ch05_the statement of cash flows

7/26/2019 Ch05_The Statement of Cash Flows

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TheStatement ofCash Flows

chapter5

An electronic presentation

by Douglas Cloud

Pepperdine University


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1. Describe the circumstances in which thecash flow statement is a particularly

important companion to the income

statement.

2.Outline the structure of and information

reported in the three main categories of

the cash flow statement: operating,

investing, and financing.

Learning Objectives

Continued


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3.Compute cash flow from operationsusing either the direct or indirect method.

4.Prepare a complete statement of cash

flows and provide the requiredsupplemental disclosures.

5.Understand the differences among cash

flow statements prepared according to

U.S. GAAP, U.K. GAAP, and

international accounting standards.

Learning Objectives

Continued


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Learning Objectives

6.Assess a firms financial strength byanalyzing the relationships among cashflows from operating, investing, and

financing activities and by computingfinancial ratios based on cash flow data.

7.Use knowledge of how the three

primary financial statements tie togetherin order to prepare a forecasted statementof cash flows.


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5What Good Is a Cash FlowStatement?

Does a statement of cashflows tell us anything we

dont already know from

other statements?


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Yes, because there aresituations where net

income does not give us an

accurate picture.


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Also, everything you wantto know about a company

is summarized in this one

statement.

Finally, a statement of cashflows is an excellent

forecasting tool.


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8Structure of the Cash FlowStatement

What is a cash

equivalent?

It is a short-term,

highly liquid

investment.

It must be readily convertible to cash

and it must be so near to maturity that

there is insignificant risks of changes in

value due to changes in interest rate.

f h h l


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CASH

INFLOWS

Cash Inflows

Operating

Activities

Investing

Activities

Financing

Activities

Structure of the Cash FlowStatement


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Operating ActivitiesTransactions andevents that enter into the determination of netincome.

Investing ActivitiesTransactions and

events that involve the purchase and sale ofsecurities, property, plant, equipment, andother assets not generally held for resale, andthe making and collecting of loans.

Financing ActivitiesTransactions andevents whereby resources are obtained fromor repaid to owners and creditors.

Cash Flow Patterns


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Cash Flow Patterns

Over the Life of a Company

Start-up, High-Growth Company

Financing

Investing

Operating


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Cash Flow Patterns


Steady-State Company

Operating

Investing

Financing

Dividends


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Cash Flow Patterns


Cash Cow

Operating

Investing

FinancingDividends

Share Repurchases

Loan Repayment


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Noncash Transactions

Investing and financing activities thatdo not affect cash.

Significant transactions should be

disclosed separately.

These transactions do not affect the

statement of cash flows.

R ti C h F l f


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15Reporting Cash F lows fromOperations

Direct MethodA method of reporting netcash flows from operations that shows cash

receipts and payments for a period of time.

This method is more straight forward.

Indirect MethodA method of reporting net

cash flow from operations that involves

reconciling net income to a cash basis. It

shows how noncash flows affect net income.

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The Direct Method

This method reports directly the majorclasses of operating cash receipts andpayments of an entity during a period.

Accrual-basis revenues and expensesmust be converted to equivalent cashreceipts and payments.

The amount of cash actually collectedor paid is determined.

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Indirect Method

Adjustments for receivables and other

current operating assets. Adjustments for payables and other

current liabilities.

Adjustments for depreciation and othernoncash items.

Adjustments for gains and losses.

The indirect method makes thefollowing adjustments:

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Operating Activi ties

Cash Inflow

Cash receipt of

sales Collection of

receivables

Interest revenue

Dividend revenue

Cash Outflow

Inventory payments Interest payments

Wages

Utilities

Rent

19R l ti hi B t N t


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19Relationship Between NetIncome and Operating Cash Flow

Business engages inoperating activities

Net income

Apply accrualaccounting rules

Undo accrualaccounting to get

back to cash flow

Cash is received and

disbursed

Operating cash flow

20E l f O ti A ti iti


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Sales and Cash Collected from Customers:

Beginning accounts receivable $ 40

+ Sales 150

= Cash available for collection $190 Ending accounts receivable 60

= Cash Collected from Customers $130

Example of Operating ActivitiesSection for the Direct Method



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Cost of Goods Sold and Cash Paid for Inventory:

Ending inventory $ 75

+ Cost of goods sold 80

= Required inventory $155 Beginning inventory 100

= Cash paid for inventory this year $ 55




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Wages Expense and Cash Paid for Wages:

Beginning wages payable $ 7

+ Wages expense 25

= Total obligation to employee $32 Ending wages payable 10

= Cash paid for wages $22


23Adj t t f G i


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23Adjustments for Gainsand Losses

Gains or losses do not represent the casheffect of the transaction.

Adjustment toAccount Net Income

Losses

Gains

These adjustments are made to net income

since the sale of an investment is an investing

activity, not an operating activity.

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Adjustments for Receivables

Changes in accounts directly affectrevenues recorded on an accrual basis.

Account Adjustment toAccount Change Net Income

Accounts Receivable

Accounts Receivable

Inventory

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Adjustments for Payables

Changes in liabilities mean the reverse of

changes in current operating asset accounts.

Account Adjustment toAccount Change Net Income

Accounts Payable

Wages Payable

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Noncash Adjustments

Depreciation and similar noncash items donot affect cash and are not reported on thestatement of cash flows.

Any noncash item that reducesnet incomeshould be added back to net income in theindirect method.

Any noncash item that increases net income

should be subtracted from net income in theindirect method.

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I nvesting Activities

Cash Inflow

Sale of plant assets

Sale of securities,other than trading

securities

Collection ofprincipal on loans

Cash Outflow

Purchase of plant assets

Purchase of securities,

other than trading

securities

Making of loans with

other entities

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F inancing Activi ties

Cash Inflow

Issuance of own

stock Borrowings

Cash Outflow

Dividend payments Repaying principal

on borrowing

Treasury Stockpurchase

29Differences between I ncome and


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29Differences between I ncome and

Cash from Operations

Cash from Net

Company Name Operations Income Difference

General Motors $19,750 $ 4,452 $(15,298 )

Lehman Brothers (14,733 ) 1,775 16,508

Ford Motors 33,764 3,467 (30,297 )

Citigroup 2,673 13,519 10,846

SOURCE: Standard and Poor COMPUTSTAT

Year 2000

(All amounts are in

millions)

30General Format of a


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30General Format of aStatement of Cash F lows

Cash Provided by (Used for):

Operating Activities $XXX

Investing Activities XXX

Financing Activities XXX

Net Increase (Decrease) in Cash $XXX

CashBeginning of Year XXXCashEnd of Year $XXX

31Preparing a


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31Preparing aCash Flow Statement

1. Compute how much the cash balance changedduring the year.2. Convert the income statement from an

accrual-basis to a cash-basis summary of

operations.a.Eliminate expenses that do not involve the

outflow of cash, such as depreciation.

b.Eliminate gains and losses associated withinvesting or financing activities.

c. Adjust for changes in the balances of

current assets and current liabilities.

32Preparing a


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3. Analyze the long-term assets to identify thecash flow effects of investing activities.4. Analyze the long-term debt and stockholders

equity account to determine the cash flow

effects of any financing transactions.5. Make sure that the total new cash flow from

operating, investing, and financing activitiesis equal to the net increase or decrease in cash

as computed in Step 1, then prepare a formalstatement.

6. Prepare supplement disclosure of significant

noncash transactions.

Preparing aCash Flow Statement

33Example: Comparative


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33Example: ComparativeBalance Sheet

Accounts PayableLong-term Notes Payable

Common Stock

Retained Earnings

Total Liabilities and Equity

2005 2004Assets

Cash and Cash EquivalentsAccounts Receivable

Inventory

Equipment

Accumulated Depreciation

Total Assets

Liabilities and Equity

$ 82180

170

200

(72)

$560

$100100

250

110

$560

$ 40150

200

140

(60)

$470

$ 8050

250

90

$470

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Income Statement, 2005

SalesExpenses:

Cost of goods sold

Selling and general expense

DepreciationInterest expense

Operating income

Gain from sale of equipmentIncome before income taxes

Income tax expense

Net income

$345

$120

58

202 (200 )

$145

5$140

30

$110

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Cash 2004........................... $ 40Cash 2005........................... 82

Change in Cash................... $ 42

Determine change in cash and cash

equivalents:

Step 1

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Convert from an accrual-basis to a cash-

basis summary of operations:

Step 2

EXAMPLE: Eliminate depreciation

expense, $44, because it does

not require the use of cash.

Cash provided by operations 44Accumulated Depreciation 44

(t-account or work sheet entry)

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Convert from an accrual-basis to a cash-

basis summary of operations:

Step 2

EXAMPLE: Eliminate the $5 gain fromselling equipment.

Cash 33

Accumulated Depreciation 32Equipment 60

Gain on Sale of Equipment 5

Add back $5 to cash

provided by operations.

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Analyze the long-term assets to identify the

ash flow effects of investing activities.

Step 3

Expenditures for Property, Plant, and Equipment:

Beginning equipment $140 Equipment sold during the year 60

= 80

Ending equipment 200= Expenditures for equipment during

year $ 120

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Analyze the long-term debt andstockholders equity accounts to determine

the cash flow effects of any financing

transactions:

Step 4

Expenditures for Long-Term Debt:

Beginning L-T Notes Payable balance $ 50

Notes reacquired during the year 0

= 50

Ending L-T Notes Payable balance 100

= L-T Notes Payable issued during year 50

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Analyze the long-term debt andstockholders equity accounts to determine

the cash flow effects of any financing

transactions:

Step 4

Payment of Dividends:

Beginning Retained Earnings balance $ 90

+ Net income 110

= 200

Ending Retained Earnings balance 110

= Dividends paid 90

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S d 6


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Steps 5 and 6

Steps 5 and 6 relateto actually preparing

the formal and

supplementarystatements.

42Operating Activities Section:


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Cash Flows from Operating Activities:Net income $110

Adjustments:

Depreciation expense 44Gain on sale of equipment (5 )

Increase in accounts receivable (30 )

Decrease in inventory 30

Increase in accounts payable 20Net Cash Provided by Operating

Activities $169

Operating Activities Section:Indirect Method

Continued

Operating Activities Section:

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Cash Flows from Operating Activities:Cash Collected from Customers $414

Cash Payments for:

Inventory (155 )Selling & General Expenses (58 )

Interest (2 )

Income Taxes (30 )

(245 )Net Cash Provided by Operating

Activities $169

Operating Activities Section:Direct Method

Continued

44Operating Activities Section:


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The investing and

financing sections are the

same whether the direct or

indirect approach is used.

Operating Activities Section:Direct Method

45Investing and Financing


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Investing and FinancingActivities Sections

Cash Flows from Investing Activities:

Proceeds from sale of equipment $ 33

Purchase of equipment (120 )

Net cash provided by investing

activities (87 )Cash Flows from Financing Activities:

Issuance of long-term notes payable 50

Payment of cash dividends (90 )

Net cash used for financing activities (40 )Net increase in cash 42

Cash, January 1, 2005 40

Cash, December 31, 2005 82

46Investing and Financing


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Investing and FinancingActivities Sections

Cash Flows from Investing Activities:

Proceeds from sale of equipment $ 33

Purchase of equipment (120 )

Net cash provided by investing

activities (87 )Cash Flows from Financing Activities:

Issuance of long-term notes payable 50

Payment of cash dividends (90 )

Net cash used for financing activities (40 )Net increase in cash 42

Cash, January 1, 2005 40

Cash, December 31, 2005 82

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Q i k R i


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Which of the following items would be listedunder Cash Provided by Investing Activities?

Paid cash dividend

Issued preferred stock

Sold merchandise for

cash

Sold equipment at

book value

Quick Review

Click the bulls nose to skip Quick Review

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Q i k R i


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Which of the following items would be shown

under Cash Provided by Operating Activities?

Issued bonds to finance

new construction

Purchased treasury stock

Paid the weekly payroll

Declared and paid a cash

dividend

Quick Review

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Q i k R i


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Which of the following items would be shown

under Cash Provided by Financing Activities?

Payment of a cash dividend

Recorded depreciation for theperiod

Received cash on account

from a customerPayment of cash to acquireland

Quick Review

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Which of the following statement is true

concerning preparing the statement of cash

flows using the indirect method?A loss from the sale of equipment is added

to net income under the cash provided by

operating activities category.

A gain on sale of land is an investing activity

because a noncurrent asset is involved.

Issuing common stock to purchase land is

both a financing activity and an investingactivity.

An increase inAccounts Payable results in a

decrease in the adjusted cash-basis net income.

51I nternational Cash


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I nternational Cash

F low Statements

In 1987, the United States

led the world concerning

the statement of cash flows

by issuing SFAS No. 95.



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I nternational Cash

F low Statements

Interest and dividends received can be classified as

either operating or investing.

Interest and dividends paid can be classified as

operating or investing.

Income taxes will be classified as operating unless

specifically related to financing or investing

transactions.

In 1992, the IASC issued I AS 7which closelymatched the provisions of SAFS No. 7. The

international standard was more flexible in

classification of certain transactions.



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In 1991, the United

Kingdom issued

FRS 1. It specified

eight categories forclassifying cash

flows.

I nternational Cash

F low Statements

Operating activities Returns on investments and

servicing of finance

Taxation

Capital expenditures andfinancial investment

Acquisition and disposal

Equity dividend paid

Management of liquid

resources

Financing

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A i F i i l St th


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Assessing F inancial Strength

Financial strength isa function of

Liquidity

ProfitabilityGrowth potential

Risk

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A i F i i l St th


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Cash flow-to-net income

Cash from operations

Net income

o Measure of earnings quality

o Tends to be greater than 1

o Should remain fairly stablefor the years for a specific

company

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A i F i i l St th


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Cash flow adequacy

Cash from operations

Net income

o Measures relationship between investment spending

and cash generated by operations

o Indicate a companys attitude towards reinvestment

in long-lived production assetso When ratio is small it indicates that cash flows from

operations fall short of funding growth

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A i F i i l St th


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Cash times interest earned

Cash from operations + Interest paid + Taxes paid

Interest expense

o Measures ability to service

debt

o Generally, a higher ratio

indicates more solvency

58Forecasted Statement of


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o ecasted State e t oCash F lows

Six Steps1. Compute the change in cash.

2. Convert the income statement

from an accrual to cash basis.3. Analyze the long-term asset

accounts.

4. Analyze the long-term debt and

stockholders equity.5. Prepare the forecasted

statement of cash flows.

6. Disclose noncash activities.

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The End

chapter 5

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