Chapter 12
statement of cash flows: reports cash receipts, cash payments, and net change in
cash resulting from operating, investing, and financing activities
1. The entity’s ability to generate future cash flows. Investors can better
predict the amounts, timing, and uncertainty of future cash flows.
2. The entity’s ability to pay dividends and meet obligations. No cash = , it
cannot pay employees, settle debts, or pay dividends. Employees, creditors,
and stockholders should be particularly interested.
3. The reasons for the difference between net income and net cash
provided (used) by operating activities. Net income provides information
on the success or failure of a business. However, some are critical because it
requires many estimates. Such is not the case with cash.
4. The cash investing and financing transactions during the period. A
financial statement reader can understand why assets and liabilities changed
in period.
Classification of Cash Flows
Cash receipts and cash payments are operating, investing, and financing activities.
Transactions and other events characteristic of each kind of activity are as follows.
Operating activities: The cash effects of transactions that generate revenues and
expenses.
Cash inflows:
From sale of goods or services.
From interest received and dividends received.
Cash outflows:
To suppliers for inventory.
To employees for wages.
To government for taxes.
To lenders for interest
To others for expenses.
Investing activities
(a) acquiring and disposing of investments and property, plant, and equipment
(b) lending money and collecting the loans.
Cash inflows:
From sale of property, plant, and equipment.
From sale of investments in debt or equity securities of other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase investments in debt or equity securities of other entities.
To make loans to other entities.
Financing activities
(a) obtaining cash from issuing debt and repaying the amounts borrowed
(b) obtaining cash from stockholders, repurchasing shares, and paying dividends.
Cash inflows:
From sale of common and preferred stock.
From issuance of debt (bonds and notes).
Cash outflows:
To stockholders as dividends.
To redeem long-term debt or reacquire capital stock (treasury stock).
Summary:
Operating activities involve income statement items.
Investing activities involve cash flows resulting from changes in investments
and long-term asset items.
Financing activities involve cash flows resulting from changes in long-term
liability and stockholders’ equity items.
Noncash:
- Direct issuance of common stock to purchase assets.
- Conversion of bonds into common stock.
- Direct issuance of debt to purchase assets.
- Exchanges of plant assets.
 Reported in separate schedule(satisfies full disclosure principle)
Format:
List of individual items -> Net cash provided or used by operating
List of individual items -> Net cash provided or used by investmens
List of individual items -> Net cash provided or used by financing
Net increase in cash
Cash BOP
Cash EOP
Noncash investing and financing
100K shares for 800K USD: Cas inflow Financing operations
200K borrow with 5 year end: Cash inflow financing
Purchased two trucks for 170K: Cash outflow investments
12K personnel wage: Cash outflow operating
20K revenue: operating cash inflow
LO2 – Statement of cashflow – indirect method
Coming from:
Comparative balance sheets -> changes in A/L/E
Current Income statement -> Net cash used/provided in operating
Aditional information -> Transaction data(to know how cash is used)
Three major steps:
1. Determine net cash by operating activities by converting net income from accrual
to cash basis. Use of Income Statement/Comparative Balance/other
2. Analyze changes in noncurrent asset, liability and equity accounts. Report as
investing or financing activities
3. Compare net change in cash from cash flows to cash on balance sheet.
Indirect and direct methods
Step 1 is done by either of the two methods
Indirect: Adjusts net income for items that not affect cash
Majority uses -> easier, less costly, focus on differences
between
net income and net cash flow from operating
Direct: Shows operating cash receipts and payments.
Adjusting each item in the income statement from accrual basis to the
cash basis
Example: computer company
1: Operating activities(indirect):
- In indirect: adjust net income, but why net income converted to net cash??
-> Revenues include credit sales which have not been collected
-> Expenses include items that have not been payed In cash
-> Net income is not net cash provided by operating act.
- 1. Add back noncash expenses: depreciation- and amortization expense
- Depreciation reduces net income, but doesn’t reduce cash
-> Add depreciation expense to net income
2. Deduct gains and add losses: results from financing and investing
- Loss on disposal of plant assets: Plant asset sold -> Investing
, so companies removes this from net income
-> Add plant loss(in this case) to net income
3. Analyze changes: noncash current asset, noncash current liability
- Prepaird insurance, salaries/wages payable/
1. Changes in noncash current assets
- Deduct from net income -> increases current assets accounts
1. AR decrese
- Example: AR from 30K to 20K : cash receipts>sales revenue by
10K
So: Add 10K to Receipts from customers
2. Inventory increase
-Example: Inv. From 10K to 15K : Merchandise purchased > COGS
So: company deducts 5K from net income
3. Increase in prepaid Expenses
-Example: went up 4K: cash paid for expenses>expenses
- Add to net income -> decreases in current asset accounts
1.AR increase
- AR from 20K ->30K: Deduct 10K from receipts from customers
2.Inventory decrease
3. Decrease in prepaid expenses
2. Changes in current liabilities
- Add to Net income -> increases liability accounts
1. Increase in AP
- Example: AP increase 16K: More received goods than payed for
So: Add 16K in net income
2. Decrease in Income Taxes Payable: incurs income tax, but not
paid
- Example: ITP decreased 2K -> incurred was 2k less than paid
- So: reduce net income by 2K
-Deduct from net income -> decreases in current liability
accounts
1. Decrese in AP -> less goods than payed for -> deduct from
income
2. Increase in ITP -> too much incurred tov paid -> increase net
income
Summary of operating activities(3 types):
1. Noncash charges such as depreciation and amortizations
2. Gains and losses on the disposal of plant assets
3. Changes in noncash current asset and current liability accounts
Check page for list examples!
Step 2: Investing and financing activities
1. Increase of land:
- Generally classified as investing, but by directly exchanging bonds -> No
effect
on cash. But still is a significant investment
2.Increase in building:
- Office building in cash -> cash outflow investing
3.Increase in equipment:
-Sell/buy of equipment
-Loss on Disposal of Plant Assets -> equipment costing 8k, selling for 4K
-> Cash +4k, Acc depreciation +1k, Equipment -8K, LODPA(CR) -3K
4.Increase in bonds payable:
5.Increase in common stock:
6.Increae in retained earnings:
- Dividens = financing out flow
CHECK STATEMENT EIND STAP 2! DOIT 2B
Stap 3: Net change in cash
- Net change in cash should agree with cash account on balance sheet.
LO3- Analyze the statement of cash flows
Free cash flow = net cash(operating activities) -capital expenditures - dividens
- Net cash provided by operating activities is intented as cash generating capability
->Net cash provided by operating activities fails to take into account that a
company must invest in new fixed assets.
-> also at least maintain dividends to satisfy investors
-Example:
- 10K computers produced and sold
- 100k net cash
- in order to maintain production -> invest 15K in equipment and pay 5k in dividends
- Free cash flow is 80k -> use for purchasing assets or expand business, or pay 80k
in dividends and choose to produce 10k computers