reporting the statement of cash flows

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin

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Reporting the Statement of Cash Flows

Chapter

1616


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Learning objectivesLearning objectives

1. Basics of Cash flow reporting

2. Cash flow from operating

3. Cash flow from investing

4. Cash flow from financing

5. Interpretation of Statement of Cash flow

6. Decision analysis: Cash flow on total assets


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How does a company obtain its

cash?

How does a company obtain its

cash?

Where does a company spend its

cash?

Where does a company spend its

cash?

What explains the change in the cash

balance?

What explains the change in the cash

balance?

1. Basics of Cash flow reporting - Purpose of the Statement of Cash Flows

1. Basics of Cash flow reporting - Purpose of the Statement of Cash Flows


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How did the business fund its

operations?

How did the business fund its

operations?

Did the business borrow any funds or

repay any loans?

Did the business borrow any funds or

repay any loans?

Does the business have sufficient cash to pay its debts as

they mature?

Does the business have sufficient cash to pay its debts as

they mature?

Did the business make any dividend

payments?

Did the business make any dividend

payments?

1. Basics of Cash flow reporting - Importance of Cash Flows

1. Basics of Cash flow reporting - Importance of Cash Flows


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CashCashCurrency

Cash Equivalents

Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by

interest rate changes.

Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by

interest rate changes.

1. Basics of Cash flow reporting - Measurement of Cash Flows

1. Basics of Cash flow reporting - Measurement of Cash Flows


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The Statement of Cash Flows includes the following three sections:

Operating Activities Investing ActivitiesFinancing Activities

1. Basics of Cash flow reporting - Classifying Cash Flows

1. Basics of Cash flow reporting - Classifying Cash Flows


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Outflows Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other.

Outflows Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other.

Inflows Receipts from customers. Cash dividends received. Interest from borrowers. Other.

Inflows Receipts from customers. Cash dividends received. Interest from borrowers. Other.

Operating ActivitiesOperating Activities


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Outflows Purchasing long-term

productive assets. Purchasing equity

investments. Purchasing debt investments. Other.

Outflows Purchasing long-term

productive assets. Purchasing equity

investments. Purchasing debt investments. Other.

Inflows Selling long-term productive

assets. Selling equity investments. Collecting principal on loans. Other.

Inflows Selling long-term productive

assets. Selling equity investments. Collecting principal on loans. Other.

Investing ActivitiesInvesting Activities


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Outflows Pay dividends. Purchasing treasury stock Repaying cash loans. Paying owners’ withdrawals.

Outflows Pay dividends. Purchasing treasury stock Repaying cash loans. Paying owners’ withdrawals.

Inflows Issuing its own equity

securities. Issuing bonds and notes. Issuing short- and long-term

liabilities.

Inflows Issuing its own equity

securities. Issuing bonds and notes. Issuing short- and long-term

liabilities.

Financing ActivitiesFinancing Activities


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Items requiring separate disclosure include:

Retirement of debt by issuing equity securities.

Conversion of preferred stock to common stock.

Leasing of assets in a capital lease transaction.

Items requiring separate disclosure include:

Retirement of debt by issuing equity securities.

Conversion of preferred stock to common stock.

Leasing of assets in a capital lease transaction.

1. Basics of Cash flow reporting - Noncash Investing and Financing

1. Basics of Cash flow reporting - Noncash Investing and Financing


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Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites $ #####Cash flows from investing activities: [List of individual inflows and outflows] Net cash provided (used) by investing activites #####Cash flows from financing activities: [List of individual inflows and outflows] Net cash provided (used) by financing activites #####Net increase (decrease) in cash $ #####Cash (and equivalents) balance at beginning of period #####Cash (and equivalents) balance at end of period $ #####

Company NameStatement of Cash FlowsFor Period Ended Date

1. Basics of Cash flow reporting - Format of SCF

1. Basics of Cash flow reporting - Format of SCF


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Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites $ #####Cash flows from investing activities: [List of individual inflows and outflows] Net cash provided (used) by investing activites #####Cash flows from financing activities: [List of individual inflows and outflows] Net cash provided (used) by financing activites #####Net increase (decrease) in cash $ #####Cash (and equivalents) balance at beginning of period #####Cash (and equivalents) balance at end of period $ #####

Company NameStatement of Cash FlowsFor Period Ended Date

There are two acceptable methods to determine Cash Flows from Operating Activities:

Direct Method

Indirect Method

2. Cash flow from Operating - Two methods

2. Cash flow from Operating - Two methods


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Let’s look at the Direct Method for preparing

the Cash Flows from Operating

Activities section.


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Analyzing the Cash AccountAnalyzing the Cash Account

Balance, Jan. 1, 2005 12,000 Payments for merchandise 319,000

Receipts from customers 570,000 Payments for wages & other operat. Exp. 218,000

Receipts from sale of plant assets 12,000 Payments for interest 8,000

Receipts from stock issuance 15,000 Payments for taxes 5,000

Payments for equipment 10,000

Payments for bond retirement 18,000

Payments for dividends 14,000

Balance, Dec. 31, 2005 17,000

Cash

Let’s use this Cash account to prepare B&G Company’s Statement of Cash

Flows under the Direct Method.


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Cash flows from operating activities Cash received from customers 570,000$

Cash paid for merchandise (319,000) Cash paid for wages & other operat. exp. (218,000) Cash paid for interest (8,000) Cash paid for taxes (5,000)

Net cash provided by operating activities 20,000 Cash flows from investing activities

Proceeds from sale of plant assets 12,000

Purchase of equipment (10,000) Net cash used by investing activities 2,000 Cash flows from financing activities

Proceeds from issuance of common stock 15,000 Redemption of bonds (18,000) Payment of dividends (14,000)

Net cash used by financing activities (17,000) Net increase in cash 5,000 Cash, January 1, 2005 12,000 Cash, December 31, 2005 17,000$

B&G CompanyStatement of Cash Flows

For the Year Ended December 31, 2005


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Let’s look at the Indirect Method

for preparing the Cash Flows from Operating

Activities section.


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Net Income

Net Income

Cash Flows from Operating

Activities


Activities

97.5% of all companies use the indirect method.97.5% of all companies use the indirect method.

Changes in current assets and current liabilities.

Changes in current assets and current liabilities.

+ Losses and – Gains from Non-

operating activities

+ Losses and – Gains from Non-

operating activities

+ Noncash expenses such as

depreciation and amortization.

+ Noncash expenses such as

depreciation and amortization.

2. Cash Flow from Operating - Indirect Method 2. Cash Flow from Operating - Indirect Method


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Use this table when adjusting Net Income to Operating Cash Flows.

Indirect Method of Reporting Operating Cash FlowsIndirect Method of Reporting Operating Cash Flows


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East, Inc. reports $125,000 net income for the year ended December 31, 2005.

Accounts Receivable increased by $7,500 during the year and Accounts Payable

increased by $10,000.

During 2005, East reported $12,500 of Depreciation Expense.

East, Inc. reports $125,000 net income for the year ended December 31, 2005.

Accounts Receivable increased by $7,500 during the year and Accounts Payable

increased by $10,000.

During 2005, East reported $12,500 of Depreciation Expense.

What is East, Inc.’s Operating Cash Flow for 2005?

Indirect MethodExampleIndirect MethodExample


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Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

Net income 125,000$

Deduct: Increase in accounts receivable


For the indirect method, start with

net income.

For the indirect method, start with

net income.



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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable


Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable


Add noncash expenses such as

depreciation, depletion,

amortization, or bad debt expense.

Add noncash expenses such as

depreciation, depletion,

amortization, or bad debt expense.



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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)


Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)




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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities



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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$


If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.


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Let’s prepare a Statement of

Cash Flows for B&G Company

using the Indirect Method.


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Additional Information for 2005:• Net income was $38,000.a. The accounts payable balances result from

merchandise inventory purchases. b. Purchased plant assets costing $70,000 by

paying $10,000 cash and issuing $60,000 of bonds payable.

c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.

d. Received cash of $15,000 from issuing 3,000 shares of common stock.

e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain.

f. Cash dividends declared and paid were $14,000.

Additional Information for 2005:• Net income was $38,000.a. The accounts payable balances result from

merchandise inventory purchases. b. Purchased plant assets costing $70,000 by

paying $10,000 cash and issuing $60,000 of bonds payable.






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Cash flows from operating activitiesNet income 38,000$

Adjustments to accrual-basis net income:



Add noncash expenses and

losses.

Subtract noncash revenues and gains.

Add noncash expenses and

losses.

Subtract noncash revenues and gains.

Start with accrual-basis net income.

Start with accrual-basis net income.

Then, analyze the changes in current assets and current

liabilities.

Then, analyze the changes in current assets and current

liabilities.


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Adjustments to accrual-basis net income: Depreciation expense 24,000$

Increase in accounts receivable (20,000) Increase in inventory (14,000) Increase in prepaid expenses (2,000) Decrease in accounts payable (5,000) Decrease in interest payable (1,000) Increase in income taxes payable 10,000 Loss on sale of plant assets 6,000 Gain on retirement of bonds (16,000) Total adjustments (18,000)

Net cash provided by operating activities 20,000




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Cash flows from operating activities Cash received from customers 570,000$

Cash paid for merchandise (319,000) Cash paid for wages & other operat. exp. (218,000) Cash paid for interest (8,000) Cash paid for taxes (5,000)

Net cash provided by operating activities 20,000



2. Cash Flow from operation - reconciliation with direct method2. Cash Flow from operation - reconciliation with direct method


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Cash received from customer Vs. Accounts receivable Cash received from customer Vs. Accounts receivable

Accounts Receivable

Beg Bal: 40,000

End Bal: 60,000

Sales 590,000 Cash receipts 570,000

Increase in A/R balance from 40,000 to 60,000 indicates that the company collects $20,000 less cash from customer than is reported in sales, i.e. Cash received from customer $570,000


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Purchase Vs. Merchandise InventoryPurchase Vs. Merchandise Inventory

Merchandise inventory

Beg Bal: 70,000

End Bal: 84,000

Purchases 314,000 Cost of goods sold 300,000

Increase in merchandise inventory balance from 70,000 to 84,000 indicates that the company has $14,000 higher purchase than cost of goods sold, i.e. Purchase during the period $314,000 (not the cash paid to supplier)


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Prepaid expensePrepaid expense

Beg Bal 4,000

Prepaid expense

End Bal 6,000

Cash payment 218,000Wages and other operating exp 216,000

Increase in prepaid expense balance from 4,000 to 6,000 indicates the company pay $2,000 less cash than operating expense, i.e. Cash payment for wage and other operating expense $218,000


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Cash paid for merchandise Vs. Accounts payableCash paid for merchandise Vs. Accounts payable

The decrease in A/P balance from 40,000 to 35,000 indicates that company pay $5,000 more cash than purchases for the period, i.e. Cash paid for merchandise $319,000

Accounts payable

Cash payment

319,000

Beg Bal 40,000

Purchases 314,000

End Bal 35,000


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Interest payableInterest payable

The decrease in interest payable balance from 4,000 to 3,000 indicates that company pay $1,000 more cash than interest expense, i.e. Cash paid for interest $8,000

Interest payable

Cash paid for interest 8,000

Beg Bal 4,000

Interest expense 7,000

End Bal 3,000


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Income tax payableIncome tax payable

The increase in income tax payable balance from 12,000 to 22,000 indicates that company pay $10,000 less cash than reported income tax, i.e. Cash paid for Tax $5,000

Income tax payable

Beg Bal 12,000

Income tax expense

15,000

Cash paid for taxes 5,000

End Bal 22,000


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Additional Information for 2005:

b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable.





3. Cash flow from Investing3. Cash flow from Investing


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Adjustments to accrual-basis net income: Depreciation expense 24,000$



Proceeds from sale of Plant assets 12,000

Purchase of Plant assets (10,000) Net cash providedd by investing activities 2,000



Now, let’s complete the

investing section.


investing section.


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3. Cash Flow from Investing - Reconstruction analysis3. Cash Flow from Investing - Reconstruction analysis


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3. Cash Flow from Investing - Reconstruction analysis3. Cash Flow from Investing - Reconstruction analysis

b. Plant Assets 70,000 Cash 10,000 Bond Payable 60,000 Purchase plant assets with cash and bond

c. Cash 12,000 Loss on Sales of Plant assets 6,000 Accumulated Depriciation 12,000

Plant Assets 30,000 Sell plant assets with loss


c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash,

yielding a $6,000 loss.


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Beg. Bal 48,000

Sale 12,000

End Bal. 60,000

Dep. Expense 24,000

Accumulated Depreciation

Plant Assets

Beg Bal 210,000

Purchase 70,000 Sale 30,000

End Bal 250,000


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4. Cash flow from Financing4. Cash flow from Financing


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Cash flows from operating activitiesNet income 38,000$ Adjustments to accrual-basis net income: Depreciation expense 24,000$



Proceeds from sale of Plant assets 12,000 Purchase of Plant assets (10,000)

Net cash providedd by investing activities 2,000

Cash flows from financing activitiesProceeds from issuance of common stock 15,000 Retirement of bonds (18,000) Payment of dividends (14,000)

Net cash used by financing activities (17,000)

Net increase in cash 5,000

Cash, January 1, 2005 12,000

Cash, December 31, 2005 17,000$

B&G SCF For the Year Ended December 31, 2005


financing section.


financing section.


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4. Cash Flow from Financing - Reconstruction analysis4. Cash Flow from Financing - Reconstruction analysis


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d. Cash 15,000 Common stock 15,000 Issue common stock

e. Bond payable 34,000 Cash 18,000 Gian on bond retirement 16,000 Retire bond with gain

f. Retained earning 14,000 Cash 14,000 Cash dividend payment





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Beg. Bal 64,000

Retired bond 34,000

End Bal. 90,000

Issue bonds 60,000

Bond Payable

Retained Earning

Beg Bal 88,000

Cash dividend 14,000 Net Income 38,000

End Bal 112,000

Common Stock

Beg Bal 80,000

Issue stock 15 ,000

End Bal 95,000



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5. Interpretation of SCF - Analyzing Cash Sources and Uses5. Interpretation of SCF - Analyzing Cash Sources and Uses


Cash Flows from

Investing

Cash Flows from

Financing

General Explanation

1. + + + Building up pile of cash. Possibly looking for acquisition.

2. + – – Operating cash flow being used to buy fixed assets and pay down debt.

3. + + – Operating cash flow and sale of fixed assets being used to pay down debt.

4. + – + Operating cash flow and borrowed money being used to expand.


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Cash Flows from

Operating

Cash Flows from

Investing

Cash Flows from

Financing

General Explanation

5. – + +

Operating cash flow problems covered by sale of fixed assets, borrowing, and contributions.

6. – – + Rapid growth, short-falls in operating cash flow, and purchase of fixed assets.

7. – + – Sale of fixed assets is financing operating cash flow shortages.

8. – – –

Company is using cash reserves to finance cash flow short-falls and pay creditors.


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BMX ATV Trex

90,000$ 40,000$ (24,000)$

26,000 (48,000) (25,000)

13,000 (27,000) 15,000$ 15,000$ 15,000$

Cash Flows of Competing Companiesall numbers in thousandsCash provided (used) by operating activities

Cash provided (used) by investing activities:

Repayment of debtNet increase (decrease) in cash

Proceeds from sale of operating assetsPurchase of operating assets

Cash provided (used) by financing activities:

Proceeds from issuance of debt


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Used, along with income-based ratios, to assess company performance.

Used, along with income-based ratios, to assess company performance.

Cash Flow on Total Assets =

Operating cash flows Average total assets

6. Decision Analysis: - Cash Flow on Total Assets6. Decision Analysis: - Cash Flow on Total Assets


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End of Chapter 16End of Chapter 16

reporting the statement of cash flows

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