Chapter 12
Reporting and
Interpreting the Statement
of Cash Flows
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objective 1
Identify cash flows
arising from operating,
investing, and
financing activities.
12-2
Business Activities and Cash Flows
Ability to generate cash
from its operations.
Management of current
assets and current liabilities.
The statement focuses
attention on:
Expenditures for
long-term assets.
Amount received from
external financing.
12-3
Business Activities and Cash Flows
The statement helps to answer these questions:

Is there enough cash to pay short-term debt?

Are accounts receivable and inventory adequately
managed?

Has the company purchased sufficient equipment and
other long-term assets?

Did the company generate enough cash internally to
finance the purchases, or did it rely on external
financing?

Is the company changing the source of its external
financing?
12-4
Business Activities and Cash Flows
Checking and
Savings
Accounts
Cash
Currency
Cash Equivalents
 Highly liquid short-term investments
within three months of maturity.
12-5
Classifying Cash Flows
The Statement of Cash Flows must include
the following three sections, as defined in
FASB Statement 95:
Operating
Activities
Investing
Activities
Financing
Activities
12-6
Classifying Cash Flows
NAUTILUS, INC.
Condensed Statement of Cash flows
In thousands for year ended
Net cash provided by (used for) operating activities
+ (-) Net cash provided by (used for) investing activities
+ (-) Net cash provided by (used for) financing activities
Net increase (decrease) in cash
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
December
31, 2005
$ (38,091)
(2,087)
28,896
(11,282)
19,266
$
7,984
12-7
Operating Activities
Cash inflows and
outflows that directly
relate to revenues
and expenses
reported on the
income statement.
12-8
Operating Activities
Inflows from:

Sales to customers.
 Interest and dividends
received.
+
Outflows to:




Purchase of goods for resale
and services.
Salaries and wages.
Income taxes.
Interest on liabilities.
_
Cash
Flows
from
Operating
Activities
12-9
Investing Activities
Inflows from:


Sale or disposal of property,
plant, and equipment.
Sale or maturity of investments
in securities.
+
Outflows to:


Purchase property, plant, and
equipment.
Purchase investments in
securities.
_
Cash
Flows
from
Investing
Activities
12-10
Financing Activities
Inflows from:


Borrowing on notes,
mortgages, bonds, etc. from
creditors.
Issuing stock to owners.
+
Outflows to:



Repay principal to creditors
(excluding interest).
Repurchase stock from owners.
Dividends to owners.
_
Cash
Flows
from
Financing
Activities
12-11
Relationships Between Balance
Sheet and Cash flow Categories
Operating Activities Affect
Current Assets
Current Liabilities
Investing Activities Affect
Financing Activities Affect
Noncurrent Assets
Noncurrent Liabilities
Stockholders' Equity
12-12
Relationship With Other
Financial Statements
Information needed to prepare a
statement of cash flows:
 Comparative Balance Sheets.
 Income Statement.
 Additional details concerning
selected accounts.
12-13
Relationship With Other
Financial Statements
Recall that the basic balance sheet equation is:
Assets = Liabilities Stockholders’ Equity
From this basic balance sheet equation, we
develop our model to solve for the change in cash:
 Cash = Liabilities Stockholders’
Equity Noncash Assets
12-14
Learning Objective 2a
Report cash flows
from operating
activities, using the
indirect method.
12-15
Cash Flows from Operating
Activities - Indirect Method
The indirect method adjusts net income by eliminating
noncash items.
Changes in current assets
and current liabilities.
Cash Flows
from Operating
Activities Indirect Method
Net
Income
+ Losses and
- Gains
+ Noncash
expenses such as
depreciation and
amortization.
12-16
Relationships to the Balance
Sheet and the Income Statement
Change in account
balances during the year
Increase
Decrease
Current Assets
Subtract from
net income.
Add to
net income.
Current Liabilities
Add to
net income.
Subtract from
net income.
Use this table when adjusting Net Income
to Operating Cash Flows using the
indirect method.
12-17
Statement of Cash Flows
Indirect Method Example
Use the following
financial statements
for The Nautilus
Group and prepare
the Statement of
Cash Flows for the
year ended
December 31, 2005
12-18
Statement of Cash Flows
Indirect Method Example
NAUTILUS, INC.
Balance Sheet
(Unaudited)
In Thousands
December 31
2005
ASSETS
Current assets:
Cash & cash equivalents
$
Short-term investments
Accounts receivable
Inventories
Prepaid expenses
Total current assets
Equipment
Less: Accumulated depreciation
Total assets
$
December 31
2004
7,984 $
116,908
96,084
24,215
245,191
215,130
(47,035)
413,286 $
19,266
85,319
95,593
49,104
16,591
265,873
127,724
(33,956)
359,641
Change
(11,282)
(85,319)
21,315
46,980
7,624
87,406
(13,079)
12-19
Statement of Cash Flows
Indirect Method Example
NAUTILUS, INC.
Balance Sheet
(Unaudited)
In Thousands
December 31 December 31
2005
2004
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable
$
61,132 $
Accrued liabilities
36,941
Total current liabilities
98,073
Long-term debt
62,747
Stockholders' equity:
Contributed capital
4,343
Retained earnings
248,123
Total stockholders' equity
252,466
Total liab. & stockholders' equity
413,286
57,861
38,463
96,324
11,281
13,562
238,474
252,036
359,641
Change
3,271
(1,522)
51,466
(9,219)
9,649
12-20
Statement of Cash Flows
Indirect Method Example
NAUTILUS, INC
Income Statement
(Unaudited)
In Thousands
Net sales
Cost of sales
Gross profit
Operating expenses:
Selling, general, and administative expenses
Depreciation
Total operating expenses
Operating income
Interest revenue
Income before income taxes
Income tax expense
Net income
Year ended
Dec. 31, 2005
$631,310
352,496
278,814
231,931
13,079
245,010
33,804
1,489
35,293
12,293
$ 23,000
The Statement
of Cash Flows
will begin with
Nautilus, Inc.’s
net income
from the
Income
Statement.
12-21
NAUTILUS, INC
Statement of Cash flows
(Unaudited)
In thousands for year ended
Cash flows from operating activities:
Net income
December
31, 2005
$
23,000
Next, adjust for the non-cash items included
in net income.
For Nautilus, the only non-cash adjustment
is for depreciation expense $13,079.
12-22
NAUTILUS, INC
Statement of Cash flows
(Unaudited)
In thousands for year ended
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation
December 31,
2005
$
23,000
13,079
To complete the cash flows from operating activities
section, we must examine comparative balance sheets
to determine the changes in current assets and
current liabilities from the beginning of the period to
the end of the period.
(Remember, we showed the balance sheets a few slides earlier.)
12-23
INCFlows Indirect
StatementStatement
ofNAUTILUS,
Cash
of Cash flows
(Unaudited)
Method Example
December 31,
In thousands for year ended
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation
Changes in assets and liabilities:
Accounts receivable increase
Inventory increase
Prepaid expense increase
Accounts payable increase
Accrued liabilities decrease
Net cash provided (used) by operating activities
Increase
Decrease
Current Assets
Subtract from
net income.
Add to
net income.
2005
$
23,000
13,079
$
(21,315)
(46,980)
(7,624)
3,271
(1,522)
(38,091)
Current Liabilities
Add to
net income.
Subtract from
net income.
12-24
Learning Objective 2b
Report cash flows
from operating
activities, using the
direct method.
12-25
A Comparison of the Direct
and Indirect Methods



Net cash flow is the same for both methods.
The direct method provides more detail about
cash from operating activities.
The investing and financing sections for the
two methods are identical.
12-26
Direct Method Operating Activities
NAUTILUS, INC.
Statement of Cash Flows
(Unaudited)
In thousands for year ended
Cash flows from operating activities:
Cash collected from customers
Cash payments to suppliers
Cash payments for operating expenses
Cash received for interest
Cash payments for income taxes
Net cash provided (used) by operating activities
December 31,
2005
$
$
609,995
(396,205)
(241,077)
1,489
(12,293)
(38,091)
When we prepared the operating section using the indirect
method, we also arrived at net cash inflow of ($38,091).
Let’s see how we arrive at these cash flows.
12-27
Direct Method Operating Activities
Net Sales
- Increase in accounts receivable
= Cash collected from customers
Interest revenue
$ 631,310
(21,315)
$ 609,995
$
No change in interest receivable
Cash receipts for interest
Income tax expense
No change in taxes payable
Cash payments for income taxes
1,489
0
$
$
$
1,489
Cost of goods sold
+ Increase in inventory
- Increase in accounts payable
= Cash payments to suppliers
SG&A expenses
+ Increase in prepaid expenses
+ Decrease in accrued liabilities
= Cash payments for expenses
$ 352,496
46,980
(3,271)
$ 396,205
$ 231,931
7,624
1,522
$ 241,077
12,293
0
12,293
With the direct method, we convert each revenue and
expense on the income statement to a cash flow.
12-28
Learning Objective 3
Report cash flows
from investing
activities.
12-29
Reporting Cash Flows from
Investing Activities
NAUTILUS, INC.
Statement of Cash Flows
(Unaudited)
In thousands for year ended
December 31,
2005
Net cash provided (used) by operating activities
$
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Short-term investments decreased
Net cash provided by investing activities
during the year.
by
(38,091)
85,319
(87,406)
$85,319
(2,087)
Cash flows from financing activities:
Additional long-term debt borrowed
51,466
If
we
could
examine
the
detailed
accounting
Stock repurchases
(9,219)
records,
we paid
would find that Nautilus sold(13,351)
shortCash dividends
Net
cash used
in financing activities
term
investments
and received $85,319 in28,896
cash.
Net increase in cash & cash equivalents
(11,282)
The
sale
of
short-term
investments
is
a
cash
Cash & cash equivalents at beginning of period
19,266
Cash & cash equivalents at end inflow.
of period
$
7,984
12-30
Reporting Cash Flows from
Investing Activities
NAUTILUS, INC.
Statement of Cash Flows
(Unaudited)
In thousands for year ended
December 31,
2005
Net cash provided (used) by operating activities
$
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Net cash provided by investing activities
(38,091)
85,319
(87,406)
(2,087)
The balance sheet indicates that Equipment
Cash flows from financing activities:
increased
Additional
long-term by
debt$87,406
borrowed during the year.
51,466
Stock repurchases
(9,219)
Cash dividends
paid
(13,351)
Nautilus
purchased
equipment for $87,406
cash
Net cash used in financing activities
28,896
and
did innot
any
equipment during the
year.
Net
increase
cashsell
& cash
equivalents
(11,282)
Cash & cash equivalents at beginning of period
19,266
The
equipment
purchase
is
a
cash
outflow.
Cash & cash equivalents at end of period
$
7,984
12-31
Learning Objective 4
Report cash flows
from financing
activities.
12-32
Reporting Cash Flows from
Financing Activities
NAUTILUS, INC.
Statement of Cash Flows
(Unaudited)
In thousands for year ended
December 31,
2005
Net cash provided (used) by operating activities
$
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Net cash provided (used) by investing activities
Cash flows from financing activities:
Additional long-term debt borrowed
Stock repurchases
Cash dividends paid
Long-term debt increased by $51,466
Net cash used in financing activities
Net increase
in cash
& cash equivalents
the year.
Nautilus
borrowed $51,466
Cash & cash equivalents at beginning of period
is a cash inflow.
Cash & cash equivalents at end of period
$
(38,091)
85,319
(87,406)
(2,087)
51,466
(9,219)
(13,351)
during
28,896
(11,282)
which
19,266
7,984
12-33
Reporting Cash Flows from
Financing Activities
NAUTILUS, INC.
Statement of Cash Flows
(Unaudited)
In thousands for year ended
December 31,
2005
Net cash provided (used) by operating activities
$
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Net cash provided (used) by investing activities
(38,091)
85,319
(87,406)
(2,087)
Cash flows from financing activities:
Additional long-term debt borrowed
51,466
Stock repurchases
(9,219)
Cash dividends paid
(13,351)
capital
decreased $9,219 because
NetContributed
cash used in financing
activities
28,896
Net increase
in cash
& cash equivalents
Nautilus
purchased
common stock for (11,282)
cash.
Cash & cash equivalents at beginning of period
19,266
Cash & cash equivalents at end of period
$
7,984
12-34
Reporting Cash Flows from
Financing Activities
NAUTILUS, INC.
Statement of Cash Flows
(Unaudited)
In thousands for year ended
December 31,
2005
Net cash provided (used) by operating activities
$
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Net cash provided (used) by investing activities
Cash flows from financing activities:
Additional long-term debt borrowed
Stock repurchases
Cash dividends paid
Net cash Provided (used) in financing activities
Nautilus
Group
declared
and paid
Net
increase in
cash & cash
equivalents
Cash & cash
beginning
ofequivalents
$13,351atwhich
isofaperiod
cash
Cash & cash equivalents at end of period
(38,091)
85,319
(87,406)
(2,087)
51,466
(9,219)
(13,351)
28,896
cash dividends
(11,282)
outflow.19,266
$
7,984
12-35
Reporting Cash Flows from
Financing Activities
NAUTILUS, INC.
Statement of Cash Flows
Now
we can reconcile the change in cash to the ending
(Unaudited)
December
31,
cash balance that appears on the Balance
Sheet.
In thousands for year ended
Net cash provided (used) by operating activities
2005
$
(38,091)
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Net cash provided (used) by investing activities
85,319
(87,406)
(2,087)
Cash flows from financing activities:
Additional long-term debt borrowed
Stock repurchases
Cash dividends paid
Net cash provided (used) in financing activities
Net decrease in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
51,466
(9,219)
(13,351)
28,896
(11,282)
19,266
7,984
$
12-36
Noncash Investing and
Financing Activities
NAUTILUS,
INC.
Required Supplemental
Information:
Statement of Cash Flows
(Unaudited)
1. Cash
paid for taxes and interest.
thousands for year
ended
2.In Significant
non-cash
investing
Net cash provided
(used) by activities.
operating activities
financing
December 31,
2005
and
$
(38,091)
Cash flows for investing activities:
Maturities (sale) of short-term investments
Purchases of equipment
Net cash provided (used) by investing activities
85,319
(87,406)
(2,087)
Cash flows from financing activities:
Additional long-term debt borrowed
Stock repurchases
Cash dividends paid
Net cash provided (used) in financing activities
Net decrease in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
51,466
(9,219)
(13,351)
28,896
(11,282)
19,266
7,984
$
12-37
Learning Objective 5
Interpret cash flows
from operating,
investing, and
financing activities
using ratios.
12-38
Interpreting Operating Cash Flows
• Operating cash flows
must be positive over the
long-run for a company to
be successful.
• An upward trend in
operating cash flows over
time indicates growth and
efficient operations.
12-39
Interpreting Investing Cash Flows
Capital
Acquisitions =
Ratio
Net Cash Flow from Operating Activities
Cash Paid for Property, Plant, and Equipment
A measure for determining whether a company is generating
enough cash internally to purchase long-term assets.
A ratio greater than 1.0 indicates that outside
financing was not needed to purchase long-term assets.
12-40
Interpreting Investing Cash Flows
Relevant Information (millions)
Average 2003-2005
Company
2005
2004
2003
Average Ratio Calculation
Net Operating Cash $ (38.1) $ 47.0 $ 44.7 $ 17.9
Nautilus
$17.9/$34.5 = 0.52
Cash for PPE
$ 87.4 $
9.0 $
7.0 $ 34.5
Net Operating Cash $
7.2 $
4.5 $
0.8 $
4.2
Cybex
$4.2/$2.3 = 1.83
Cash for PPE
$
4.2 $
2.1 $
0.6 $
2.3
Capital expenditures vary from year to year, so three-year
averages are more appropriate for comparisons.
For the three-year period, Nautilus’ cash flow from operations
has been insufficient to finance its investment in property, plant,
and equipment. Nautilus’ primary competitor generated almost
twice as much cash flow from operations as needed for its
investment in property, plant, and equipment.
12-41
Interpreting Financing Cash Flows
Cash
Coverage
Ratio
=
Net Cash Flow from Operating Activities +
Interest Paid + Income Taxes Paid
Interest Paid
A measure for determining whether a company is
generating enough cash before the costs of
financing and taxes to cover its interest payments.
A ratio greater than 1.0 indicates that
operating cash flows are sufficient.
12-42
Chapter 12
Supplement A
Reporting Sales of Property, Plant,
and Equipment (Indirect)
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Reporting Sales of Property, Plant,
and Equipment (PPE) (Indirect)
Depreciation
Expense
Loss on Sale
of PPE
Gain on Sale
of PPE
A loss on the sale of PPE is added
back to net income just as
depreciation expense is added back.
Adding these noncash items restores
net income to what it would have been
had depreciation and the loss not
been subtracted at all.
Just the opposite is true for a gain on
the sale of PPE. Subtracting the gain
reverses the effect of the gain having
been added to net income.
12-44
Chapter 12
Supplement B
Spreadsheet Approach (Indirect
Method)
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Spreadsheet Approach
(Indirect Method)
Reconstructing the events and transactions that
occurred during the period helps identify the
operating, investing and financing activities to be
reported.
A spreadsheet can be used to ensure that
no reportable activities are inadvertently
overlooked.
Let’s see how to use a spreadsheet to prepare a
Statement of Cash Flows on the next few slides.
12-46
NAUTILUS, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2004
Debits
Credits
Items from Balance Sheet
Cash and cash equivalents (A)
19,266
Short-term investments (A)
85,319
Accounts receivable (A)
95,593
Inventories (A)
49,104
Prepaid expenses (A)
16,591
Equipment (A)
127,724
Accumulated depreciation (xA)
33,956
Accounts payable (L)
57,861
Accrued liabilities (L)
38,463
Long-term debt (L)
11,281
Contributed capital (SE)
13,562
Retained earnings (SE)
238,474
Dec. 31,
2005
7,984
116,908
96,084
24,215
215,130
47,035
61,132
36,941
62,747
4,343
248,123
We begin by
entering the
beginning and
ending balances
for each account
on the
comparative
balance sheets.
Cash
Inflows
Statement of Cash Flows
Outflows
The cash inflows
and outflows
columns will be
used later to
explain the
changes in each
account balance.
12-47
NAUTILUS, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2004
Debits
Credits
Items from Balance Sheet
Cash and cash equivalents (A)
19,266
Short-term investments (A)
85,319
Accounts receivable (A)
95,593
C
21,315
Inventories (A)
49,104
D
46,980
Prepaid expenses (A)
16,591
E
7,624
Equipment (A)
127,724
Accumulated depreciation (xA)
33,956
B
13,079
Accounts payable (L)
57,861
F
3,271
Accrued liabilities (L)
38,463
G
1,522
Long-term debt (L)
11,281
Contributed capital (SE)
13,562
Retained earnings (SE)
238,474
A
23,000
Cash
Inflows
Statement of Cash Flows
Operating Activities:
Net income
Adjustments to reconcile net income to cash
Depreciation
Changes in assets and liabilities
Accounts receivable increase
Inventories increase
Prepaid expenses increase
Accounts payable increase
Accrued liabilities decrease
A
23,000
B
13,079
F
Outflows
C
D
E
21,315
46,980
7,624
G
1,522
Dec. 31,
2005
7,984
116,908
96,084
24,215
215,130
47,035
61,132
36,941
62,747
4,343
248,123
Changes in
balance sheet
accounts are
analyzed in terms
of debits and
credits in the top
half of the
spreadsheet and
recorded as cash
inflows and
outflows in the
bottom half of the
spreadsheet.
We will begin with
operating
activities.
3,271
12-48
NAUTILUS, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2004
Debits
Credits
Items from Balance Sheet
Cash and cash equivalents (A)
19,266
M
11,282
Short-term investments (A)
85,319
H
85,319
Accounts receivable (A)
95,593
Inventories (A)
49,104
Prepaid expenses (A)
16,591
Equipment (A)
127,724
I 87,406
Accumulated depreciation (xA)
33,956
Accounts payable (L)
57,861
Accrued liabilities (L)
38,463
Long-term debt (L)
11,281
J
51,466
Contributed capital (SE)
13,562
K
9,219
Retained earnings (SE)
238,474
L
13,351
Cash
Inflows
Statement of Cash Flows
Investing activities
Maturities (sale) of short-term investments
Purchases of equipment
Financing activities
Additional long-term debt borrowed
Stock repurchases
Cash dividends paid
Net decrease in cash and cash equivalents
H
J
M
Outflows
85,319
I
87,406
K
L
9,219
13,351
51,466
11,282
Dec. 31,
2005
7,984
116,908
96,084
24,215
215,130
47,035
61,132
36,941
62,747
4,343
248,123
Changes in
balance sheet
accounts are
analyzed in terms
of debits and
credits in the top
half of the
spreadsheet and
recorded as cash
inflows and
outflows in the
bottom half of the
spreadsheet. Now
we will complete
the analysis with
investing and
financing
activities.
12-49
Spreadsheet Approach
(Indirect Method)
NAUTILUS, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2004
Debits
Credits
Items from Balance Sheet
Cash and cash equivalents (A)
19,266
M
11,282
Short-term investments (A)
85,319
H
85,319
Accounts receivable (A)
95,593
C
21,315
Inventories (A)
49,104
D
46,980
Prepaid expenses (A)
16,591
E
7,624
Equipment (A)
127,724
I
87,406
Accumulated depreciation (xA)
33,956
B
13,079
Accounts payable (L)
57,861
F
3,271
Accrued liabilities (L)
38,463
G
1,522
Long-term debt (L)
11,281
J
51,466
Contributed capital (SE)
13,562
K
9,219
Retained earnings (SE)
238,474
L
13,351
A
23,000
187,417
187,417
Statement of Cash Flows
Operating Activities:
Net income
Adjustments to reconcile net income to cash
A
23,000
Dec. 31,
2005
7,984
116,908
96,084
24,215
215,130
47,035
61,132
36,941
62,747
4,343
248,123
The top of the
completed
spreadsheet
is shown here.
12-50
Spreadsheet Approach
(Indirect Method)
Cash
Inflows
Statement of Cash Flows
Operating Activities:
Net income
Adjustments to reconcile net income to cash
Depreciation
Changes in assets and liabilities
Accounts receivable increase
Inventories increase
Prepaid expenses increase
Accounts payable increase
Accrued liabilities decrease
Investing activities
Maturities (sale) of short-term investments
Purchases of equipment
Financing activities
Additional long-term debt borrowed
Stock repurchases
Cash dividends paid
Net decrease in cash and cash equivalents
A
23,000
B
13,079
F
H
J
M
Outflows
C
D
E
21,315
46,980
7,624
G
1,522
I
87,406
K
L
9,219
13,351
3,271
85,319
The bottom of the
completed
spreadsheet
is shown here.
51,466
11,282
187,417
187,417
12-51
End of Chapter 12
12-52