chapter 6 the statement of cash flows. the purpose of the statement of cash flows

Chapter 6The

Statement ofCash Flows

The Purpose of theStatement of Cash Flows

3

Financial Accounting, 7e Stice/Stice, 2006 © Thomson

The Statement of Cash Flows

Summarizes cash flows for a period of time

– “For the year ended...”

Explains how cash was generated and used

– Reflects transactions already reported in the

•balance sheet

•income statement

4



Particularly useful when net income does not accurately reflect the economic performance of a business:

– Noncash expenses are high– Growth companies use more cash than

expenses imply– Accrual basis accounting assumptions

are stretched to the limit

5



A one-page summary of the results of a company’s operating, investing, and financing activitiesA pro forma SCF

– As a forecasting tool– Whether future cash activities are

consistent and workable

Information Reported onStatement of Cash Flows

7


Cash Equivalents

The SCF explains the changes in cash and cash equivalents during a period

– short-term, highly liquid investments– i.e., treasury bills, commercial paper,

and money market funds

8


Three Categories of Cash Flows

Cash receipts and disbursements are classified into three main categories:

– Operating activities– Investing activities– Financing activities

9


Operating Activities

Includes all transactions relating to a company delivering or producing its goods for sale and providing its services

10


Major Cash Flows:Operating Activities

Cash receipts from:

– Sale of goods or services

– Sale of trading securities

– Interest revenue– Dividend revenue

Cash payments for:– Inventory purchases– Wages and salaries– Taxes– Interest expense– Other expenses (e.g.,

utilities, rent)– Purchase of trading

securities

11


Investing Activities

Includes cash inflows and outflows from changes in noncurrent assets:

– Productive assets– Investment securities– Loans to others

12


Major Cash Flows:Investing Activities

Cash receipts from:– Sale of plant assets– Sale of a business

segment– Sale of nontrading

securities– Collection of

principal on loans

Cash payments for:– Purchase plant

assets– Purchase of

nontrading securities– Making loans to

other entities

13


Financing Activities

Includes obtaining resources from– owners and providing them a return

on their investment– creditors and repaying those

borrowings

14


Major Cash Flows:Financing Activities

Cash receipts from:– Issuance of stock– Borrowing (e.g.,

bonds, notes, mortgages)

Cash payments for:– Cash dividends– Repayment of

loans– Repurchase of

stock (treasury stock)

15


Relationship of the SCF to the

Balance Sheet and Income StatementBalance Sheet Stmt of Cash Flows

Income Statement

Current Assets

Current Liabilities

Revenues

Expenses

Operating

Investing

Financing

Net Change in CashLong-term Assets

Long-term Liabilities

Stockholders’ Equity Net Income

Accts Pay & Accrued LiabilShort-term Loans PayCurrent Portion Long-term

Accrual Adjustments

16


Cash Flow Pattern

Cash from...

Cash flow is typicallyInflow

(positive)Outflow

(negative)

Operations Investing Financing or

17


Cash Flow Pattern

A company’s cash flow pattern is a general reflection of where the company is in its life cycle ...

18


Investing

Financing

Operating

Cash Flow Pattern

Start-Up, High Growth Company

19


Dividends

Investing

Financing

Operating

Cash Flow Pattern

Steady-State Company

20


Dividends

Share Repurchases

Loan Repayment

Investing

Financing

Operating

Cash Flow Pattern

Cash Cow

21


Noncash Investing and Financing Activities

Activities that affect a company’s financial position but do not result in cash flows

Example: Land acquired by issuing stock

These activities should be disclosed separately in a schedule or in the notes to the financial statements

Preparing a SCFA Simple Example

23


Analysis of Transactionsnot a cash

Tx Descript activity Operating Investing Financing1 Sales on account X2 Collections on account 14,000 3 Purchase inven on acct X4 Cost of goods sold X5 Paid accts pay (8,100) 6 Purchase PPE for cash (1,700) 7 Sold PPE 500 8 Repaid long-term debt (200) 9 Issued stock for cash 450

10Recorded depreciation expense X

11 Paid interest on debt (180) 12 Recorded accrued interest X13 Paid misc expenses (3,200) 14 Recorded income tax X15 Paid income tax (440)

Totals 2,080 (1,200) 250

Cash Activity

Statement of Cash Flows

Tx #Cash flows from Operations:

Collections on account 2 14,000$ Payments for inventory 5 (8,100) Payments for misc exp 13 (3,200) Payment for interest 11 (180) Payment for taxes 15 (440) Net Cash Provided by Operations 2,080$

Cash flows from Investing Activities:Sold PP&E 7 500 Purchased PP&E 6 (1,700) Net Cash Used by Investing Activities (1,200)

Cash flows from Investing Activities:Issued Stock 9 450Repaid long-term debt 8 (200) Net Cash Used by Financing Activities 250

Net increase in cash 1,130$ Beginning Cash Balance 300 Ending Cash Balance 1,430$

Silmaril, Inc.Statement of Cash Flows

For the Year Ended December 31, 2005

Same as 12/31/05 balance sheet

Analysis of Other PrimaryFinancial Statement for SCF

26


Alternative ApproachStatement of Cash Flows

Determine cash inflows and outflows through analysis of changes in

– Individual income statement accounts– Individual balance sheet accounts

A Six-step ProcessFor Preparing The SCF

1. Compute cash balance change for the year2. Convert income statement from accrual to cash basis

a. Eliminate non-cash expensesb. Eliminate gains and losses from investing and financing

activitiesc. Adjust revenues and expenses for changes in current assets and

current liabilities

3. Analyze long-term assets to determine investing activities4. Analyze long-term debt and stockholders’ equity to determine

financing activities5. Reconcile total of steps 2, 3, & 4 with step 1; prepare statement6. Disclosure other significant non-cash financing and investing

activities

28


Step #1Silmaril Inc.

Compute the change in the cash balance during the period.

2004 2005 change

Cash 300$ 1,430$ 1,130 Accts Rec 2,500 2,000 (500) Inventory 1,900 1,800 (100)

Silmaril, Inc.Comparative Balance Sheets

December 31

29



Convert the income statement from accrual basis to cash basis.

Income Statement Adjustments

Cash Flows from Operations

Sales $13,500 Cost of Goods Sold (8,000) Misc Expenses (3,200) Interest Expense (200) Income Tax Expense (450) Depreciation Expense (500) Gain on Sale of PPE 100 Net Income $1,250

30



2a) Eliminate noncash expenses

Income Statement Adjustments Cash Flows from

Operations Sales $13,500 Cost of Goods Sold (8,000) Misc Expenses (3,200) Interest Expense (200) Income Tax Expense (450) Depreciation Expense (500) +500 (not a cash flow

item) 0

Gain on Sale of PPE 100 $1,250

31



2b) Eliminate the effects of non-operating activities



Sales $13,500 Cost of Goods Sold (8,000) Misc Expenses (3,200) Interest Expense (200) Income Tax Expense (450) Depreciation Expense (500) +500 (not a cash flow

item) 0

Gain on Sale of PPE 100 -100 (not an operating cash flow item)

0

$1,250

32



2c) Adjust remaining current assets and liabilities from accrual to cash

2004 2005 change

Cash 300$ 1,430$ 1,130 Accts Rec 2,500 2,000 (500) Inventory 1,900 1,800 (100) PPE 4,000 4,500 500 Accum Dep (1,200) (900) 300 Accts Pay (1,700) (1,500) 200 Interest Pay - (20) (20) Taxes Pay (40) (50) (10) Long-Term Debt (2,200) (2,000) 200 Common Stock (1,000) (1,450) (450) Retained Earnings (2,560) (3,810) (1,250)

-$ -$


December 31

33



Completed worksheet Income

Statement Adjustments Cash Flows from

Operations Sales $13,500 +500 (A/R decreased) 14,000 Cost of Goods Sold (8,000) +100 (Inven decrease)

-200 (A/P decrease) (8,100)

Misc Expenses (3,200) (3,200) Interest Expense (200) +20 (Int Pay increase) (180) Income Tax Expense (450) +10 (Inc Tax Pay increase) (440) Depreciation Expense (500) +500 (not a cash flow item) 0 Gain on Sale of PPE 100 -100 (not an operating cash

flow item) 0

$1,250 +830 net adjustment $2,080

34


Reporting Cash Flows From Operations

Two methods– Indirect Method

Used by most companies because it is easy to construct from the balance sheet and income statement

– Direct MethodPreferred by the FASB and many users because it is easy to understand

35


Indirect Method

Net Income + Depreciation Expense ± Changes in balance sheet accounts involving

operating activities Current Assets other than cash Current Liabilites ± Other accounting items = Net cash provided (used) by operating activities

36


Some Rules of Thumb for the Indirect Method

ACCOUNT

Current asset

Current asset

Current liability

Current liability

DIRECTION OF CHANGE

Increase

Decrease

Increase

Decrease

NECESSARY ADJUSTMENT

Subtract the increase

Add the decrease

Add the increase

Subtract the decrease

37


Silmaril Inc.

Cash Flows from Operations: Indirect Method Income

Statement Adjustments Cash Flows from

Operations Sales $13,500 +500 (A/R decreased) 14,000 Cost of Goods Sold (8,000) +100 (Inven decrease)

-200 (A/P decrease) (8,100)


flow item) 0

$1,250 +830 net adjustment $2,080

38


Statement of Cash FlowsDirect Method

Cash received from operating activities - Cash paid for operating activities - Taxes and interest paid (disclose separately) = Net cash provided (used) by operating activities

39


Silmaril Inc.



Sales $13,500 +500 (A/R decreased) 14,000 Cost of Goods Sold (8,000) +100 (Inven decrease)

-200 (A/P decrease) (8,100)


flow item) 0

$1,250 +830 net adjustment $2,080

Cash Flows from Operations: Direct Method

40


Silmaril Inc.Cash from Operations

Direct Method Indirect MethodCash flows from Operations:

Collections on account 14,000$ Payments for inventory (8,100) Payments for misc exp (3,200) Payment for interest (180) Payment for taxes (440) Net Cash Provided by Operations 2,080$

Net Income 1,250$

Add Depreciation Exp 500 Less Gain on Sale of PPE (100) Decrease in Accts Rec 500 Decrease in Inventory 100 Decrease in Accts Pay (200) Increase in Interest Pay 20 Increase in Income Taxes Pay 10 830 Net Cash Provided by Operations 2,080$

41



Analyze long-term assets to identify financing transactions

2004 2005

Cash 300$ 1,430$ Accts Rec 2,500 2,000 Inventory 1,900 1,800 PPE 4,000 4,500 Accum Dep (1,200) (900) Accts Pay (1,700) (1,500) Interest Pay - (20) Taxes Pay (40) (50) Long-Term Debt (2,200) (2,000) Common Stock (1,000) (1,450) Retained Earnings (2,560) (3,810)

-$ -$


December 31

Cash PPEAccum

Dep Gain/LossBeginning Balance 4,000 (1,200) Sold PPE 500 (1,200) 800 100 Purchased PPE (1,700) 1,700 Deprec Expense (500) Ending Balance 4,500 (900)

42



Cash

Long-Term Debt

Common Stock

Retained Earnings

Beginning Balance 2,200 1,000 2,560 Issued Stock 450 450 Repaid long-term debt -200 (200) Net Income 1,250 Dividends paid -

(2,000) (1,450) (3,810)

2004 2005

Cash 300$ 1,430$ Accts Rec 2,500 2,000 Inventory 1,900 1,800 PPE 4,000 4,500 Accum Dep (1,200) (900) Accts Pay (1,700) (1,500) Interest Pay - (20) Taxes Pay (40) (50) Long-Term Debt (2,200) (2,000) Common Stock (1,000) (1,450) Retained Earnings (2,560) (3,810)

-$ -$


December 31 Analyze long-term liabilities and stockholders’ equity to identify financing transactions

Net Income 1,250$

Add Depreciation Exp 500 Less Gain on Sale of PPE (100) Decrease in Accts Rec 500 Decrease in Inventory 100 Decrease in Accts Pay (200) Increase in Interest Pay 20 Increase in Income Taxes Pay 10 830 Net Cash Provided by Operations 2,080$

Cash flows from Investing Activities:Sold PP&E 500 Purchased PP&E (1,700) Net Cash Used by Investing Activities (1,200)

Cash flows from Investing Activities:Issued Stock 450Repaid long-term debt (200) Net Cash Used by Financing Activities 250

Net increase in cash 1,130$ Beginning Cash Balance 300 Ending Cash Balance 1,430$

Silmaril, Inc.Statement of Cash Flows

For the Year Ended December 31, 2005

Silmaril Inc. Step 5SCF Indirect Method

Using Cash FlowInformation to Forecast

45


Using Cash Flow Information To Forecast

Financial PositionThe same six-step process can be used to construct a forecasted statement of cash flows

– Use a projected balance sheet and income statement

The cash flow projection allows a company to plan the timing of new loans, stock issuances, asset acquisitions, etc.

46


Projected cash flow statements allow – Potential lenders to evaluate the debt

repaying ability of debtors– Potential investors to evaluate the

likelihood of receiving cash dividends in the future

Using Cash Flow Information To Forecast

Financial Position

47


In Summary ...

• SCF provides information on cash sources and uses

• SCF describes three types of cash activities

• Cash flow patterns reflect the life cycle stage of the business

• SCF can follow either the indirect or direct format

chapter 6 the statement of cash flows. the purpose of the statement of cash flows

Documents

major cash flows

statement of cash flowsa

loans cash payments

cash equivalentsthe

termdiamond chapter

othersdiamond chapter

entitiesdiamond chapter

workablediamond chapter