14 statement of cash flows

Statement of Cash Flows

Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University

Chapter 14

Copyright © Houghton Mifflin Company. All rights reserved. 14–2

The Statement of Cash Flows

… shows how a company’s operating, investing, and financing activities

affected cash during an accounting period

• Explains the net increase (or decrease) in cash during the accounting period


Cash and Cash Equivalents

• Cash includes cash and cash equivalents– Cash

• Money on hand

• Deposits in company checking accounts

– Cash equivalents• Short-term, highly liquid investments including

– Money market accounts

– Commercial paper

– U.S. Treasury bills

• Combined with the Cash account on the statement of cash flows


Purposes of the Statement of Cash Flows

… is to provide information about a company’s cash receipts and cash

payments during an accounting period

• Other financial statements may also provide some of this information


Internal Uses of the Statement of Cash Flows

• Management uses the statement of cash flows to– Assess liquidity

• Determine if short-term financing is necessary

– Determine dividend policy• Decide whether to raise or lower dividends

– Evaluate the effects of investment and financing decisions

• Plan for investing and financing needs


External Uses of the Statement of Cash Flows

• Investors and creditors use the statement of cash flows to assess a company’s ability to– Manage cash flows

– Generate positive future cash flows

– Pay its liabilities

– Pay dividends and interest

– Anticipate its need for additional financing


Classification of Cash Flows

• The statement of cash flows classifies cash receipts and cash payments into categories

1. Operating activities

2. Investing activities

3. Financing activities


Operating Activities

… include the cash effects of transactions and other events that affect the income

statement

• In effect, items on the income statement are changed from an accrual to a cash basis


Operating Activities

• Cash inflows– Cash receipts from customers for goods and services

– Interest and dividends received on loans and investments

– Sales of trading securities

• Cash outflows– Cash payments for

• Wages

• Goods and services

• Expenses

• Interest

• Taxes

• Purchases of trading securities


Investing Activities

… include the cash effects of transactions that affect long-term assets

• Acquiring and selling long-term assets

• Acquiring and selling marketable securities other than trading securities or cash equivalents

• Making and collecting loans


Investing Activities

• Cash inflows– Cash receipts from selling long-term assets

and marketable securities

– Collecting loans

• Cash outflows– Cash expended for purchases of long-term

assets and marketable securities

– Cash loaned to borrowers


Financing Activities

… include the cash effects of transactions that affect long-term liabilities and

stockholders’ equity

• Obtaining resources from stockholders

• Returning resources to stockholders and providing them with a return on their investment

• Obtaining resources from creditors

• Repaying amounts borrowed from creditors or otherwise settling obligations– Repayments of accounts payable or accrued liabilities are

classified under operating activities


Financing Activities

• Cash inflows– Proceeds from issues of stock

– Proceeds from short-term and long-term borrowing

• Cash outflows– Repayment of loans

– Payments to owners (cash dividends)

– Treasury stock transactions

Classification of Cash Inflows and Cash Outflows

Gail Mestas

Insert updated Figure 1, Classification of cash inflows and cash outflows, chapter 14, FA


Noncash Investing and Financing Transactions

• Involve only long-term assets long-term liabilities

stockholders’ equity

in significant investing and financing activities

• Not reflected on the statement of cash flows because they do not involve either cash inflows or cash outflows

• Disclosed in a separate schedule as part of the statement of cash flows

Format of the Statement of Cash Flows

• Divided into three sections– Cash flows from operating activities

– Cash flows from investing activities

– Cash flows from financing activities

• A reconciliation of beginning and ending Cash balances appears near the bottom of the statement

• Schedule of noncash investing and financing transactions


1. Cash Flow Yield

Shows how much of net income actually results in operating cash inflows

IncomeNet

Activities Operating from FlowsCash Net Yield FlowCash

times1.8 $479

$850

Cash-Generating Efficiency (CGE)

…shows the company’s ability to generate cash from its current or

continuing operations• There are three measures of CGE


2. Cash Flows to Sales

3. Cash Flows to Assets

Shows how much of net sales actually results in cash inflows

Shows how much cash is being generated by operations for each dollar of assets

SalesNet

Activities Operating from FlowsCash Net Sales toFlowsCash

8.5% $10,017

$850

Assets Total Average

Activities Operating from FlowsCash Net Assets toFlowsCash

10.9% 2 $7,324) ($8,239

$850

Cash-Generating Efficiency (CGE) (cont’d)


Free Cash Flow = Net Cash Flows from Operating Activities – Dividends – Purchases of Plant Assets + Sales of Plant Assets

Free Cash Flow (FCF)

… is the amount of cash that remains after paying for continuing operations at the current level, interest, income taxes,

dividends, and net capital expenditures

• Shows how much cash a company has available to reduce debt or expand


Free Cash Flow (cont’d)

• If free cash flow is positive, the company– Has met all of its planned cash commitments

– Has cash available to reduce debt or expand

• If free cash flow is negative, the company will have to – Sell investments

– Borrow money

– Issue stock in the short term

to continue at its planned level of operation


Determining Cash Flows from Operating Activities

• There are two methods of converting the income statement from an accrual basis to a cash basis1. The direct method

• Adjusts each item in the income statement to its cash equivalent

• More easily understood by the average reader

2. The indirect method• Lists only necessary adjustments to convert net income to

net cash flows• Superior from an analyst’s perspective• Used by most companies

• Both methods produce the same net figure


Indirect Method of Determining Net Cash Flows from Operating Activities

Gail Mestas

Insert updated Figure 2, Indierct method of determining net cash flows from operating activiites, chapter 14 , FA


Depreciation

• Depreciation, amortization, and depletion expense are allocations of expense and do not involve cash flows

• An adjustment is needed to increase net income by the amount recorded


Effect on income statement: -$37,000 Effect on cash flows: zero Cash flow out is $37,000 less, because depreciation expense has no cash effect Add $37,000 to net income

Depreciation Expense Income Taxes Payable Cash

37,000 37,000

Depreciation expense $37,000

Adjustments to Depreciation


Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000

Depreciation expense $37,000

Depreciation Expense Accumulated Depreciation Cash

37,000 37,000

Adjustments to Depreciation


Gains and Losses

• Gains and losses do not affect cash flows from operating activities and need to be removed from this section

• The cash receipts that resulted in the gains or losses are shown with investing activities


Gain on sale of investments $12,000 Investments sold for $102,000 (original cost $90,000)

Effect on income statement: +$12,000 Effect on cash flows: +$102,000 (Shown under investing activities) Gains do not affect cash flows from operating activities and need to be removed from this section Deduct $12,000 from net income

Gain on Sale - Investments Investments Cash

90,000

-0-

90,000

12,000 102,000

Adjustments to Gains and Losses


Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000)

Gain on sale of investments $12,000 Investments sold for $102,000 (original cost $90,000)


90,000

-0-

90,000

12,000 102,000



Loss on sale of plant assets $3,000 Plant assets (original cost $10,000) sold for $5,000

Effect on income statement: -$3,000 Effect on cash flows: +$5,000 (Shown under investing activities) Losses do not affect cash flows from operating activities and need to be removed from this section Add $3,000 to net income

Loss on Sale of Plant Assets

10,000

-0-

10,0003,000 2,000

Accum. Dep.Plant AssetsPlant Assets Cash

-0-

2,0005,000




Loss on sale of plant assets $3,000 Plant assets (original cost $10,000) sold for $5,000

Loss on Sale of Plant Assets

10,000

-0-

10,0003,000 2,000


-0-

2,0005,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000


Changes in Current Assets

• Decreases are added to net income

• Increases are deducted from net income


Adjustments to Changes in Current Assets

– Add $8,000 to net income because cash received from sales was $8,000 more than sales ($706,000 - $698,000)

Cash Receipts from

Customers Sales toCustomers

Accounts Receivable

Beg. Bal. 55,000

End. Bal. 47,000

706,000

698,000

• Example

– Accounts Receivable balance decreased by $8,000 ($47,000 - $55,000)


Sales 698,000

Beginning Accounts Receivable $ 55,000 Ending Accounts Receivable 47,000

Effect on income statement: +$698,000 Effect on cash flows: +$706,000 Cash flow in is $8,000 more than Sales because Accounts Receivable decreased $8,000 Add $8,000 to net income

Sales Accounts Receivable Cash

706,000

47,000

55,000698,000

706,000698,000



Beginning Accounts Receivable $ 55,000 Ending Accounts Receivable 47,000 Sales 698,000

Sales Accounts Receivable Cash

706,000

47,000

55,000698,000

706,000698,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000



Inventory Cash

144,000

110,000

Beginning Inventory $110,000 Ending Inventory 144,000

34,000 34,000

Effect on income statement: None Effect on cash flows: -$34,000 Cash flow out is $34,000 more because the Inventory account increased Deduct 34,000 from net income



Inventory Cash

144,000

110,000


34,000 34,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000 Increase in inventory (34,000)



Beginning Prepaid Expenses $5,000 Ending Prepaid Expenses 1,000

Insurance expense 6,000

Effect on income statement: -$6,000 Effect on cash flows: -$2,000 Cash flow out is $4,000 less than expenses because Prepaid Expenses decreased $4,000 Add $4,000 to net income

Insurance Expense Prepaid Expenses Cash

2,000

1,000

5,0006,000

2,0006,000



Beginning Prepaid Expenses $5,000 Ending Prepaid Expenses 1,000

Insurance expense 6,000

Insurance Expense Prepaid Expenses Cash

2,000

1,000

5,0006,000

2,0006,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000 Increase in inventory (34,000) Decrease in prepaid expenses 4,000



Changes in Current Liabilities

• Increases are added to net income

• Decreases are deducted from net income


Adjustments to Changes in Current Liabilities

– Add $7,000 to net income because cash paid for purchases was $7,000 less than what appears on the income statement ($554,000 - $547,000)

Purchases

Cash Paid to Suppliers

Accounts Payable

Beg. Bal. 43,000

End. Bal. 50,000

554,000

547,000

• Example

– Accounts Payable balance increased by $7,000 ($50,000 - $43,000)



Cost of Goods Sold 520,000

Accounts Payable Cash

50,000

43,000

513,000 513,000

Effect on income statement: -$520,000 Effect on cash flows: -$513,000 Cash flow out is $7,000 less because Accounts Payable decreased Add $7,000 to net income

Beginning Accounts Payable $43,000 Ending Accounts Payable 50,000

Cost of Goods Sold

520,000 520,000



Beginning Accounts Payable $43,000 Ending Accounts Payable 50,000 Cost of Goods Sold 520,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000 Increase in inventory (34,000) Decrease in prepaid expenses 4,000 Increase in accounts payable 7,000

Accounts Payable Cash

50,000

43,000

513,000 513,000

Cost of Goods Sold

520,000 520,000




Cost of goods sold 520,000

Effect on income statement: -$520,000 Effect on cash flows: -$547,000 Cash flow out is $27,000 more than expenses (-$34,000 + $7,000) $34,000 deducted from net income for increase in Inventory($144,000 - $110,000) $7,000 added to net income for increase in Accounts Payable ($50,000 - $43,000)

Cost of Goods Sold

520,000

144,000

110,000520,000

554,000

Accounts PayableInventory Cash

50,000

43,000

547,000

Purchases 554,000

554,000547,000

Relationship of Inventory and Accounts Payable Accounts




Cost of goods sold 520,000

Cost of Goods Sold

520,000

144,000

110,000520,000

554,000

Accounts PayableInventory Cash

50,000

43,000

647,000

Purchases 554,000

554,000647,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000 Increase in inventory (34,000) Decrease in prepaid expenses 4,000 Increase in accounts payable 7,000

Relationship of Inventory and Accounts Payable Accounts


Accrued Expenses Accrued Liabilities

12,000

9,000

Beginning Accrued Liabilities $ 9,000 Ending Accrued Liabilities 12,000

3,000 3,000

Effect on income statement: -$3,000 Effect on cash flows: None Cash flow out is $3,000 less than expenses Add $3,000 to net income



Accrued Expenses Accrued Liabilities

12,000

9,000

Beginning Accrued Liabilities $ 9,000 Ending Accrued Liabilities 12,000

3,000 3,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000 Increase in inventory (34,000) Decrease in prepaid expenses 4,000 Increase in accounts payable 7,000 Increase in accrued liabilities 3,000



Income Taxes Payable Cash

3,000

5,000

Beginning Income Taxes Payable $5,000 Ending Income Taxes Payable 3,000

2,000 2,000

Effect on income statement: None Effect on cash flows: -$2,000 Cash flow out is $2,000 more because Income Taxes Payable decreased Deduct $2,000 from Net Income

Current Liabilities



3,000

5,000

Cash Flows from Operating Activities Net income $16,000 Depreciation expense $37,000 Gain on sale of investments (12,000) Loss on sale of plant assets 3,000 Decrease in accounts receivable 8,000 Increase in inventory (34,000) Decrease in prepaid expenses 4,000 Increase in accounts payable 7,000 Increase in accrued liabilities 3,000 Decrease in income taxes payable (2,000)

Beginning Income Taxes Payable $5,000 Ending Income Taxes Payable 3,000

2,000 2,000


Schedule of Cash Flows from Operating Activities: Indirect Method

Gail Mestas

Insert Exhibit 3, schedule of cash flows form operating activities: indirect method, chapter 14, FA (MNS 14-14 in Galley)


Add to or Deduct from Net Income

Depreciation expense Add Amortization expense Add Depletion expense Add Losses Add Gains Deduct

Effects of Items on the Income Statement That Do Not Affect Cash Flows


Add to Net Income

Deduct from Net Income

Current assets Accounts receivable (net) Decrease Increase Inventory Decrease Increase Prepaid expenses Decrease Increase Current liabilities Accounts payable Increase Decrease Accrued liabilities Increase Decrease Income taxes payable Increase Decrease

Adjustments for Increases and Decreases in Current Assets


Preparing the Statement of Cash Flows: Investing Activities

• Objective 4– Determine cash flows from investing

activities


Cash Flows from Investing Activities

• Analyze increases and decreases in the Investments account to determine effects on Cash account

• Objective– Explain the change in each account balance from

one year to the next

• Focus – Long-term assets (balance sheet)

– Short-term investments (current asset section of the balance sheet)

– Investment gains and losses (income statement)


Sale of investments (which cost $90,000) 102,000

Purchase of investments 78,000

Accounting for Investments

Beginning Investments $127,000 Ending Investments 115,000

Effects on cash flows: Purchase of investment –$78,000 Sale of investment +$102,000


78,000

115,000

127,000

90,000 102,00078,000

12,000

Cash Flows from Investing Activities Purchase of investments ($78,000) Sale of investments 102,000


Plant Assets

• Explain changes in both the asset and related accumulated depreciation accounts– Purchases increase plant assets

– Sales decrease plant assets

• Accumulated depreciation is– Increased by the amount of depreciation expense

– Decreased by the removal of accumulated depreciation associated with plant assets that are sold


Accounting for Plant Assets

Sale of plant assets 5,000

Purchase of plant assets 120,000

Effects on cash flows: Purchase of plant assets –$120,000 Sale of plant assets +$5,000

Loss on SalePlant Assets

120,000

715,000

505,000120,000

10,000


103,000

68,000

2,000 5,000

Beginning Plant Assets $505,000 Ending Plant Assets 715,000

8,000

Cash Flows from Investing Activities Purchase of investments ($78,000) Sale of investments 102,000 Purchase of plant assets (120,000) Sale of plant assets 5,000

37,000


Beginning Plant Assets $505,000 Ending Plant Assets 715,000 Purchase of plant assets 120,000 Sale of plant assets 5,000 Loss on Sale

Plant Assets

120,000505,000120,000

10,000


68,000

2,000 5,000???

8,000

All items affecting the Plant Assets account have not been accounted for

715,000 103,00037,000

Accounting for Plant Assets


???100,000

Issue of bonds in exchange for plant assets $100,000

715,000

505,000120,000

10,000

Cash

100,000

Effects on cash flows: None

Schedule of Noncash Investing and Financing Activities Issue of Bonds Payable for Plant Assets $100,000

Bonds PayablePlant Assets

Accounting for Noncash Investing and Financing Transactions


Cash Flows from Investing Activities Purchase of investments ($78,000) Sale of investments 102,000 Purchase of Plant Assets (120,000) Sale of Plant Assets 5,000

Net cash flows from investing activities (91,000)

Accounting for Cash Flows from Investing Activities


Schedule of Noncash Investing and Financing Activities

Issue of bonds payable for plant assets $100,000

Accounting for Noncash Investing and Financing Transactions


Cash Flows fromFinancing Activities

• Analysis similar to investing activities, including treatment of related gains or losses

• Focus– Short-term borrowings

– Long-term liabilities

– Stockholders’ equity accounts

• Cash dividends from the statement of stockholders’ equity must also be considered


Effects on cash flows: Repayment of bonds -$50,000

Beginning Bonds Payable $245,000 Ending Bonds Payable 295,000 Issue of bonds payable for plant assets 100,000

Repayment of bonds at face value maturity 50,000


295,000

245,000

50,000 50,000

Cash Flows from Financing Activities Repayment of bonds ($50,000)

100,000

Accounting for Cash Flows from Financing Activities


Effects on cash flows: Issue of common stock +$175,000

Beginning Paid-in Capital in Excess of Par, Common 115,000 Ending Paid-in Capital in Excess of Par, Common 189,000

Beginning Common Stock $200,000 Ending Common Stock 276,000

Issue of common stock 175,000

Common Stock Paid-in Capital - Common Cash

189,000

115,000

99,000 175,00076,000

295,000

245,000

Cash Flows from Financing Activities Repayment of bonds ($50,000) Issue of common stock 175,000



Effects on cash flows: Paid dividends -$8,000

Dividends paid 8,000

Beginning Retained Earnings $132,000 Ending Retained Earnings 140,000

Net income 16,000

Income Summary Retained Earnings Cash

8,000

140,000

132,000

16,0008,000

16,000

Cash Flows from Financing Activities Repayment of bonds ($50,000) Issue of common stock 175,000 Dividends paid (8,000)



Treasury Stock Cash

Purchase of treasury stock 25,000

25,000 25,000

Effects on cash flows: Purchase of treasury stock -$25,000

Cash Flows from Financing Activities Repayment of bonds ($50,000) Issue of common stock 175,000 Dividends paid (8,000) Purchase of treasury stock (25,000)



Cash Flows from Financing Activities Repayment of bonds ($50,000) Issue of common stock 175,000 Payment of dividends (8,000) Purchase of treasury stock (25,000)

Net cash flows from financing activities $92,000


Statement of Cash Flows:

Indirect Method

Gail Mestas

Insert Exhibit 4, statement of cash flows: indirect method, chapter 14 , FA (MNS 14-19 in Galley). Fit to page


Discussion

a) As cash flows from operating activitiesb) As cash flows from investing activitiesc) As cash flows from financing activitiesd) In the schedule of noncash investing and

financing transactionse) Not at all

Q. Using the indirect method to prepare the statement of cash flows, tell whether each of the following items would appear


a) As cash flows from operating activitiesb) As cash flows from investing activitiesc) As cash flows from financing activitiesd) In the schedule of noncash investing and financing

transactionse) Not at all

1. Dividends paid2. Cash receipts from sales3. Decrease in accounts receivable4. Sale of plant assets5. Gain on sale of investment6. Issue of stock for plant assets7. Issue of common stock8. Net income

1. c2. e3. a4. b5. a6. d7. c8. a

Discussion (cont’d)

14 statement of cash flows

Education

loans cash outflows

cash equivalents cash

cash available

cash account

cash basis

cash balances

thestatement of cash

operating cash inflows