Statement of Cash Flows
„
Learning Objectives
1.
2.
3.
4.
Understand the different activities of a business and
how this influences the cash flow statement
Understand the direct and indirect methods for
preparation of the Operating Section of the Cash
Flow Statement
Prepare a full statement of cash flows
Use cash flows to analyze liquidity and risk
1
Statement of Cash Flows
„
„
Financial statement that shows the amount of
cash collected and disbursed by a firm over a
specified period for operating, investing, and
financing activities
Provides financial statement users with the
information necessary to reconcile the change in
a company’s cash and cash equivalents
2
Classification of Business Activities
Financing Activities:
Operating Activities:
Cash received from: Investing Activities: Cash received from:
• Sale of capital
• Sale of goods/
Cash received from:
stock
services
• Sale of property,
• Issuance of debt
• Interest
investments, or
marketable
Cash paid for:
• Dividends
securities
• Repayment of
Cash paid for:
Cash paid for:
debt
• Salaries
• Purchase of
• Purchase of
• Inventory
investments or
treasury stock
• Taxes
property
•
Payment of
• Other expenses
dividends
3
1
Other Cash Flows Disclosures
„
In addition to the statement of cash flows,
companies must provide information concerning
significant noncash transactions and events:
Acquisition
of assets by issuing equity securities or
issuing debt
Exchanges of nonmonetary assets
Refinancing of long-term debt
Retirement of long-term debt by issuing equity
Conversion of debt or preferred stock into common
stock
„
Companies should also disclose the amount of
cash paid for interest and taxes.
4
Cash Flows from Operating Activities
This section of the statement of cash
flows may be prepared using the direct
method or the indirect method.
„ Direct Method - Each item within the
income statement’s income from
continuing operations” section is
converted into its cash equivalent
„ Indirect Method - Net income is adjusted
for items that do not affect cash flows,
such as depreciation, amortization, gains,
and losses
„
5
Direct Method Versus the Indirect Method
Direct Method
Indirect Method
„ Reconciliation of net income
„
„
Shows the full amount of
and the cash provided or used
by activities is important to
cash inflows and outflows
understand, as it demonstrates
that arise from operating
the connection between
activities
economic activities and the
generation and use of cash.
Provides information
about the amount of sales „ May involve significant costs
compared to the direct method
that resulted in actual
„ Most companies use the
cash inflows
indirect method because of its
simplicity.
6
2
The Indirect Method
„
The indirect method requires that three
general types of adjustments be made to
net income to arrive at cash provided or
used by operating activities:
1.
2.
3.
Adjustments for noncash income items
Adjustments for realized gains and losses
recognized in the income statement
Adjustments for changes in current
operating asset and liability accounts,
excluding the Cash account
7
The Indirect Method
„
Examples of noncash operating items that will be added back to net income
under the indirect method are:
Depreciation expense
Amortization expense
Losses due to impairment
Unrealized losses on trading
security investments
Net loss from investments
accounted for under the
equity method
„
Compensation expense
related to stock option plans
Examples of noncash operating items that will be
subtracted from net income under the indirect method are:
Amortization of premium
on notes or bonds payable
Unrealized gain on trading
securities
Net revenue from investments accounted for under the
equity method
8
The Direct Method
„
„
When preparing the operating activities section
using the direct method, the income from continuing
operations section of the income statement and the
two most recent balance sheets are needed.
Each line in the income from continuing operations
will be transformed into its related cash flows.
Sales
Cash collected from customers
Cost of goods sold
Cash paid for inventory
Expenses
Cash paid
Interest expense
Cash paid for interest
9
3
Sales Transformed to Cash
Collected from Customers
„
In order to transform sales into cash collected
from customers, information on sales is needed
along with the beginning and ending balances
for Accounts Receivable.
Beginning balance of Accounts Receivable
Plus: Sales
Cash available for collection
Less: Ending balance of Accounts Receivable
Less: Accounts receivable written off as uncollectible
Cash collected from customers
10
Cost of Goods Sold Transformed to
Cash Paid for Inventory
„
Examine Accounts Payable and Inventory to
determine how much cash was paid for inventory:
Ending balance of Inventory
Plus: Cost of goods sold
Available inventory
Less: Beginning balance of Inventory
Inventory purchased
Plus: Beginning balance of Accounts Payable
Inventory obligations outstanding
Less: Ending balance of Accounts Payable
Cash paid for inventory
11
Expenses Transformed
to Cash Paid
„
„
„
First, determine whether the expense is an accrued
expense or a prepaid expense.
To transform accrued expenses into cash paid, begin
with the liability account’s beginning balance and add
the expense for the period, then subtract the beginning
balance of the liability account. This yields the actual
cash paid.
To transform prepaid expenses into cash paid, begin
with the ending balance of the related asset account,
add the expense for the period, then subtract the ending
balance of the asset account.
12
4
Interest Expense Transformed
to Cash Paid for Interest
„
„
„
To obtain the amount of cash paid for interest,
the expense must be adjusted for the amount of
premium or discount amortized during the
period.
If a discount is involved, begin with interest
expense for the period and subtract the discount
amortized to obtain the cash paid for interest.
If a premium is involved, begin with interest
expense for the period and add the premium
amortized to obtain the cash paid for interest.
13
Preparing the Investing
Activities Section
„
Requires an analysis of the accounts associated
with investing activities like the following:
Equipment
Accumulated
Depreciation
Land
Available-for-Sale
„
Securities
Note that cash proceeds and payments should
be shown independently in the investing
activities section.
14
Investing Activities:Equipment
and Accumulated Depreciation
„
„
Examine any sales of equipment and recognize
the full amount of cash proceeds of a sale.
Also examine any purchases of equipment. To
determine actual cash paid for equipment sales,
use the following formula:
Ending balance of Equipment
Less: Beginning balance of Equipment
Plus: Sale of equipment
Purchase of equipment
15
5
Investing Activities: Land
Analyze the balance sheet for changes in
the Land account
„
If changes in the Land
account involved cash,
report this amount as an
increase or decrease in
cash as applicable.
„
If cash is not involved in a
significant change in the Land
account (such as purchase of
land for a long-term note
payable), this information can
be reported in an
accompanying schedule or
report or at the end of the
statement of cash flows in a
section called ‘Significant
noncash transactions.’
16
Investing Activities: Investments
„
„
„
The purchase or sale of investments (available-for-sale,
held-to-maturity, and investments accounted for under
the equity method) should be reported in the investing
activities section.
Note that transactions involving trading securities
should be part of operating activities.
Loans made by the company to others should also be
reported in the investing activities section. (Examine
changes in the Notes Receivable account.)
17
Preparing the Financing Activities
Section
„
Requires an analysis of accounts associated
with financing activities such as:
Long-Term
Notes Payable
Stock
Preferred Stock
Retained Earnings
Treasury Stock
Dividends
Common
„
Note that cash proceeds and payments should
be shown independently in the financing
activities section.
18
6
Financing Activities: Common
Stock and Treasury Stock
Examine the Common Stock account.
„ Increases reflect issuances of stock, and are
usually a source of cash provided by financing
activities.
Examine the Treasury Stock account.
„ Increases in this account reflect repurchases of
a company’s own stock and usually indicates an
outflow of cash for the purchase.
19
Financing Activities: Dividends
„
Examine the Retained Earnings account to
determine the amount of cash paid for
dividends.
20
Product Life Cycles and Cash
Flows
„
„
Product life cycle—the stages that a product
goes through from concept to use to eventual
withdrawal from the marketplace
Four phases of the cycle:
Introductory
Growth
Maturity
Decline
„
Each phase has unique cash flow implications.
21
7
Product Life Cycle: Introductory Phase
Cash flows from
Cash flows from
Cash flows from
Operating activities: investing activities: financing activities:
• Cash flows from • Acquisition of
• Because the
operating
physical assets
company is not
activities are
needed to
generating
negative
manufacture
adequate cash
because of the
products result in
from operations,
costs of
negative cash
it must usually
developing and
flows.
engage in
introducing the
financing
product.
activities, often
by issuing
equity.
22
Product Life Cycle: Growth Phase
Cash flows from
Cash flows from
Cash flows from
Operating activities: investing activities: financing activities:
• Companies in this • While companies
• Sales begin to
in this phase may
phase may still
accelerate and
still require cash
have negative
generate positive
from financing
cash flows from
cash flows.
activities, they
investing activities
may be in a
because they will
place to begin
need to make
issuing debt.
investments to
increase capacity.
23
Product Life Cycle: Maturity Phase
Cash flows from
Cash flows from
Cash flows from
Operating activities: investing activities: financing activities:
• The company is • The company
• Net income is
does not need to
now paying for
positive and
investing activities obtain cash from
reaching its
with the cash flow financing
peak.
activities and
generated from
• Product sales are
may begin to pay
operations.
reaching
dividends or
maximum levels.
repurchase
treasury stock.
24
8
Product Life Cycle: Decline Phase
Cash flows from
Cash flows from
Cash flows from
Operating activities: investing activities: financing activities:
• The company
• The company
• Net income is
will repay debt
has excess
beginning to
and pay
manufacturing
decline.
dividends, using
capacity and
• Cash flows from
cash.
may begin to sell
operations are
off excess plant
still positive, but
and equipment,
declining as well.
generating cash.
25
Liquidity Measurement
Operating Cash Flow Ratio =
Cash Flows from Operating Activities
Current Liabilities
Measures resources generated over a period of
time that are available to meet current liabilities
„
26
Risk Assessment
Cash Current Debt Coverage Ratio =
Cash Flows from Operating Activities – Current Dividends
Current Interest-Bearing Debt
„
Measures risk associated with repayment
of debt after dividends are paid to
stockholders
27
9