The Relationship Between Business Activities
and Cash Flows
Cash
Equivalents
Cash
Currency
 Short-term, highly liquid investments.
 Readily convertible into cash.
 So near maturity that market value is unaffected by interest rate
changes (i.e., less than 3 months to maturity).
McGraw-Hill/Irwin
Slide 1
The Relationship Between Business Activities
and Cash Flows
Operating
Activities
Cash inflows and outflows directly
related to earnings from normal
operations.
Investing
Activities
Cash inflows and outflows related to
the acquisition or sale of productive
facilities and investments in the
securities of other companies.
Financing
Activities
Cash inflows and outflows related to
external sources of financing
(owners and creditors) for the
enterprise.
McGraw-Hill/Irwin
Slide 2
CASH INFLOWS
Operating Activities
Cash received
from revenues
Investing Activities
Sale of operational assets
Sale of investments
Collections of loans
Financing Activities
Issuance of stock
Issuance of bonds
and notes
Business
Cash paid for
expenses
Purchase of operational
assets
Purchase of investments
Loans to others
Payment of dividends
Repurchase of stock
Repayment of debt
CASH OUTFLOWS
Slide 3
Cash Flows from Operating Activities
Inflows
Cash received from:
 Customers
 Dividends and interest on
investments
Outflows
Cash paid for:
 Purchase of goods for resale
and services (electricity, etc.)
 Salaries and wages
 Income taxes
 Interest on liabilities
McGraw-Hill/Irwin
+
_
Cash
Flows
from
Operating
Activities
Slide 4
Cash Flows from Operating Activities
Two Formats for Reporting Operating Activities
Direct Method
Indirect Method
Reports the
cash effects of
each operating
activity
Starts with
accrual net
income and
converts to
cash basis
Note that no matter which format is used, the same amount
of net cash flows from operating activities is generated.
McGraw-Hill/Irwin
Slide 5
Cash Flows from Investing Activities
Inflows
Cash received from:

Sale or disposal of property,
plant and equipment
 Sale or maturity of investments
in securities
Outflows
Cash paid for:
 Purchase of property, plant and
equipment
 Purchase of investments in
securities
McGraw-Hill/Irwin
+
_
Cash
Flows
from
Investing
Activities
Slide 6
Cash Flows from Financing Activities
Inflows
Cash received from:
 Borrowings on notes,
mortgages, bonds, etc. from
creditors
 Issuing stock to owners
Outflows
Cash paid for:
 Repayment of principal to
creditors (excluding interest,
which is an operating activity)
 Repurchasing stock from
owners
 Dividends to owners
McGraw-Hill/Irwin
+
_
Cash
Flows
from
Financing
Activities
Slide 7
Net Increase (Decrease) in Cash
Net cash provided by operating activities
Net cash used by investing activities
Net cash used in financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
$ 29,000
(11,000)
(19,000)
(1,000)
8,000
$ 7,000
This ending cash balance on the Statement of
Cash Flows should agree with the cash balance
on the Balance Sheet.
Slide 8
Relationships to the Balance Sheet
and the Income Statement
Information needed to prepare a
Statement of Cash Flows is found in:
 Comparative Balance Sheets.
 A complete Income Statement.
 Additional details concerning
selected accounts.
Slide 9
Relationships to the Balance Sheet
and the Income Statement
Selected Cash Transactions and Their Effect on Other Balance Sheet Accounts
Category
Transactions
Cash Effect Other Account Affected
Operating Collect accounts receivable
+Cash -Accounts Receivable (A)
Pay accounts payable
-Cash
-Accounts Payable (L)
Prepay rent
-Cash
+Prepaid Rent (A)
Pay interest
-Cash
-Retained Earnings (SE)
Sell goods/services for cash
+Cash +Retained Earnings (SE)
Investing Purchase equipment for cash
-Cash
+Equipment (A)
Sell investment securities for cash
+Cash -Investments (A)
Financing Pay back debt to bank
-Cash
-Bank Loan Payable (L)
Issue stock for cash
+Cash +Contributed Capital (SE)
Slide 10
Reporting Cash Flows from Operating
Activities—Indirect Method
The indirect method adjusts net income
by eliminating noncash items.
+/- Changes in current
assets and current
liabilities
Net
Income
+ Losses and
- Gains
McGraw-Hill/Irwin
Cash Flows
from Operating
Activities Indirect Method
+ Noncash
expenses such as
depreciation
Slide 11
Depreciation and Gains and Losses on Sale of
Long-Term Assets
Depreciation
Depreciation does not affect cash, so
we must eliminate its effect by
adding it back to net income.
Gains
Gains must be subtracted from net
income to avoid double counting the
gain.
Losses
Losses must be added to net income
to avoid double counting the loss.
McGraw-Hill/Irwin
Slide 12
Changes in Current Assets and
Current Liabilities
Current
Assets
Current
Liabilities
Change in Account Balance During Year
Increase
Decrease
Subtract from net
Add to net income.
income.
Add to net income.
Subtract from net
income.
Use this table when adjusting Net Income
to Operating Cash Flows using the
indirect method.
McGraw-Hill/Irwin
Slide 13
Reporting Cash Flows from Operating
Activities—Indirect Method
Use the following financial statements
for Nautilus and prepare the
Statement of Cash Flows for the year
ended December 31, 2006.
McGraw-Hill/Irwin
Slide 14
NAUTILUS, INC.
Balance Sheet
December 31,
2006
In Thousands
ASSETS
Current assets:
Cash & cash equivalents
Accounts Receivable
Inventories
Prepaid expenses
Total current assets
Plant and equipment
Less: Accumulated depreciation
Land
Total assets
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable
Accrued liabilities
Total current liabilities
Long-term debt
Total liabilities
Stockholders' Equity:
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities & stockholders' equity
McGraw-Hill/Irwin
$
$
$
$
December 31,
2005
Changes
7,000 $
138,000
76,000
33,000
254,000
219,000
(54,000)
10,000
429,000 $
8,000 $
117,000
96,000
24,000
245,000
203,000
(47,000)
12,000
413,000
(1,000)
21,000
(20,000)
9,000
64,000 $
38,000
102,000
67,000
169,000
61,000
37,000
98,000
63,000
161,000
3,000
1,000
5,000
255,000
260,000
429,000 $
4,000
248,000
252,000
413,000
1,000
7,000
16,000
(7,000)
(2,000)
4,000
Slide 15
NAUTILUS, INC.
Income Statement
For the Year Ended December 31, 2006
In Thousands
Net sales
$
Cost of goods sold
Gross profit
Operating expenses:
Selling, general and administrative
Depreciation
Total operating expenses
Operating income
Gain on sale of land
Interest revenue (expense)
Net income before taxes
Income tax expense
Net income
680,000
382,000
298,000
250,000
7,000
257,000
41,000
3,000
(1,000)
43,000
12,000
$31,000
The Statement of Cash Flows will begin with
net income from the Income Statement.
Slide 16
NAUTILUS, INC.
Statement of Cash Flows
For the Year Ended December 31, 2006
(Unaudited--In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation
Gain on sale of land
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses
Accounts payable
Accrued liabilities
Net cash provided by operating activities
Cash flows for investing activities:
Purchases of plant and equipment
Sales of land
Net cash used by investing activities
Cash flows from financing activities:
Repayment of principal on existing debt
Additional long-term debt borrowed
Proceeds from issuance of common stock
Cash dividends paid
Net cash used in financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
$
31,000
7,000
(3,000)
(21,000)
20,000
(9,000)
3,000
1,000
29,000
(16,000)
5,000
(11,000)
$
(2,000)
6,000
1,000
(24,000)
(19,000)
(1,000)
8,000
7,000
Slide 17
NAUTILUS, INC.
Statement of Cash Flows
For the Year Ended December 31, 2006
(Unaudited--In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation
Gain on sale of land
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses
Accounts payable
Accrued liabilities
Net cash provided by operating activities
Cash flows for investing activities:
Purchases of plant and equipment
Sales of land
Net cash used by investing activities
Cash flows from financing activities:
Repayment of principal on existing debt
Additional long-term debt borrowed
Proceeds from issuance of common stock
Cash dividends paid
Net cash used in financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
$
31,000
7,000
(3,000)
(21,000)
20,000
(9,000)
3,000
1,000
29,000
(16,000)
5,000
(11,000)
$
(2,000)
6,000
1,000
(24,000)
(19,000)
(1,000)
8,000
7,000
Slide 18
NAUTILUS, INC.
Statement of Cash Flows
For the Year Ended December 31, 2006
(Unaudited--In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation
Gain on sale of land
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses
Accounts payable
Accrued liabilities
Net cash provided by operating activities
Cash flows for investing activities:
Purchases of plant and equipment
Sales of land
Net cash used by investing activities
Cash flows from financing activities:
Repayment of principal on existing debt
Additional long-term debt borrowed
Proceeds from issuance of common stock
Cash dividends paid
Net cash used in financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
$
31,000
7,000
(3,000)
(21,000)
20,000
(9,000)
3,000
1,000
29,000
(16,000)
5,000
(11,000)
$
(2,000)
6,000
1,000
(24,000)
(19,000)
(1,000)
8,000
7,000
Slide 19
NAUTILUS, INC.
Statement of Cash Flows
For the Year Ended December 31, 2006
(Unaudited--In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation
Gain on sale of land
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expenses
Accounts payable
Accrued liabilities
Net cash provided by operating activities
Cash flows for investing activities:
Purchases of plant and equipment
Sales of land
Net cash used by investing activities
Cash flows from financing activities:
Repayment of principal on existing debt
Additional long-term debt borrowed
Proceeds from issuance of common stock
Cash dividends paid
Net cash used in financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
$
31,000
7,000
(3,000)
(21,000)
20,000
(9,000)
3,000
1,000
29,000
(16,000)
5,000
(11,000)
$
(2,000)
6,000
1,000
(24,000)
(19,000)
(1,000)
8,000
7,000
Slide 20
Quality of Income Ratio
Quality of
Net Cash Flow from Operating Activities
=
Income Ratio
Net Income
In general, this ratio measures the portion of
income that was generated in cash. All other
things equal, a higher quality of income ratio
indicates greater ability to finance operating
and other cash needs from
operating cash inflows.
Nautilus's Quality of Income Ratio
$29,000
= 0.94 times
$31,000
McGraw-Hill/Irwin
Slide 21
Supplement 16B: Spreadsheet Approach—
Indirect Method
The spreadsheet approach offers a
systematic way to keep track of data. A
spreadsheet is organized as follows:
1. Four columns to record dollar amounts are
established (beginning balance, debit changes, credit
changes, and ending balance).
2. On the far left of the top half of the spreadsheet,
each account name from the balance sheet is
entered.
3. On the far left of the bottom half of the spreadsheet,
the name of each item that will be reported on the
statement of cash flows is entered.
McGraw-Hill/Irwin
Slide 22
NAUTILUS, INC.
Changes
Dec. 31, 2005
Balance Sheet
Assets:
Cash and equivalents (A)
Accounts receivable (A)
Inventories (A)
Prepaid expenses (A)
Plant and equipment (A)
Accumulated depreciation (XA)
Land (A)
Accounts payable (L)
Accrued liabilities (L)
Long-term debt (L)
Contributed capital (SE)
Retained earnings (SE)
Statement of Cash Flows
Cash flows from operating activities:
Net income
Adj. to reconcile net income to net cash
provided by operating activities:
Depreciation
Gain on sale of land
Changes in assets and liabilities:
Accounts receivable
Inventories
Prepaid expense
Accounts payable
Accrued liabilities
Net cash provided by operating activities
Cash flows for investing activities:
Purchase of equipment
Sale of land
Net cash used by investing activities
Cash flows from financing activities:
Repayment of principal on existing debt
Additional long-term debt borrowed
Stock issuance
Cash dividends paid
Net cash used in financing activities
Net decrease in cash & cash equivalents
Totals
8,000
117,000
96,000
24,000
203,000
47,000
12,000
61,000
37,000
63,000
4,000
248,000
Debits
(n)
1,000
(d)
20,000
(b)
(i)
(f)
(g)
2,000 (k)
(l)
24,000 (a)
7,000
2,000
3,000
1,000
6,000
1,000
31,000
(c)
21,000
(e)
(h)
9,000
16,000
(j)
(m)
Credits
Inflows
(a)
31,000
(b)
7,000
(d)
20,000
(f)
(g)
3,000
1,000
Outflows
(i)
3,000
(c)
21,000
(e)
9,000
Dec. 31, 2006
7,000
138,000
76,000
33,000
219,000
54,000
10,000
64,000
38,000
67,000
5,000
255,000
Subtotals
29,000
(h)
(i)
16,000
5,000
(11,000)
(k)
(l)
(j)
2,000
(m)
24,000
After entering
all the
transactions
illustrated in
the textbook,
this is what the
spreadsheet
looks like.
6,000
1,000
(19,000)
(n)
1,000
147,000
147,000
(1,000)
Slide 23