13 Statement of
Cash Flows
FINANCIAL
ACCOUNTING
2ND EDITION
BY
DUCHAC, REEVE, & WARREN
© Copyright 2007 Thomson South-Western, a part
of The Thomson Corporation. Thomson, the Star
Logo, and South-Western are trademarks used
herein under license.
1
LEARNING GOALS
When you finish this
chapter, you should be
able to
2
LEARNING GOALS
1. Summarize types of cash flow activities reported
in statement of cash flows.
2. Prepare statement of cash flows using indirect
method.
3. Prepare statement of cash flows using direct
method.
4. Calculate, interpret cash conversion cycle, flow
ratio, free cash flow.
Continued
3
DELL Inc.
Dell Inc.
Understanding company cash flows is
important to understanding earning power
Has billions in cash & temporary
investments
Has 60% of assets in cash
Pressure to declare dividend
4
LEARNING GOALS
1
Summarize types of cash
flow activities reported in
statement of cash flows.
5
LG 1
How do you report a
company’s cash flows?
The Statement of Cash
Flows reports sources and
uses of cash.
6
LG 1
CASH FLOW STATEMENT
• 3 sections reporting cash flows
from different activities
– Cash flows from operating activities
– Cash flows from investing activities
– Cash flows from financing activities
7
LG 1
EXHIBIT 1
Cash flows
8
LG 1
CASH FLOWS: Operating Activities
• Most important cash flows of a business
• 2 methods
– Direct method
• Reports operating cash flows as sources, uses of
cash
– Indirect method
• Reports operating cash by adjusting accrual net
income to cash flows
9
LG 1
EXHIBIT 2
Direct & Indirect
methods
10
LG 1
CASH FLOWS: Investing Activities
• Cash inflows from investing activities arise
from
– Selling fixed assets, investments, intangible
assets
• Cash outflows from investing activities
arise from
– Buying fixed assets, investments, intangible
assets
11
LG 1
CASH FLOWS: Financing Activities
• Cash inflows from financing activities arise
from
– Issuing debt, equity securities
• Cash outflows from financing activities
arise from
– (Re)Paying dividends, debt, purchasing
treasury stock
12
LG 1
EXERCISE 13-3a
Identify cash flow from operating activity.
1.
2.
3.
4.
5.
6.
Purchased patents
Purchased buildings
Purchased treasury stock
Sold equipment
Net income
Issued preferred stock
7. Redeemed bonds
8. Paid cash dividends
9. Sold long-term
investment
10. Issued common stock
11. Issued bonds
Click
button to
skip this
exercise
Press “Enter” or click left mouse button for answer.
13
LG 1
EXERCISE 13-3b
Identify cash flow from investing activity.
1.
2.
3.
4.
5.
6.
Purchased patents
Purchased buildings
Purchased treasury stock
Sold equipment
Net income
Issued preferred stock
7. Redeemed bonds
8. Paid cash dividends
9. Sold long-term
investment
10. Issued common stock
11. Issued bonds
Click
button to
skip this
exercise
Press “Enter” or click left mouse button for answer.
14
LG 1
EXERCISE 13-3c
Identify cash flow from financing activity.
1.
2.
3.
4.
5.
6.
Purchased patents
Purchased buildings
Purchased treasury stock
Sold equipment
Net income
Issued preferred stock
7. Redeemed bonds
8. Paid cash dividends
9. Sold long-term
investment
10. Issued common stock
11. Issued bonds
Click
button to
skip this
exercise
Press “Enter” or click left mouse button for answer.
15
LG 1
NONCASH ACTIVITIES
• Arise from investing, financing activities
– Examples
• Issue stock to retire long-term debt
• Issue stock, debt in exchange for fixed asset
– Has no direct effect on cash flows
– Disclosed in separate schedule
16
LG 1
EXHIBIT 3
Comparative balance sheet
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LEARNING GOALS
2
Prepare statement of
cash flows using
indirect method.
18
LG 2
INDIRECT METHOD:
Retained Earnings
• Retained Earnings balance shows change
from 1/1 – 12/31
• Change in Retained Earnings due to
– Net Income (Loss)
– Dividends declared
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LG 2
RETAINED EARNINGS:
Changes
Rundell, Inc.
Retained Earnings
12/31 Dividends
28,000
202,300
108,000
310,300
1/1 Balance
282,300
12/31 Balance
12/31 Net Income
20
LG 2
EXHIBIT 4
Indirect method
21
LG 2
INDIRECT METHOD:
Equation
Net Income
+Depreciation, Amortization
+Decreases CA, Increases CL
+Losses
- Increases CA, Decreases CL
- Gains
=
Net cash flow from Operating Activities
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LG 2
EXERCISE 13-5a
Identify items added to net income under indirect method to determine net cash flow
from Operating Activities.
1.
2.
3.
4.
5.
6.
Inc current NP
Loss disposal assets
Dec AP
Inc AR
Dec Salary payable
Dec Prepaid exp.
7.
8.
9.
10.
11.
Depreciation
Dec AR
Amortization
Inc Inventory
Gain retiring debt
Click
button to
skip this
exercise
Press “Enter” or click left mouse button for answer.
23
LG 2
EXERCISE 13-5b
Identify items subtracted from net income under indirect method to determine net
cash flow from Operating Activities.
1.
2.
3.
4.
5.
6.
Inc current NP
Loss disposal assets
Dec AP
Inc AR
Dec Salary payable
Dec Prepaid exp.
7.
8.
9.
10.
11.
Depreciation
Dec AR
Amortization
Inc Inventory
Gain retiring debt
Click
button to
skip this
exercise
Press “Enter” or click left mouse button for answer.
24
LG 2
EXHIBIT 5
Rundell, Inc. Operating Cash
Flow Indirect Method
25
LG 2
RUNDELL CASH FLOWS:
Investing
• Rundell’s investing cash flows
– Bought building for cash ($60,000)
– Bought land for cash ($15,000)
– Sold land for cash ($72,000)
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LG 2
RUNDELL CASH FLOWS:
Financing
• Rundell’s financing cash flows
– Paid cash dividends ($24,000)
– Issued stock for cash ($48,000)
– Retired bonds with cash ($50,000)
27
LG 2
EXHIBIT 6
Rundell, Inc. Cash Flow Statement
Indirect Method
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LEARNING GOALS
4
Calculate, interpret
cash conversion cycle,
flow ratio, free cash
flow.
29
LG 4
CASH CONVERSION CYCLE
• Cash conversion cycle
– Measures the cycle of
•
•
•
•
Buying inventory
Paying for inventory (account payable)
Selling inventory
Collecting account receivable
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LG 4
CASH CONVERSION CYCLE:
Equation
Days’ sales in A/R = A/R / Avg. daily net Sales
+
Days’ sales in inventory = Avg. Inv. / Avg. CGM
Days’ sales in A/P = Avg. A/P / Avg CGM
31
LG 4
CASH CONVERSION CYCLE:
Calculation
Apple
# Days’ Sales
Receivables
Inventory
Accounts Payable
Conversion Cycle
34
5
<79>
<40>
Dell
30
4
<74>
?
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LG 4
ANALYSIS: Cash Conversion Cycle
• The more positive the conversion cycle, the
less efficient the operations
– Reduces amount of noncash current assets
– Increases level of current liabilities
– Releases cash for other purposes
• Negative cycles indicate highly efficient use
noncash working capital
33
LG 4
How does Dell’s cash
conversion cycle compare
with Gateway, if Gateway’s
cycle is <7>?
34
LG 4
FREE CASH FLOW
• Measures of operating cash flow available for
corporate purposes after providing for
sufficient fixed asset additions and dividends.
Operating Cash Flow
– Asset additions to maintain current production
– Dividends
= Free Cash Flow
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LG 4
FREE CASH FLOW: Calculation
Cash Flow
Apple
Operations
Used for PPE
Used to pay dividends
Free Cash Flow
$934 $3,670
<176> <329>
$758
?
Free Cash Flow as % Cash
Flow Operations
81%
Free Cash Flow as % Sales
?
Dell
?
?
36
LG 4
ANALYSIS: Free Cash Flow
• Positive cash flow funds
– Internal growth
– Debt retirement
– Financial flexibility
37
LG 4
If Dell’s free cash flow is
$3,341, how does it compare
with Apple’s?
38
LG 4
Compare Dell’s free cash flow
as a % of cash flow operations
of +91% with Gateway’s
–12%.
39
LG 4
Compare Dell’s free cash flow
as a % of sales of +8% with
Sun Microsystems’ ratio of
18%.
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CHAPTER 13
THE END
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