chapter 5: cash flow statement

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Prepared by R. E. Harms CMA John Wiley & Sons Canada, Ltd. ©2015 CHAPTER 5 THE STATEMENT OF CASH FLOWS Canadian Edition FINANCIAL ACCOUNTING Understanding

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Page 1: Chapter 5: Cash Flow Statement

Prepared by R. E. Harms CMA John Wiley & Sons Canada, Ltd. ©2015

CHAPTER 5 THE STATEMENT OF CASH FLOWS

Canadian Edition

FINANCIAL ACCOUNTING

Understanding

Page 2: Chapter 5: Cash Flow Statement

Significance of the Cash Flow Statement

¨  Information in the statements enable the user to retrospectively: ¤ Assess company’s ability to generate cash flows from

operations ¤ Evaluate where cash has come from – debt or equity ¤ Assess level and type of capital asset investments ¤ Determine how much cash was used for debt

repayment ¤ Evaluate the distribution of cash dividends

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Page 3: Chapter 5: Cash Flow Statement

Significance of the Cash Flow Statement

¨  Information in the statements enable the user to prospectively: ¤ Estimate the value of the company based on cash flows ¤ Assess the company’s ability to repay debt in the

future ¤ Evaluate the potential for dividend payments in the

future ¤ Estimate the company’s future cash requirements and

capital structure

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Page 4: Chapter 5: Cash Flow Statement

Cash Flow versus Income

¨  The statement of cash flows differs from the income statement because is: ¤ Reflects the cash basis rather than the

accrual basis of accounting ¤ Focuses on more than just the operating

activities – it includes investing and financing activities as well

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Page 5: Chapter 5: Cash Flow Statement

The Cash Flow Statement

¨  Measures the cash flow the company in three categories: ¤ Operating Activities ¤  Investing Activities ¤ Financing Activities

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The Cash Flow Statement

¨  Operating activities ¤  Sale of goods and services to customers ¤ Changes to current assets and current liabilities ¤ All other transactions not covered by financing or investing

activities

¨  Cash flows from operating activities are key because: ¤  They are result of day to day business operations ¤  They are the source for future debt repayment ¤  They are the source for future dividend payments

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Cash Flow Statement

¨  Financing activities ¤ Obtaining and repaying resources from shareholders

and lenders ¤ Examples: shares, bonds, mortgages, notes, dividends

¨  Investing activities ¤  Investment, sale, or disposal of long-term assets ¤ Examples: property, plant, equipment, long-term

marketable securities

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Cash Flow Transactions by Category 8

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Definition of “Cash”

¨  Includes both cash and cash equivalents ¨  Cash includes cash on hand together with demand

deposits ¨  Cash Equivalents include short term, highly liquid

investments, for example: ¤ Money market funds ¤ Short term deposits ¤ Treasury bills

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The Cash Flow Statement

¨  Companies may choose between the direct method and the indirect method

¨  The only difference is how the cash flows from operating activities are determined – total cash flows are the same under both methods

¨  The choice of method has NO effect on cash flows from investing or financing activities

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Page 11: Chapter 5: Cash Flow Statement

Direct vs Indirect Method

¨  Most companies prefer the indirect method for the following reasons: ¤  Simpler to prepare ¤ Uses information available in most accounting systems ¤  Provides a link b/w profit and cash flows from operating

activities

¨  The indirect method is also known as the reconciliation method

¨  Standards setters prefer the direct method; however, most public companies still use the indirect method

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Page 12: Chapter 5: Cash Flow Statement

Preparing the Cash Flow Statement

¨  In order to prepare the cash flow statement, a company requires the following information: ¤ Comparative Statement of Financial Position, for the

current and previous period ¤ Statement of Income for the current period ¤ Any additional relevant information

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Comparative Statement of Financial Position 13

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Statement of Income 14

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Additional Information 15

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Steps for Preparing the CF Statement

¨  Step 1 – Determine the net change in cash during the period ¤ Subtract the balance of cash and cash equivalents at

the beginning of the period from the balance at the end of the period

¨  Step 2 – Read the additional information provided and cross reference it to the related statement of financial position accounts

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Page 17: Chapter 5: Cash Flow Statement

Steps for Preparing the CF Statement

¨  Step 3 – Using the statement of income: ¤  record net income ¤  adjust if for non cash items included in the statement,

such as depreciation / amortizations, ¤ and any items that do not involve operating activities,

such as gains / losses from sale of capital assets and investments

¤ This is the process under the Indirect method

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Steps for Preparing the CF Statement

¨  Step 4 – Determine the net change in cash in each current asset and currently liability account (other than cash and dividends payable) and record the impact of these change on cash

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Steps for Preparing the CF Statement

¨  Step 5 – Determine and record the cash proceeds received from selling and buying capital assets with cash during the year. In our example: ¤ Equipment that originally cost $25,000 and had a net

book value of $5,000 was sold for $8,900 during the year

¨  A T-account may be useful in your analysis

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Steps for Preparing the CF Statement

¨  Reconstruct the transactions in the PPE account

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Equipment

Beginning Balance 62,000 25,000 Cost of Equipment sold

Balance after sale 37,000 Of Equipment

Cost of Equipment 90,000 Purchased

This is the missing amount, which will produce the ending balance

Ending Balance 127,000

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Steps for Preparing the CF Statement

¨  Step 6 – Determine and record the cash proceeds from the sale of shares of other companies (investments) and the cost of any investments in other companies purchased with cash during the year

¨  Step 7 – Determine the amount of cash dividends paid during the year

¨  A T-account can help organize the data

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Steps for Preparing the CF Statement

¨  Reconstruct the transactions in the R/E account

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Retained Earnings

23,750 Beginning Balance 86,000 Net Earnings for 2016

109,750

Dividends Declared 3,200 This is the missing amount, which will produce the ending balance

106,550 Ending Balance

Page 23: Chapter 5: Cash Flow Statement

Steps for Preparing the CF Statement

¨  Reconstruct the transactions in the Dividends Payable account

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Dividends Payable

5,200 Beginning Balance 3,200 Dividends Declared

8,400

Dividends Paid during yr 5,200 This is the missing amount, which will produce the ending balance

3,200 Ending Balance

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Steps for Preparing the CF Statement

¨  Step 8 – Determine and record the cash received from borrowings (new loans or increases to existing loans) made during the year and the amount of cash principal repaid on loans during the year

¨  A T-account can help organize the data

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Page 25: Chapter 5: Cash Flow Statement

Steps for Preparing the CF Statement

¨  Reconstruct the transactions in the Loan Payable account

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Loan Payable

36,000 Beginning Balance

Balance after principal repayments 36,000

This is the missing amount, which will produce the ending balance

7,000 New Borrowings

43,000 Ending Balance

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Steps for Preparing the CF Statement

¨  Step 9 – Determine the cash received from shares issued during the period

¨  Step 10 –Calculate the sum of the cash flows from operating, investing and financing activities. It should reconcile back to the amount in Step 1

¨  Companies are also required to disclose: ¤  Interest paid and received during the period ¤ Dividends paid and received during the period ¤  Income taxes paid during the period

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Statement of Cash Flows 27

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Statement of Cash Flows

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Direct Method

¨  The direct method differs only in the way the operating activities section of the cash flow statement is prepared. The direct method categorizes cash flows by cash receipts and cash payments.

¨  These categories are as follows: ¤  Receipts from customers ¤  Payments to suppliers ¤  Payments to employees ¤  Payment to interest ¤  Payments of income taxes

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Using the Direct Method 30

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Using the Direct Method 31

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Investing / Financing Activities

¨  It is possible to have activities that do NOT appear on the cash flow statement. For example: ¤ Company purchased assets by assuming debt or issuing

shares ¤ Company acquired the shares of another company by

assuming debt or issuing shares rather than paying cash ¤ Company repaid debt by issuing shares rather than paying

debt

¨  Since there is no cash inflow or outflow needs only to be disclosed in the notes to the financial statements

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Interpreting the CF Statement

¨  The longer a company’s cash-to-cash cycle the more pressure placed on cash flows

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Mitigating Cash Flow Challenges

¨  Companies can resolve common cash flow challenges by taking the following measures: ¤ Reduce the rate of growth ¤ Shorten the cash-to-cash cycle ¤  Increase company’s capitalization

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Cash Flow Patterns 35

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Cash Flow Patterns

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Financial Statement Analysis

¨  Cash Flow to Total Liabilities = Cash Flows from Operating Activities

Total Liabilities ¨  This ratio measures the percentage of a company’s

total liabilities that could be met with one year’s operating cash flows

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Danier Leather Example 38

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Financial Statement Analysis

¨  Net Free Cash Flow is a Non-IFRS financial measure, and therefore is not standardized. Used to measure amount of cash generated from operations that is in excess of cash require to maintain the company’s productive capacity

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Danier Leather Example 40

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Copyright © 2015 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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