Chapter 13
STATEMENT OF
CASH FLOWS
1
Questions the Statement of Cash
Flow Answers
2
The Primary Purpose of the
Statement of Cash Flows Is...
• To provide information about:
– cash receipts,
– cash payments, and
– the net change in cash resulting from:
•operating,
•investing, and
•financing activities of a
company during a period.
Why Report the Causes of
Changes in Cash?
Because investors, creditors, and
other interested parties want to
know what is happening to a
company’s most liquid asset,
CASH
4
Usefulness of the Statement of
Cash Flow
• The entity’s ability to generate future cash
flows.
• The entity’s ability to pay dividends and
meet obligations.
• The reason for the difference between net
income and net cash provided (used) by
operating activities.
• The cash investing and financing
transactions during the period.
5
Operating Activities...
Include:
– The cash effects of transactions that create
revenues and expenses and
– Enter into determination of net income.
Involve Income Statement Items
6
Operating Activities…
Types of Cash Flows
• Cash inflows:
– From sale of goods or services
– From return on loans (interest received) and on
equity securities (dividends received)
• Cash outflows:
– To suppliers for inventory
– To employees for services
– To government for taxes
– To lenders for interest
– To others for expenses
7
Investing Activities...
Include:
– Purchasing and disposing of investments
and productive long-lived assets using cash
and
– Lending money and collecting the loans.
Involve Investments and
Noncurrrent Asset Items
8
Investing Activities...
Types of Cash Flows
• Cash inflows:
– From sale of property, plant, and equipment
– From sale of 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 debt or equity securities of other entities
– To make loans to other entities
9
Financing Activities...
Include:
– Obtaining cash from issuing debt and repaying
the amounts borrowed and
– Obtaining cash from stockholders and paying
dividends.
Involve Noncurrent Liability and
Stockholders’ Equity Items
10
Financing Activities...
Types of Cash Flows
• Cash inflows:
– From sale of equity securities (company's own
stock)
– From issuance of debt (bonds and notes)
• Cash outflows:
– To stockholders as dividends
– To redeem long-term debt or reacquire capital
stock
11
Operating Activities - ALERT
Some cash flows relating to investing or
financing activities are classified as operating
activities. For example...
• Receipts of investment revenue (interest
and dividends) and
• Payments of interest to lenders are
classified as operating activities because
these items are reported in the income
statement.
Significant
Noncash Activities...
• That do NOT affect cash are NOT reported
in the body of the statement of cash flows.
• Are reported:
– In a separate schedule at the bottom of the
statement of cash flows or
– In a separate note or supplementary
schedule to the financial statements.
Significant
Noncash Activities...
1. Issuance of common stock to purchase
assets.
2. Conversion of bonds into common stock.
3. Issuance of debt to purchase assets.
4. Exchanges of plant assets.
14
Question
Which is an example of a cash flow from an
operating activity?
a. Payment of cash to lenders for interest.
b. Receipt of cash from the sale of capital stock.
c. Payment of cash dividends to the company’s
stockholders.
d. None of the above.
Question
Which is an example of a cash flow from an
operating activity?
a. Payment of cash to lenders for interest.
b. Receipt of cash from the sale of capital stock.
c. Payment of cash dividends to the company’s
stockholders.
d. None of the above.
Format
Three parts:
– Operating
– Investing
– Financing
Body of
Statement
Plus significant noncash investing and
financing activities in separate schedule
or at bottom of the.
Major Steps in Preparing
Statement of Cash Flows
Major Steps in Preparing
Statement of Cash Flows
In order to perform step 1
a company MUST convert net
income from a cash to accrual
basis.
Can used the Direct
Method or Indirect Method
Over Ninety-eight (98.8)% of
companies use the indirect method.
Indirect Method
• The indirect method is used extensively in
practice.
• Most companies favor the indirect method
for the following reasons:
– it is easier to prepare.
– it focuses on the differences between net income
and net cash flow from operating activities.
– it tends to reveal less company information to
competitors.
Statement Of Cash Flows
Indirect Method
• Start with Net Income
Determine Net Cash Provided/Used By
Operating Activities
• Adjust net income for items that did not affect
cash.
• Net income must be converted because
– Noncash expenses, such as depreciation must be
added back.
– Earned revenues may include credit sales that have
not been collected in cash.
– Expenses incurred that may not have been paid.
Constructing the Statement of Cash Flows
Using Noncash Balance Sheet Accounts
Increases in noncash asset accounts imply
uses of cash.
Example: Inventory is
purchased on credit from
a supplier.
It is implied that cash
was used to acquire the
inventory.
Constructing the Statement of Cash Flows
Using Noncash Balance Sheet Accounts
Decreases in noncash assets accounts imply
sources of cash.
Example: Accounts receivable
decreases when a customer
pays their bill.
When the customer pays his
bill, the company’s cash
increases.
Constructing the Statement of Cash Flows
Using Noncash Balance Sheet Accounts
Increases in liability accounts imply sources
of cash.
Example: Inventory is
purchased on credit from
a supplier.
It is implied that an increase
in a payable has the effect
of increasing cash available
for other uses.
Constructing the Statement of Cash Flows
Using Noncash Balance Sheet Accounts
Decreases in liability accounts imply uses of
cash.
Example: The company made a
payment on a note payable held
by a creditor.
When the company makes
the payment, cash decreases.
I.O.U.
Question
Which of the following would be considered a
"use" of cash for purposes of constructing a
statement of cash flows?
a. an increase in accounts payable.
b. an increase in prepaid expenses.
c. an increase in accrued liabilities.
d. an increase in accumulated
depreciation.
Question
Which of the following would be considered a
"use" of cash for purposes of constructing a
statement of cash flows?
a. an increase in accounts payable.
b. an increase in prepaid expenses.
c. an increase in accrued liabilities.
d. an increase in accumulated
depreciation.
Operating Activities
Net Income (Loss)
$ XXX
Add:
XXX
XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Decr. in Current Noncash Assets
Incr. in Current Liabilities
Depreciation Charges
Losses
Less:
Incr. in Current Noncash Assets
Decr. in Current Liabilities
Gains
Net Cash Flows from Operating Activities
Includes those activities that enter into the determination of net
income
Investing Activities
Add:
Proceeds from sale of land,
buildings, equipment, or other
noncurrent assets
Receipt of principal from
investments
Less:
Payments to acquire land,
buildings, equipment, or other
noncurrent assets
Payments to acquire
investments
Net Cash Flows from Investment Activities
$ XXX
XXX
(XXX)
(XXX)
$ XXX
Includes transactions that involve the
acquisition or disposal of noncurrent assets.
Financing Activities
Add:
Proceeds from borrowings
Proceeds from issuing capital
stock
Proceeds from sale of bonds
Less:
Principal payments on
borrowed funds
Payments related to bond
maturities
Dividend payments
Net Cash Flows from Investment Activities
$ XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Includes transactions involving receipts
from or payments to creditors and owners.
Question
Which is an example of a cash flow from a
financing activity?
a. Receipt of cash from sale of land.
b. Issuance of debt for cash.
c. Purchase of equipment for cash.
d. None of the above.
Question
Which is an example of a cash flow from a
financing activity?
a. Receipt of cash from sale of land.
b. Issuance of debt for cash.
c. Purchase of equipment for cash.
d. None of the above.
Question
An increase in the Interest Payable account of a
company from $0 at the beginning of the year, to $1,000
at the end of the year, would be shown on the company's
statement of cash flows prepared under the indirect
method as:
a. a source of cash of $1,000 in Operating Activities.
b. a use of cash of $1,000 in Operating Activities.
c. a source of cash of $1,000 in Investing Activities.
d. a use of cash of $1,000 in Financing Activities.
Question
An increase in the Interest Payable account of a
company from $0 at the beginning of the year, to $1,000
at the end of the year, would be shown on the company's
statement of cash flows prepared under the indirect
method as:
a. a source of cash of $1,000 in Operating Activities.
b. a use of cash of $1,000 in Operating Activities.
c. a source of cash of $1,000 in Investing Activities.
d. a use of cash of $1,000 in Financing Activities.
Indirect and Direct Methods
• Both methods arrive at the same total
amount for “Net cash provided by
Operating Activities”.
• The methods differ in disclosing the
items that make up the total amount.
• The choice of methods affects only the
operating activities section; the
investing and financing activities
sections are the same.
Direct Method
• The FASB prefers the direct method but
allows the use of either method.
• When the direct method is used, the net
cash flow from operating activities as
computed using the indirect method must
also be reported in a separate schedule.
Technology Services Company
Statement of Cash Flows--Direct Method (Partial)
For the Year Ended December 31, 2008
Cash flows from operating activities
Cash receipts from customers
$ 765,000
Cash payments
To supplier
$550,000
For operating expenses
158,000
For income taxes
48,000 756,000
Net cash provided by operating activities
$ 9,000
Formula to Compute Cash Receipts from
Customers-Direct Method
Formula to Compute Cash Payment to
Suppliers - Direct Method
Formula to Compute Cash Payments for
Operating Expenses-Direct Method
Direct Method or Indirect
Method?
Indirect Method
Direct Method
• Net income is reconciled
to cash flow from
operating activities.
• Net income is
reconstructed on a cash
basis.
• No supplemental schedule
is required.
• Requires a supplemental
reconciliation of net
income to cash flow from
operating activities.
• Used by 98.8% of
companies.
• Used by 1.2% of
companies.
Product Life Cycle
• A series of phases all products go through
• The phases are often referred to as the:
– introductory phase
– growth phase
– maturity phase
– decline phase
• The phase a company is in affects its cash
flows.
Introductory Phase
To support asset purchases the company may
issue stock or debt. Expect:
• cash from operations to be negative.
• cash from investing to to be negative.
• cash from financing to be positive.
Growth Phase
The company is striving to expand its
production and sales.
Expect:
• small amounts of cash to be generated
from operations.
• cash from investing to be negative.
• cash from financing to be positive.
Maturity Phase
Sales and production level-off.
Expect:
• cash from operations to exceed investing
needs.
• cash from investing to be neutral.
• cash from financing to be
negative.
Decline Phase
Sales and production decline.
Expect:
• cash from operations to decline.
• cash from investing to
possibly become
positive.
• cash from financing
to possibly become
negative.
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Impact of Product Life Cycle on Cash Flows
48
Free Cash Flow
• In the Statement of Cash Flows, cash from
operations is intended to indicate the cashgenerating capability of the company.
• Statement of Cash flows fails to take into
account that a company must invest in new
fixed assets to maintain its current level of
operations and it must maintain dividends at
current levels to satisfy investors.
Free Cash Flow
Cash Provided By Operations
–
Capital Expenditures
–
Dividends Paid
Free Cash Flow
Using Cash Flows
to Evaluate a Company
The 2008 statement of cash flows of Microsoft Corporation
provides information for the computations of these measures.
MICROSOFT CORPORATION
STATEMENT OF CASH FLOWS (PARTIAL)
2008
Cash flows from operations
Additions to property, plant,
and equipment
Acquisition of companies
Sales of investments, net of purch.
Cash used by investing activities
$21,612
$ (3,182)
(8,053)
6,648
(4,587)
MICROSOFT CORPORATION
STATEMENT OF CASH FLOWS (Partial)
2008
Cash flows from operations
Less: Expenditures on property, plant,
and equipment
Dividends
Free Cash Flow
21,612
3,182
4,015
14,415
Assessing Liquidity, Solvency, and
Profitability Using Cash Flows
In addition to using numbers from the income
statement for assessment purposes, we often use
numbers from the statement of cash flows.
The ratios are cash-based instead
of accural-based.
53
Cash-Based Measures
• Accrual-based measures allow too
much management discretion.
• One disadvantage to the cash-based
measures is no readily available
published industry averages for
comparison are available.
Liquidity
• Liquidity is the ability of a business to meet its
immediate obligations.
• One measure of liquidity is the current ratio.
– A disadvantage of the current ratio is that it
uses year-end balances of current assets and
current liabilities. (May not be representative of
a company's position during most of the year.)
– Also, it is subject to some “window dressing”
such as paying down payables prior to Y/E.
Current Cash Debt
Coverage Ratio
• A ratio that partially corrects this is the
current cash debt coverage ratio.
Cash provided by operations
Average current liabilities
• Since cash from operations involves the entire
year rather than a balance at one point in
time, it is often considered a better
representation of liquidity on the average day.
Solvency
• Solvency is the ability of a firm to survive over
the long term.
– One measure of solvency is the debt to total assets
ratio.
• A measure of solvency that uses cash figures is
the cash debt coverage ratio.
Cash Provided By Operations
Average Total Liabilities
• This ratio measures a company's ability to repay its
liabilities from cash generated from operations.
Current Cash Debt Coverage Ratio
Current Cash Debt
Coverage Ratio
Cash Provided by Operations
=
.
Average Current Liabilities
Cash Debt Coverage Ratio
Cash Debt
Coverage Ratio
=
Cash Provided by Operations
.
Average Total Liabilities
Profitability
• Profitability refers to a company's ability to
generate a reasonable return.
• Accrual-based ratios that measure
profitability are the gross profit rate, profit
rate margin, and return on assets.
• A cash-based measure of performance is the
cash return on sales ratio.
Question
The data given below are from the accounting records of the Kuhn Company:
Net Income (accrual basis) ....................... $45,000
Depreciation Expense ............................... $ 9,000
Decrease in Accounts Payable .................. $ 2,500
Decrease in Merchandise Inventory ........ $ 3,000
Increase in Long-term Liabilities ............ $10,000
Sale of Capital Stock for cash .................. $30,000
Increase in Accounts Receivable .............. $ 4,500
Based on this information, the cash provided by operating activities using the
indirect method would be:
a.
b.
c.
d.
$55,000.
$50,000.
$58,000.
$60,000.
End of Chapter 13
Now, this is
what I call
CA$H
FLOW!