15 statement of cash flows

7/29/2019 15 Statement of Cash Flows

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Learning Objectives

Power Notes

1. Purpose of the Statement of Cash Flows2. Reporting Cash Flows

3. Statement of Cash Flows The Indirect Method

4. Statement of Cash Flows The Direct Method

5. Financial Analysis and Interpretation

Chapter15

C15

Statement of Cash Flows


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Cash Flow Basics Statement of Cash Flows Two Methods

Changes in Current Accounts

Statement of Cash Flows Indirect Method

Statement of Cash Flows Direct Method Free Cash Flow

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Power NotesChapter15



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Reporting Cash Flows

1. Operating activitiestransactions that affectnet income.

2. Investing activitiestransactions that affectnoncurrent assets.

3. Financing activitiestransactions that affectequity and debt of the entity.

The statement of cash flows reports a firms majorcash inflows and outflows for a period. Cash flowsare reported by three types of activities.


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Cash Flows

Increases in Cash Decreases in Cash

Cash


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Cash Flows

Increases in Cash

(receipts fromrevenues)

Decreases in Cash

Operating

Cash


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Cash Flows

Increases in Cash


(payments forexpenses)

Decreases in Cash

Operating Operating

Cash


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Cash Flows

Increases in Cash



(receipts from sales ofnoncurrent assets)

Decreases in Cash

Operating

Investing

Operating

Cash


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Cash Flows

Increases in Cash




(payments for aquiringnoncurrent assets)

Decreases in Cash

Operating

Investing

Operating

InvestingCash


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Cash Flows

Increases in Cash




(receipts from issuingequity and debt securities)


Decreases in Cash

Operating

Investing

Financing

Operating

InvestingCash


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Cash Flows

Increases in Cash


(payments for dividends, andredemption of debt securities)



(receipts from issuingequity and debt securities)


Decreases in Cash

Operating

Investing

Financing

Operating

Investing

Financing

Cash


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Cash Flows Operating Activities

Typical cash inflows Typical cash outflows

What are someof the typicalcash inflowsfrom operatingactivities?


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Interest Revenue

Sales of goodsand services

Dividend Revenue

What are someof the typicalcash outflowsfrom operatingactivities?


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Sales of goodsand services

Merchandisepurchases

Payments ofwages & other

expenses

Tax payments

Interest Revenue

Dividend Revenue


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Cash Flows Investing Activities


What are someof the typicalcash inflowsfrom investingactivities?


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Sales of fixed assetsand other long-term

investments

Sale of marketablesecurities andinvestments

What are someof the typicalcash outflowsfrom investingactivities?


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Sales of fixed assetsand other long-term

investments

Sale of marketablesecurities andinvestments

Purchase of fixedassets and other long-

term investments

Purchase ofmarketable securities

and investments


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Cash Flows Financing Activities


What are someof the typicalcash inflowsfrom financingactivities?


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Sales (issuance)of stock

Sale (issuance) ofbonds and other

money market debt

Borrowing from banks

and other lendinginstitutions

What are someof the typicalcash outflowsfrom financingactivities?


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Sales (issuance)of stock

Sale (issuance) ofbonds and other

money market debt

Purchase oftreasury stock

Repayment andredemption of debt

(bonds, notes, other)

Payment of cashdividends

Borrowing from banks

and other lendinginstitutions


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1. Generate cash flow from operations.

2. Maintain and expand operating capacity.3. Pay dividends.

4. Pay debts, including interest, when due.

5. Generate future profits.

The primary attention is the flow of cash ratherthan net income.

The statement of cash flows is invaluable inassessing the capacity of a firm to achieve goalssuch as:


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Preparing the Statement of Cash Flows

Net cash flows from operating activities will bethe difference between the operating cashreceipts and operating cash payments.

Net cash flows from operating activities isdetermined by adjusting the accrual net income

from operations to reflect a cash-based net incomefrom operations.

Direct Method

Indirect Method


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Advantages of Using the Direct Method

1. Reports the sources and uses of operatingcash receipts and payments.

2. Is easier to understand for many investors.3. Recommended by the Financial Accounting

Standards Board (FASB).Note: The total amount of net cash flow fromoperating activities will be the same for bothdirect and indirect methods.

Investing and Financing activities sections willbe identical for both methods.


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Advantages of Using the Indirect Method

1. Focuses on the differences between netincome and net cash flow from operations.

2. Reveals the relationship between the incomestatement, the balance sheet, and thestatement of cash flows.

3. Less costly to prepare.

4. Must be prepared as a supplemental reporteven if the direct method is used.

5. 98 percent of companies surveyed use theindirect method.


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Cash flows from operating activities:

Cash flows from investing activities:

Cash flows from financing activities:

NetSolutionsStatement of Cash Flows Direct MethodFor the Month Ended November 30, 2002

Cash received from customers $ 7,500Deduct cash payments for expenses

and payment to creditors 4,600

Net cash flow from operating activities $ 2,900

Cash payments for acquiring land (10,000)

Cash received as owners investment $15,000

Deduct cash withdrawal by owner 2,000Net cash flow from financing activities 13,000

Net cash flow and ending cash balance $ 5,900


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Cash flows from investing activities:

Cash flows from financing activities:

Net income, per income statement $ 3,050Add increase in accounts payable 400Deduct increase in supplies (550)


Cash payments for acquiring of land (10,000)

Cash received as owners investment $15,000

Deduct cash withdrawal by owner 2,000Net cash flow from financing activities 13,000

Net cash flow and ending cash balance $ 5,900

NetSolutionsStatement of Cash Flows Indirect MethodFor the Month Ended November 30, 2002


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and payment to creditors 4,600Net cash flow from operating activities $ 2,900

Net income, per income statement $ 3,050Add increase in accounts payable 400Deduct increase in supplies (550)Net cash flow from operating activities $ 2,900


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and payment to creditors 4,600Net cash flow from operating activities $ 2,900

Net income, per income statement $ 3,050Add increase in accounts payable 400Deduct increase in supplies (550)Net cash flow from operating activities $ 2,900


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Cash Relationships and Cash Flows

CashLiabilities

Stockholders

Equity

Balance Sheet

NoncashAssets

Assets = Liabilities + Stockholders Equity

Cash + Noncash Assets = Liabilities + Stockholders Equity

Cash = Liabilities + Stockholders Equity Noncash Assets


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CashLiabilities

Stockholders

Equity

Balance Sheet

NoncashAssets






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CashLiabilities

Stockholders

Equity

Balance Sheet

NoncashAssets

The cash flows are determined by analyzingliabilities, stockholders equity, and noncash assets.




1 2 3

1

2

3



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Determine the debit or credit change of each item above.


Change

Accounts 2003 2002 Debit CreditTrade receivables (net) $74,000 $65,000

Inventories 172,000 180,000

Accounts payable (mdse.) 43,500 46,700

Accrued expenses payable 26,500 24,300Income taxes payable 7,900 8,400

9,000

8,000

3,200

2,200500


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Change





9,000

8,000

3,200

2,200500

These debit changes are subtracted from net income in the

operating activities section of the statement of cash flows.Think of these debits as deductions from net income in arrivingat net cash flow from operations.


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Change





9,000

8,000

3,200

2,200500

These credit changes are added to net income in the operating

activities section of the statement of cash flows.Think of these credits as additions to net income in arriving atnet cash flow from operations.


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Operating Activities Indirect Method

Start with the accrual basis net incomeshown on the income statement.

Net income, per income statement $108,000Depreciation $ 7,000Decrease in inventories 8,000Increase in accrued expenses 2,200 17,200

$125,200

Increase in accounts receivables $ 9,000Decrease in accounts payable 3,200Decrease in income taxes payable 500Gain on sale of land 12,000 24,700

Net cash flow from operating activities $100,500

Deduct:

Add:


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Because depreciation expense reduced net income but did notrequire an outflow of cash, it is added back to net income.


$125,200



Deduct:

Add:


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These represent credit changes in the current accounts. Thinkof these credits as additional income from a cash perspective.Why do these represent an increased cash flow?


$125,200



Deduct:

Add:


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These represent debit changes in the current accounts. Thinkof these debits as additional expense from a cash perspective.Why do these represent a reduced cash flow?


$125,200



Deduct:

Add:


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This gain was included in net income but did not represent anoperating cash flow. The related cash inflow from the sale isreported in the cash flows from investing activities section.


$125,200



Deduct:

Add:


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These changes in current accounts were used to preparethe statement of cash flows with the indirect method.They will also be used for the direct method that follows.


Change





9,000

8,000

3,200

2,200500


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Rundell Inc.Income Statement

For the Year Ended December 31, 2003 Cash Basis

Sales $1,180,000Cost of merchandise sold 790,000Gross profit $ 390,000Operating expenses:

Depreciation expense $ 7,000

Other operating expenses 196,000Total operating expenses 203,000

Income from operations $ 187,000Other income:

Gain on sale of land $12,000

Other expense:Interest expense 8,000 4,000Income before income tax $ 191,000Income tax 83,000Net income $ 108,000This is an accrual basis income statement.The direct method of reporting cash flows willessentially convert this to a cash basis statement.


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Sales $960,000Cost of merchandise sold 580,000Gross profit $380,000Operating expenses:



Income from operations $102,000Other income:

Gain on sale of investments $30,000Other expense:

Interest expense 14,000 16,000Income before income tax $118,000Income tax 27,500Net income $ 90,500

Debit Credit

Sales 960,000

Receivables 9,000

Cash

ChangesCash collectedfrom customers

Note: All income statement accountbalances are zero at the beginningof a period. Therefore, the balanceshown represents the amount ofchange during the period.


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Sales $1,180,000Cost of merchandise sold 790,000Gross profit $390,000Operating expenses:




Gain on sale of land $12,000Other expense:

Interest expense 8,000 4,000Income before income tax $ 191,000Income tax 83,000Net income $ 108,000

Debit Credit

Sales 1,180,000

Receivables 9,000

Cash 1,171,000


Note: The changes in the current balance sheetaccounts are determined by comparing thebeginning and ending balances. Receivablesincreased by $9,000 during the period.


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Sales $1,180,000 $1,171,000Cost of merchandise sold 790,000Gross profit $390,000Operating expenses:






Debit Credit

Sales 1,180,000

Receivables 9,000

Cash 1,171,000


The increase in receivablesrepresents a reduction in cash inflowrelative to the accrual revenuereported on the income statement.


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Sales $1,180,000 $1,171,000Cost of merchandise sold 790,000Gross profit $390,000Operating expenses:






Debit Credit

Cost of mdse. sold 790,000Inventories 8,000

Accounts payable 3,200

Cash

ChangesCash payments for

merchandise


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Sales $1,180,000 $1,171,000Cost of merchandise sold 790,000 785,200Gross profit $390,000Operating expenses:






Debit Credit



Cash 785,200


merchandise


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Sales $1,180,000 $1,171,000Cost of merchandise sold 790,000 785,200Gross profit $390,000Operating expenses:


Other operating expenses 196,000Total operating expenses 203,000Income from operations $187,000Other income:



Debit Credit



Cash 785,200


merchandise

A decrease in inventories (creditchange) and an decrease in accountspayable (debit change) have theopposite effects.


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Sales $1,180,000 $1,171,000Cost of merchandise sold 790,000 (785,200)Gross profit $ 390,000Operating expenses:





Debit Credit

Depr. expense 7,000

Accum. depreciation 7,000

ChangesDepreciation


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Depreciation expense $ 7,000 0




Debit Credit

Depr. expense 7,000

Accum. depreciation 7,000

ChangesDepreciation

There is no cash flow fordepreciation expense.


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ChangesDebit Credit

Operating expenses 196,000

Accrued expenses 2,200Cash

ChangesCash payments foroperating expenses


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Other operating expenses 196,000 (193,800)Total operating expenses 203,000Income from operations $187,000Other income:



ChangesDebit Credit

Operating expenses 196,000

Accrued expenses 2,200Cash 193,800

ChangesCash payments foroperating expenses


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Sales $1,180,000 $1,171,000Cost of merchandise sold 790,000 (785,200)Gross profit $390,000Operating expenses:



Gain on sale of land $12,000 0Other expense:


Debit Credit

Cash 72,000

Investments 60,000

Gain on sale of invest. 12,000

ChangesGain on sale ofinvestments


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Debit Credit

Cash 72,000

Investments 60,000



Why isnt the cash inflowof $72,000 shown here?


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Debit Credit

Cash 72,000

Investments 60,000



The cash inflow of $72,000will be shown in theinvesting section of thestatement of cash flows.


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Debit Credit

Interest expense 8,000

Cash

ChangesCash paid forinterest expense


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Interest expense 8,000 4,000 (8,000)Income before income tax $ 191,000Income tax 83,000Net income $ 108,000

Debit Credit

Interest expense 8,000

Cash 8,000

ChangesCash paid forinterest expense

There is no interest payableaccount at the end of the year.


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Interest expense 8,000 4,000 (8,000)Income before income tax $ 191,000Income tax 83,000Net income $ 108,000

Debit Credit

Income tax expense 83,000

Income tax payable 500

Cash

ChangesCash paid forincome taxes


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Interest expense 8,000 4,000 (8,000)Income before income tax $ 191,000Income tax 83,000 (83,500)Net income $ 108,000

Debit Credit

Income tax expense 83,000

Income tax payable 500

Cash 83,500

ChangesCash paid forincome taxes


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Other operating expenses 196,000 (193,800)Total operating expenses 203,000Income from operations $ 187,000Other income:


Interest expense 8,000 4,000 (8,000)Income before income tax $ 191,000Income tax 83,000 (83,500)Net income $ 108,000 $ 100,500


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Two different views

of income from

operations


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Accrual

Basis

$ 108,000

Two different views

of income from

operations

Cash

Basis

$ 100,500

O ti A ti iti Di t M th d


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Operating Activities Direct Method

Cash inflows:Cash received from customers $1,171,000

Cash outflows:

Cash payments for merchandise $785,200

Cash payments for operating expenses 193,800

Cash payments for interest 8,000

Cash payments for income tax 83,500 1,070,500



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Financial Analysis and Interpretation

Free Cash Flow

Use: To measure operating cash flow availablefor corporate purposes after providingsufficient fixed asset additions to maintaincurrent productive capacity and dividends.

Cash flow from operations $1,400,000Less: Cash invested in fixed

assets to maintain capacity (450,000)

Less: Cash used for dividends (100,000)Free cash flow $ 850,000


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15 statement of cash flows

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