Sheets
December 31, 2009 and 2010
2010
2009
Increase (I) or
Decrease (D)
Assets
Current Assets:
Cash
$ 62,000
$ 48,000
$14,000 (I)
Accounts receivable
27,000
20,000
7,000 (I)
Inventory
35,000
45,000
10,000 (D)
4,000
2,000
2,000 (I)
Investment in stock
35,000
0
35,000 (I)
Land
70,000
80,000
10,000 (D)
Equipment
90,000
70,000
20,000 (I)
(23,000)
(14,000)
9,000 (I)
$ 300,000
$ 251,000
Prepaid rent
Long-Term Assets:
Accumulated depreciation
Total Assets
11-15
Illustration (continued)
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable
$ 22,000
$ 27,000
$ 5,000 (D)
Interest payable
2,000
1,000
1,000 (I)
Income tax payable
5,000
7,000
2,000 (D)
95,000
75,000
20,000 (I)
105,000
100,000
5,000 (I)
71,000
41,000
30,000 (I)
$ 300,000
$ 251,000
Long-Term Liabilities:
Notes payable
Stockholders’ Equity:
Common stock
Retained earnings
Total Liabilities and Equity
Additional Information for 2010:
1. Purchased stock in Intendo Corporation for $35,000.
2. Sold land originally costing $10,000 for $6,000, resulting in a $4,000 loss on sale of
land.
3. Purchased $20,000 in equipment by issuing a $20,000 note payable due in three
years. No cash was exchanged in the transaction.
4. Issued common stock for $5,000 cash.
5. Declared and paid a cash dividend of $12,000.
11-16
Basic Format
E-Games, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2010
Cash Flows from Operating Activities:
Cash Flows from Investing Activities:
Cash Flows from Financing Activities:
Net increase (decrease) in cash
14,000
Cash at the beginning of the period
48,000
Cash at the end of the period
Note: Noncash Activities
List of noncash transactions
$62,000
11-17
LO2 Operating Activities – Indirect
Method



Both net income and cash flows from operating activities
represent the same operating activities.
The income statement reports net income on an accrual basis.
On the other hand, the statement of cash flows reports the very
same activities on a cash basis.
We remove the noncash components from net income so that
what’s left is cash flows from operating activities.
We can classify the noncash components as:
(a) revenues and expenses that don’t affect cash at all (adjustments
for noncash components of net income).
(b) revenues and expenses that do affect cash, but not by the amount
reported as the revenue or expense (adjustments for changes
in current assets and current liabilities).
11-18
Adjustments for noncash components
of net income
Depreciation Expense and Loss on
Sale of Land
Cash
6,000
Loss on Sale of Land
4,000
Land
Add back
Depreciation
Expense and Loss
on Sale of Land
which was earlier
subtracted from the
net income.
10,000
(To record loss on sale of land)
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
11-19
Adjustments for Changes in Current
Assets and Current Liabilities
Increase in Accounts Receivable
(Increase in a current asset)
Subtract
Cash (to balance)
Accounts Receivable ($27,000 – $20,000)
1,005,000
7,000
Revenues (from income statement)
1,012,000
(To record increase in accounts receivable)
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
Increase in accounts receivable
(7,000)
11-20
Adjustments for Changes in Current
Assets and Current Liabilities
Decrease in Inventory
(Decrease in a Current Asset)
Add Back
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
Increase in accounts receivable
(7,000)
Decrease in inventory
10,000
11-21
Adjustments for Changes in Current
Assets and Current Liabilities
Decrease in Accounts Payable
(Decrease in a Current Liability)
Subtract
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
Increase in accounts receivable
(7,000)
Decrease in inventory
10,000
Increase in prepaid rent
(2,000)
Decrease in accounts payable
(5,000)
11-22
Adjustments for Changes in Current
Assets and Current Liabilities
Increase in Interest Payable
(Increase in a Current Liability)
Add Back
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
Increase in accounts receivable
(7,000)
Decrease in inventory
10,000
Increase in prepaid rent
(2,000)
Decrease in accounts payable
(5,000)
Increase in interest payable
1,000
11-23
Cash Flows from Operating Activities
Cash Flows from Operating Activities
Net income
$42,000
Adjustments for noncash effects:
Depreciation expense
9,000
Loss on sale of land
4,000
Increase in accounts receivable
(7,000)
Decrease in inventory
10,000
Increase in prepaid rent
(2,000)
Decrease in accounts payable
(5,000)
Increase in interest payable
Decrease in income tax payable
Net cash flows from operating activities
1,000
(2,000)
$50,000
11-24
Summary of All Adjustments
Cash Flows from Operating Activities
Net income
Adjustments for noncash effects:
For noncash components of income
+ Depreciation expense
+ Loss on sale of assets
– Gain on sale of assets
For changes in current assets and current liabilities
– Increase in a current asset
+ Decrease in a current asset
+ Increase in a current liability
– Decrease in a current liability
= Net cash flows from operating activities
11-25
LO3 Investing Activities
Cash Flows from Investing Activities
Purchase of investment
Sale of land
Net cash flows from investing activities
Cash
Outflow
(35,000)
6,000
(29,000)
Cash Flows from Financing Activities
Net cash flows from financing activities
Cash
Inflow
Noncash
activity
disclosed in
the footnote
Net increase (decrease) in cash
14,000
Cash at the beginning of the period
48,000
Cash at the end of the period
$62,000
Note: Noncash Activities
Purchased equipment by issuing a note payable
$20,000
11-26
LO3 Financing Activities
Cash Flows from Investing Activities
Purchase of investment
(35,000)
Sale of land
6,000
Net cash flows from investing activities
Cash
Inflow
(29,000)
Cash Flows from Financing Activities
Issuance of common stock
5,000
Payment of cash dividends
(12,000)
Net cash flows from financing activities
(7,000)
Net increase (decrease) in cash
14,000
Cash at the beginning of the period
48,000
Cash at the end of the period
Cash
Outflow
$62,000
Note X: Noncash Activities
Purchased equipment by issuing a note payable
Retained earnings, beg. Balance $41,000
+ Net income
42,000
– Dividends
(12,000)
Retained earnings, ending balance $71,000
$20,000
11-27
LO4 Cash Flow Analysis
Analysis based on net cash flows from
operating activities (CFFO)
($ in millions)
2006
2005
$19,315
$13,931
Net Income
1,989
1,335
Net Cash Flows from Operations (CFFO)
2,220
2,535
17,205
11,551
$55,908
$49,205
Net Income
3,572
3,043
Net Cash Flows from Operations (CFFO)
4,839
5,310
23,109
23,215
Apple
Net Sales
Total Assets
Dell
Net Sales
Total Assets
11-28
Cash Return on Assets
Return on Assets
Net
Income
÷
Average
Total Assets
=
Return on
Assets
Apple
1,989
÷
(17,205 + 11,551)/2
=
13.8%
Dell
3,572
÷
(23,109 + 23,215)/2
=
15.4%
($ in millions)
Cash Return on Assets
is higher than the
Return on Assets
Cash Return on Assets
($ in millions)
CFFO
÷
Average
Total Assets
=
Cash Return
on Assets
Apple
2,220
÷
(17,205 + 11,551)/2
=
15.4%
Dell
4,839
÷
(23,109 + 23,215)/2
=
20.9%
11-29
Components of Cash Return on
Assets
Cash Return
on Assets
=
Cash Flow
to Sales
CFFO
Average Total
Assets
Asset
Turnover
x
CFFO
Net Sales
=
x
Net Sales
Average Total
Assets
($ in millions)
CFFO
÷
Net Sales
=
Cash Flow
to Sales
Apple
2,220
÷
19,315
=
11.5%
Dell
4,839
÷
55,908
=
8.7%
Net
Sales
÷
Average
Total Assets
=
Asset
Turnover
Apple
19,315
÷
(17,205 + 11,551)/2
=
1.3 times
Dell
55,908
÷
(23,109 + 23,215)/2
=
2.4 times
©2009 The McGraw-Hill Companies, Inc.
Appendix
Operating Activities-Direct Method
11-31
LO5 Operating Activities-Direct
Method


We report the cash inflows and cash outflows
directly on the statement of cash flows. For
instance, we report cash received from customers
as the cash effect of sales activities, and cash
paid to suppliers as the cash effect of cost of
goods sold.
Income statement items that have no cash
effect—such as depreciation expense or gains
and losses on the sale of assets—are simply not
reported under the direct method.
11-32
Operating Activities-Direct Method
Cash Flows from Operating Activities
Cash Inflows:
Cash received from customers
Cash received from interest
Cash received from dividends
Less Cash Outflows:
Cash paid to suppliers
Cash paid for operating expenses
Cash paid for interest
Cash paid for income taxes
Net cash flows from operating
activities
$
xxx
11-33
Operating Activities-Direct Method
Cash Received from Customers
Revenues
$1,012,000
– Increase in accounts receivable
(7,000)
Cash received from customers
$1,005,000
Cash (to balance)
Accounts Receivable ($27,000 - $20,000)
Revenues (from income statement)
(To record increase in accounts receivable)
1,005,000
7,000
1,012,000
11-34
Operating Activities-Direct Method
Cash Paid to Suppliers
Inventory
Beginning balance
45,000
Cost of goods purchased
(increases inventory)
?
Ending balance
650,000
Cost of goods sold
(decreases inventory)
35,000
Accounts Payable
Cash paid to suppliers
(decreases A/P)
?
27,000
Beginning balance
640,000
Cost of goods purchased
(increases A/P)
22,000
Ending balance
Cost of Goods Sold (from income statement)
Accounts Payable ($27,000 – 22,000)
Inventory ($45,000 – 35,000)
Cash (to balance)
(Merchandise purchases and sales)
650,000
5,000
10,000
645,000
11-35
Operating Activities-Direct Method
Cash Paid to Suppliers
Cost of goods sold
$650,000
– Decrease in inventory
(10,000)
= Purchases
640,000
+ Decrease in accounts payable
= Cash paid to suppliers
5,000
$645,000
11-36
Operating Activities-Direct Method
Depreciation Expense and Loss on Sale
of Land
Not reported on the statement
of cash flows
Cash (selling price: given)
6,000
Loss on Sale of Land (difference)
4,000
Land (cost: given)
(Sale of land)
10,000
11-37
Operating Activities-Direct Method
Cash Paid for Interest
Interest expense
$5,000
– Increase in interest payable
(1,000)
= Cash paid for interest
$4,000
Interest Expense (from the income
statement)
5,000
Interest Payable ($2,000 – 1,000)
1,000
Cash (to balance)
4,000
(Payment for interest expense)
11-38
Operating Activities-Direct Method
Cash Paid for Income Taxes
Income tax expense
+ Decrease in income tax payable
= Cash paid for income taxes
$16,000
2,000
$18,000
Income Tax Expense (from the income
statement)
16,000
Income Tax Payable ($7,000 – 5,000)
2,000
Cash (to balance)
(Payment for income taxes)
18,000
11-39
Operating Activities-Direct Method
Cash Flows from Operating Activities
Cash received from customers
$1,005,000
Cash paid to suppliers
(645,000)
Cash paid for operating expenses
(288,000)
Cash paid for interest
Cash paid for income taxes
Net cash flows from operating activities
(4,000)
(18,000)
$50,000
©2009 The McGraw-Hill Companies, Inc.
End of chapter 11