Merchandising Operations and the Multiple

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Financial Accounting:
Tools for Business Decision Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 12
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
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Chapter 12
STATEMENT OF
CASH FLOWS
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Chapter 12
Statement of Cash Flows
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After studying Chapter 12, you should be
able to:
Indicate the usefulness of the statement of cash flows.
Distinguish among operating, investing, and financing
activities.
Explain the impact of the product life cycle on a
company's cash flows.
Prepare a statement of cash flows using the indirect
method.
Use the statement of cash flows to evaluate a company.
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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.
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Questions the Statement of Cash
Flow Answers
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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
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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.
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Operating Activities...
Include:
 The cash effects of transactions that create
revenues and expenses and
 Enter into determination of net income.
Involve Income Statement Items
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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
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Financing Activities...
Include:
 Obtaining cash from issuing debt and
repaying the amounts borrowed and
 Obtaining cash from stockholders,
repurchasing shares, and paying
dividends.
Involve Noncurrent Liability and
Stockholders’ Equity Items
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Types of Cash Flows Operating Activities
 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
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Types of Cash Flows Investing Activities
 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
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Types of Cash Flows Financing Activities
 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
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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.
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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.
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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.
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Review
Which is an example of a cash flow from an
operating activity?
a. Payment of cash to lenders for interest.
b.Receipt of stock from the sale of capital
stock
c. Payment of cash dividends to the
company’s stockholders
d.Sale of old equipment.
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Review
Which is an example of a cash flow from an
operating activity?
a. Payment of cash to lenders for interest.
b.Receipt of stock from the sale of capital
stock
c. Payment of cash dividends to the
company’s stockholders
d.Sale of old equipment.
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Format of the
Statement of Cash Flows
Three parts:
 operating
 investing
 financing
Plus significant noncash investing and
financing activities in separate schedule
or at bottom of the statement of cash
flows.
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Format of Statement of
Cash Flows
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The 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.
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Introductory Phase
To support asset purchases the
company may issue stock or debt.
Expect:
 cash from operations to be negative
 cash from investing to
be negative.
 cash from financing to
be positive.
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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.
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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.
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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
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Statement of Cash Flows Helps Users
Evaluate
1. The entity's ability to generate future cash flows
2. The entity's ability to pay dividends and meet
obligations
3. The reasons for the difference between net income
and net cash provided (used) by operating activities
4. The investing and financing transactions during the
period
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Statement of Cash Flows Helps Answer the
Following Questions
 How did cash increase when there was a net loss
for the period?
 How were the proceeds of the bond issue used?
 How was the expansion in the plant and
equipment financed?
 Why were dividends not increased?
 How was the retirement of debt accomplished?
 How much money was borrowed during the year?
 Is cash flow greater or less than net income?
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Sources of Information for the
Statement of Cash Flows
 Comparative balance sheet
 Current income statement
 Additional information
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Major Steps in Preparing
Statement of Cash Flows
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Major Steps in Preparing
Statement of Cash Flows
In order to perform step 1
a company MUST convert net
income from a cash to accrural
basis.
Over Ninety-eight (98.8)% of
companies use the indirect
method, so will we.
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Comparative Balance Sheet
Indicates the amount of
changes in assets, liabilities,
and stockholders' equities from
the beginning to the end of the
period.
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Current Income Statement
Information in this
statement helps the
reader determine the
amount of cash
provided or used by
operations during the
period.
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Income Statement and Additional
Information
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Indirect and Direct Methods
 Convert net income from an accrual
basis to a cash basis.
 This conversion may be done
by two methods:
 indirect
 direct
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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.
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Indirect Method
 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.
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3 Steps to Convert Net Income to Net
Cash from Operations
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Adjustment of Depreciation
Adjustment of Loss on Equipment
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Analysis of Accounts Receivable
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Adjustment For Changes in Current
Assets
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Adjustment For Changes in
Current Liabilities
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Adjustments Needed to Convert Net
Income to Net Cash Provided by
Operating Activities
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Statement of Cash Flows, 2007
Indirect Method
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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.
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Free Cash Flow
Cash Provided By Operations
–
Capital Expenditures
–
Dividends Paid
Free Cash Flow
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Assessing Liquidity and Solvency Using
Cash Flows
Rather than using numbers from the
income statement for assessment
purposes, we use numbers from the
statement of cash flows.
The ratios are cash-based instead
of accrual-based.
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Cash-Based Measures
 Accrual-based measures allows
too much management
discretion.
 One disadvantage to the cashbased measures is no readily
available published industry
averages for comparison.
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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.)
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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.
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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.
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