STATEMENT OF CASH FLOWS

Accounting ASW

Summer 2006

Overview of statement of cash flows

• Explains changes in “Cash” during the period

• “Cash” is cash plus cash equivalents - Equivalents are highly liquid short-term investments - E.g., bank accounts, certificates of deposits, treasury bills and uncashed checks • There are typically no “SCF” accounts - infer SCF amounts from income statement and balance sheet - typically prepared after the other statements - hardest statement to interpret

Uses of SCF

• Assess liquidity

• Alternate measure of performance

• Helpful in predicting free cash flows

Free Cash Flows

• Free cash flows=Cash from Operations + Cash from Investing

• Popular valuation approaches uses FCF - Firm value = net present value of future FCF

• However, net income is the best predictor of future free cash flows

Relation between NI and FCF

• In general, over the life of the firm

Total(FCF) = Total(NI)

• The only difference is timing

• Most differences between NI and FCF reverse quickly

- E.g., credit sales CFnow < NInow

CFlate r > NIlater

Classification on the SCF

• Specified by the FASB

• Follows the structure of the firm

- Operating

- Investing

- Financing

Components of the Statement of Cash Flows

Operating

Cash Inflows Cash OutflowsCollect from customers Pay suppliers

Collect interest and dividends Pay interest

Other operating receipts Other operating payments

Pay taxes

Pay employees

Investing

Cash Inflows

Sell PP&E

Sell securities owned

Receive loan repayments

Cash Outflows

Purchase PP&E

Purchase securities

Make loans

Financing

Cash Inflows

Borrow from creditors

Issue equity securities

Cash Outflows

Repay amounts borrowed

Repurchase stock

Pay dividends

Formats for SCF

• Both direct and indirect are allowed

• In both formats – investing and financing formats are the same

• list sources and uses of cash

– total operating cash flows is the same• format for getting there differs

• Direct method also lists sources and uses of cash for operating– preferred by FASB– rare in practice

• Indirect method operating section starts with net income – explains why cash from operations NI– uses changes in other accounts to explain

• When CF NI, slack is picked up by changes in other balance sheet accounts– if sales > cash receipts, Accts. Receivable s– if sales < cash receipts, Accts. Receivable s– if purchases > cash paid, Accts. Payable s– if purchases < cash paid, Accts. Payable s– if purchases > cost of goods sold, Inventory s– if purchases < cost of goods sold, Inventory s

Preparing SCF (Indirect Method)

• Start with attached worksheet with beginning and ending balances of non-cash accounts at ends & change in middle

• As you work through, note each change that you’ve accounted for

• If every change is accounted for, it must add

Preparing the Statement of Cash Flows

Changes in Assets Operating Investing Financing(1) Accounts Receivable x(-)

(2) Inventories x(-)

(3) Other Current Assets (Usually) x(-)(4) Investments in Securities1 x(-) Property, Plant & Equipment

(5) Cost2 (Purchases) x(-)

(6) Acc. Depr.2

(Current Yr’s Depr.) x(+)(7) Other Noncurrent Assets (Usually)1 x(-)

Changes in Liabilities and Shareholders’ Equity

Operating Investing Financing(8) Accounts Payable x(+)

(9) Notes Payable1 x(+)

(10) Current Portion of Long- Term Debt3 x(+)(11) Other Current Liabilities (Usually) x(+)(12) Long-Term Debt1 x(+)

(13) Deferred income Taxes x(+)

(14) Other Noncurrent Liabilities (Usually)1 x(+)(15) Contributed Capital x(+)

Changes in Liabilities and Shareholders’ Equity

Operating Investing Financing(16) Retained Earnings x(Net Inc)(+) x (Div.)(-)

(17) Treasure Stock __________ _________ x(-)

(18) Cash

1Increases and decreases are generally disclosed separately.2For sales of PP&E (or other investments), profits are subtracted from net income in the operating section and the entire proceeds is included as a source of cash in the investing section.3Generally combined with long-term debt.

Problem 4-26

Formats for the SCFIndirect Format (most common)

Cash From Operations

Net Income

+ Depreciation

- Gain on Sale of PP&E

- Increase in Accounts Receivable

- Increase in Inventory

- Increase in Other Current Assets

+ Increase in Accounts Payable

+ Increase in Other Current Liab.

+ Increase in Def. Income Taxes

Cash From Investing

- Investments in Securities

+ Proceeds from Sales of Sec.

- Investments in PP&E

+ Proceeds from Sales of PP&E

- Invest. in Other NC Assets

+ Proceeds from Other NC Assets

Cash From Financing

+ Issuance of Notes Payable

- Repayments of Notes Payable

+ Issuance of Long-Term Debt

- Repayments of Long-Term Debt

+ Issuance of Common Stock

- Dividends Paid

- Repurchase of Common Stock

Problem 4-37

Sales of PP&E

• Recreate the journal entryCash Selling Price

Acc. Depr. AD on Asset

PP&E HC on Asset

Gain on Sale Plug• goal is for only selling price to appear in investing• to do that, subtract gain (add loss) in operating• show selling price as a source of investing cash• that takes care of the AD and PP&E on worksheet

• Problems 4-38, 4-28

Direct Format (rare)

• Financing and investing sections are the same as in the indirect method

• The operating section is stated in terms of sources and uses of cash

Cash From Operations

Cash Inflows

+ Collections from Customers

+ Interest and Dividends Received

+ Other Operating Receipts

Cash Outflows

- Payments to Suppliers

- Payments to Employees

- Interest Paid

- Taxes Paid

- Other Operating Cash Payments

Indirect Format Worksheet Cash From Operations

Net Income+ Depreciation- Gain on Sale of PP&E- Increase in Accounts Receivable- Increase in Inventory- Increase in Other Current Assets+ Increase in Accounts Payable+ Increase in Other Current Liab.

+ Increase in Def. Income Taxes Net Cash From Operations

Cash From Investing- Investments in Securities+ Proceeds from Sales of Sec.- Investments in PP&E+ Proceeds from Sales of PP&E- Invest. in Other NC Assets

+ Proceeds from Other NC Assets Net Cash from Investing

Cash From Financing+ Issuance of Notes Payable- Repayments of Notes Payable+ Issuance of Long-Term Debt- Repayments of Long-Term Debt+ Issuance of Common Stock- Dividends Paid

- Repurchase of Common Stock Net Cash from Financing Net Change in Cash