Managerial Accounting
Dr. Baldwin
University of Arkansas – Fort Smith
Fall 2010
Administrative Stuff
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Introduction
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CHAPTER 12
Reporting and Analyzing Cash Flows
Purpose of Cash Flow Statement
C1
• The Income Statement is a summary of the
income producing activities of a company
during the period.
• The Balance Sheet shows what “stuff” we
have at any point in time.
Purpose of Cash Flow Statement
• The Cash Flow Statement is needed to provide information
about what happened to cash during the period.
C1
Sources (Increases)
of Cash?
Uses (Decreases)
of Cash?
Why did cash ↑ or ↓?
What is the change
in Cash?
Why is the Cash Flow Stmt. Important?
C1
• Can the business pay dividends?
• Does it have the ability to pay its debts when they
become due?
• Does current cash flow cover both principal and
interest?
• Does it need additional financing?
• What is the primary source of cash?
Management, creditors and investors are
particularly interested in sources, uses and
changes in cash.
What is “Cash”
C1
• Cash = Cash in Bank
• Cash Equivalents
– Readily convertible to cash
– Typically have a maturity date of <90 days
Classifications of Cash Flows
C2
• Operating Activities
• Investing Activities
• Financing Activities
Operating Activities
• Transactions or events that occur
during the normal operation of
the business and determine net
income.
• Typically involve changes in
current assets or current
liabilities.
• What are the sources (increases)?
• What are the uses (decreases)?
Operating Activities
Inflows
•Receipts from customers
•Cash dividends received
•Interest from borrowers
•Other.
Outflows
•Salaries and wages
•Payments to suppliers
•Taxes and fines
•Interest paid to lenders
•Other
Investing Activities
• Transactions or events that
affect long term assets
• Sources:
– Proceeds from sales of PP&E
or LT Investments
• Uses:
– Purchases of PP&E or LT
Investments
Financing Activities
• Transactions or events that affect long-term debt or
equity sections of the balance sheet.
• Sources:
– Sales of stock or bonds
– Bank loans
• Uses:
– Purchase of treasury stock
– Payment of dividends
– Payment on loans
Three “Foolers”
1. Interest Paid on Debt is an
OPERATING Activity
2. Interest or Dividend Income is an
OPERATING Activity
(Rationale: Once the decision to finance or
invest has been made, any further cash
received or required in an operating
activity.)
3. Dividends paid to shareholders is a
FINANCING Activity.
Non-Cash Transactions
C3
• Significant financing and
investing activities that do
not affect cash are
reported separately.
• Disclosed at the bottom
of Cash Flow Stmt in
Schedule of Noncash
Investing & Financing
Activities
• Examples:
– Issuing stock for land
– Signing a mortgage and
taking title to the related
property
– Converting or retiring
bonds to stock
– Converting common
stock to preferred stock
Presentation of Cash Flows
• There are two formats to present Cash Flow from
Operating Activities:
– Direct method
– Indirect method
C4
• Indirect method is more prevalent (97.5% of
companies)
• Direct method is easier to understand
– Lists the sources and uses of cash from operations as
individual line items:
• cash collected from customers
• cash paid for inventory
• cash paid for interest
• Each method produces the SAME amounts of Cash
Flows Provided (Used) by Operating Activities
Indirect Method for Calculating
Cash Flow from Operations
P2
• We will reconcile Accrual based Net Income to Cash flow
from Operating Activities:
Step 1: Net income
Step 2: +/- changes in Current asset accounts
Step 3: + non-cash expenses
Step 4 :+/- non-operating items
= cash from operations
Cash Flow from Operating Activities
Example



East, Inc. reports $125,000 net income for the year
ended December 31, 2008.
Accounts Receivable increased by $7,500 during
the year and Accounts Payable increased by
$10,000.
During 2008, East reported $12,500 of
Depreciation Expense.
What is East’s cash flow from operating
activities for the period end 12/31/08?
P2
Indirect Method Example
Net
Netincome
income
Deduct:
Deduct:Increase
Increasein
inaccounts
accounts
For the indirect
receivable
receivable
method, start with
Cash
Cashprovided
provided
byoperating
operating
net by
income.
activities
activities
$$ 125,000
125,000
P2
Indirect Method Example
Net
Netincome
income
Add:
Add:Depreciation
Depreciationexpense
expense
Deduct:
Deduct:Increase
Increasein
inaccounts
accounts
receivable
Add noncash expenses such as
receivable
depreciation, depletion,
amortization,
or
debt
Cash
provided
operating
Cash
providedby
bybad
operating
activities expense.
activities
$$ 125,000
125,000
12,500
12,500
P2
Indirect Method Example
Net
Netincome
income
Add:
Add:Depreciation
Depreciationexpense
expense
Deduct:
Deduct:Increase
Increasein
inaccounts
accounts
receivable
receivable
$$ 125,000
125,000
12,500
12,500
(7,500)
(7,500)
Change
in Account Balance During Year
Cash
by
Cashprovided
provided
byoperating
operating
Increase
Decrease
activities
activities
Current
Assets
Current
Liabilities
Subtract from net
income.
Add to net income.
Add to net income.
Subtract from net
income.
P2
Indirect Method Example
Net
$$ 125,000
Netincome
income
125,000
Add:
12,500
Add:Depreciation
Depreciationexpense
expense
12,500
Deduct:
Deduct:Increase
Increasein
inaccounts
accounts
receivable
(7,500)
receivable
(7,500)
Add:
10,000
Add:Increase
Increasein
inaccounts
accountspayable
payable
10,000
Cash
by
operating
Cashprovided
provided
by
operating
Change in Account Balance During Year
activities
activities
Increase
Decrease
Current
Assets
Current
Liabilities
Subtract from net
income.
Add to net income.
Add to net income.
Subtract from net
income.
P2
Indirect Method Example
Net
Netincome
income
Add:
Add:Depreciation
Depreciationexpense
expense
Deduct:
Deduct:Increase
Increasein
inaccounts
accounts
receivable
receivable
Add:
Add:Increase
Increasein
inaccounts
accountspayable
payable
Cash
Cashprovided
providedby
byoperating
operating
activities
activities
$$ 125,000
125,000
12,500
12,500
(7,500)
(7,500)
10,000
10,000
$$ 140,000
140,000
If we used the Direct Method, we would get the same $140,000 for
Cash Provided by Operating Activities.