statement of cash flows- accounting

Accounting Accounting PrinciplesPrinciplesSecond Canadian EditionSecond Canadian Edition

Prepared by: Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel · Trenholm

CASH FLOW STATEMENTCASH FLOW STATEMENT

CHAPTERCHAPTER

1818

PURPOSE OF THE PURPOSE OF THE CASH FLOW STATEMENTCASH FLOW STATEMENT

PURPOSE OF THE PURPOSE OF THE CASH FLOW STATEMENTCASH FLOW STATEMENT

• The primary purpose of the cash flow statement is to provide information about the cash receipts and cash payments of an entity during a period.

• A secondary objective is to provide information about its

– Operating activities

– Investing activities

– Financing activities

MEANING OF CASH FLOWSMEANING OF CASH FLOWSMEANING OF CASH FLOWSMEANING OF CASH FLOWS

• The cash flow statement is usually prepared using cash and cash equivalents as its basis.

• Cash equivalents are short-term, highly liquid investments that are both1. readily convertible to known amounts of

cash, and2. so near to their maturity that their

market value is relatively insensitive to changes in interest rates.

CLASSIFICATION OF CASH CLASSIFICATION OF CASH FLOWSFLOWS

CLASSIFICATION OF CASH CLASSIFICATION OF CASH FLOWSFLOWS

• Operating activities

• Investing activities

• Financing activities

• Include– Cash effects of transactions that create

revenues and expenses and– Enter into determination of net income (loss)

OPERATING ACTIVITIESOPERATING ACTIVITIES

Balance Sheet: Noncash Current Assets and Current

Liabilities; Income Statement Items

• Include– Purchasing and disposing of investments

and productive long-lived assets using cash and

– Lending money and collecting the loans

Balance Sheet: Investment and Long-Term Asset Items

INVESTING ACTIVITIESINVESTING ACTIVITIES

• Include– Obtaining cash from issuing debt and

repaying the amounts borrowed and – Obtaining cash from owners/shareholders

and paying them drawings/dividends

FINANCING ACTIVITIESFINANCING ACTIVITIES

Balance Sheet: Long-Term Liability and Equity Items

• If it does not affect cash, do NOT report in body of cash flow statement

• Report in separate note to the financial statements

SIGNIFICANT NONCASH SIGNIFICANT NONCASH ACTIVITIESACTIVITIES

Operating, investing, and financing plus the significant noncash investing and financing activities constitute the general format of the cash flow statement, an example of which is shown on the right.

ILLUSTRATION ILLUSTRATION 18-218-2 FORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENT

ILLUSTRATION ILLUSTRATION 18-218-2 FORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENT

COMPANY NAMECash Flow Statement

Period CoveredCash flows from operating activities

(List of individual items) XXNet cash provided (used) by operating activities

XXXCash flows from investing activities

(List of individual items) XXNet cash provided (used) by investing activities

XXXCash flows from financing activities

(List of individual items) XXNet cash provided (used) by financing activities

XXXNet increase (decrease) in cash

XXXCash at beginning of period

XXXCash at end of period

XXXNote x:Noncash investing and financing activities

(List of significant noncash transactions)XXX

PREPARING PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

PREPARING PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

The cash flow statement is prepared differently from the three other basic financial statements.1. It is not prepared from the adjusted trial balance.2. The cash flow statement deals with cash receipts

and payments, so the accrual concept is not used in the preparation of this statement. The information to prepare this statement usually comes from three sources:1. Comparative balance sheet2. Current income statement3. Additional information

ILLUSTRATION ILLUSTRATION 18-318-3

THREE MAJOR STEPS IN PREPARING THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT


THREE MAJOR STEPS IN PREPARING THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

+ or -The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets.

The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets.

This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data.

This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data.

XYZ Goods

This step involves analysing comparative balance sheet data and selected additional information for their effects on cash.

This step involves analysing comparative balance sheet data and selected additional information for their effects on cash.

For Sale Investing Financing

Step 1: Determine the net increase (decrease) in cash.

Step 2: Determine net cash provided (used) by operating activities.

Step 3: Determine net cash provided (used) by investing and financing activities.

STEP 1: DETERMINE NET INCOME STEP 1: DETERMINE NET INCOME (DECREASE) IN CASH(DECREASE) IN CASH

STEP 2: DETERMINE NET CASH STEP 2: DETERMINE NET CASH PROVIDED (USED) BY OPERATING PROVIDED (USED) BY OPERATING

ACTIVITIESACTIVITIES

• Net income must be converted from an accrual basis to a cash basis in the operating activities section

• Conversion may be done by two methods:– Indirect (used extensively in practice)

– Direct

INDIRECT AND DIRECT METHODSINDIRECT AND DIRECT METHODS

• Both methods arrive at the same total amount of cash provided (used) by operating activities

• Methods differ in disclosing the items that make up the total amount

• Choice of methods affects only the operating activities section; the investing and financing activities sections are the same

OPERATING ACTIVITIES – OPERATING ACTIVITIES – INDIRECT METHODINDIRECT METHOD

Section 1Section 1


NET INCOME VS. NET CASH PROVIDED NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIESBY OPERATING ACTIVITIES


NET INCOME VS. NET CASH PROVIDED NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIESBY OPERATING ACTIVITIES

The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, it adjusts net income for items that affect reported net income but do not affect cash, as shown below.

Earned Revenues

Net Income

Incurred Expenses

Accrual Basis of Accounting Cash Basis of Accounting

Net Cash Provided (Used) by Operating

Activities

Eliminate noncash revenues

Eliminate noncash expenses

NET INCOME TO NET CASH PROVIDED (USED) BY NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES

(B/S: Noncash Current Assets and Current Liabilities)(B/S: Noncash Current Assets and Current Liabilities)

Adjustments to Convert Net Incometo Net Cash Provided (Used) by

Operating ActivitiesAdd* Deduct*

Change in Current Asset Account BalanceAccounts receivable Decrease IncreaseInventory Decrease IncreasePrepaid expenses Decrease IncreaseOther current assets Decrease Increase

Change in Current Liability Account BalanceAccounts payable Increase DecreaseAccrued expenses payable Increase DecreaseOther current liabilities Increase Decrease

* Add (deduct) change in account balance to net income

NET INCOME TO NET CASH PROVIDED (USED) BY NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES

(I/S: Noncash Items)(I/S: Noncash Items)

Adjustments to Convert NetIncome to Net Cash Provided

(Used) by Operating Activities

Noncash Items on Income Statement

Amortization (of capital assets) expenseAddAmortization of bond discount to interest expenseAddAmortization of bond premium to interest expense DeductLoss on sale of asset AddGain on sale of asset DeductIncome from long-term equity investment Deduct

NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES


Cash flows from operating activitiesNet income 35,000 Adjustments to reconcile net income to net cash

provided by operating activities:Increase in accounts receivable (30,000) Increase in inventory (25,000) Increase in accounts payable 15,000 Increase in accrued expenses payable 4,000 (36,000)

Net cash used by operating activities (1,000)

Computer Services CorporationCash Flow Statement - Indirect MethodFor the Year Ended December 31, 2002

Indirect Method – Sample Format

Indirect Method – Sample Format

OPERATING ACTIVITIESOPERATING ACTIVITIES– DIRECT METHOD– DIRECT METHOD

Section 2Section 2

CASH RECEIPTS AND CASH PAYMENTSCASH RECEIPTS AND CASH PAYMENTS(Direct Method)(Direct Method)

CASH RECEIPTS FROM CASH RECEIPTS FROM CUSTOMERSCUSTOMERS

• The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable is:

Cash receipts from

customers=

Revenues from sales{ + Decrease in accounts receivable

or – Increase in accounts

receivable

Cash payments

to suppliers

=

Cost of goods sold{

+ Increase in inventory or

– Decrease in inventory

{+ Decrease in accounts payable or – Increase in accounts

payable

CASH PAYMENTS TO SUPPLIERSCASH PAYMENTS TO SUPPLIERS

• The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:

Cash payments

for services

+ Increase in prepaid expenses

or – Decrease in

prepaid expenses

+ Decrease in accrued expenses payable or – Increase in accrued

expenses payable

{Operating dxpenses {

=

CASH PAYMENTS FOR OPERATING CASH PAYMENTS FOR OPERATING EXPENSESEXPENSES

• The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:

Cash payments for income tax

{=Income

tax expense

+ Decrease in income tax payable or

– Increase in income tax payable

CASH PAYMENTS FOR INCOME CASH PAYMENTS FOR INCOME TAXTAX

• The relationships among cash payments for income tax, income tax expense, and changes in income tax payable is:

Cash flows from operating activities

Cash receipts from customers $120,000Cash payments:

To suppliers ($75,000)For operating expenses (36,000)For income tax (10,000) (121,000)Net cash used by operating activities (1,000)

COMPUTER SERVICES CORPORATIONCash Flow Statement – Direct Method

For the Year Ended December 31, 2002


Direct Method – Sample Format

Direct Method – Sample Format

STEP 3: DETERMINE NET CASH STEP 3: DETERMINE NET CASH PROVIDED (USED) BY INVESTING AND PROVIDED (USED) BY INVESTING AND

FINANCING ACTIVITIESFINANCING ACTIVITIES

• Study the balance sheet to determine changes in investments and long-term assets

• Changes in each short-term investment (unless incorporated as part of cash definition) and long-term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY INVESTING ACTIVITIESINVESTING ACTIVITIES

NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY FINANCING ACTIVITIESFINANCING ACTIVITIES

• Study the balance sheet to determine changes in noncurrent liabilities and owner’s/shareholders’ equity

• Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

Operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.

ILLUSTRATION ILLUSTRATION 18-818-8 CASH FLOW STATEMENT CASH FLOW STATEMENT

INDIRECT METHODINDIRECT METHOD


INDIRECT METHODINDIRECT METHODCOMPUTER SERVICES COMPANY

Cash Flow Statement — Indirect MethodFor the Year Ended December 31, 2002

Cash flows from operating activitiesNet income 35,000$ Adjustments to reconcile net income to net cash

provided by operating activities:Increase in accounts receivable (30,000)$ Increase in inventory (25,000) Increase in accounts payable 15,000 Increase in accrued expenses payable 4,000 (36,000)

Net cash used by operating activities (1,000) Cash flows from investing activities

Purchase of equipment (10,000)$ Net cash used by investing activities (10,000)

Cash flows from financing activitiesIssue of common shares 60,000$ Payment of cash dividend (15,000)

Net cash provided by financing activities 45,000 Net increase in cash 34,000 Cash, January 1 - Cash, December 31 34,000$


DIRECT METHODDIRECT METHOD


DIRECT METHODDIRECT METHOD

Cash flows from operating activitiesCash receipts from customers $120,000Cash payments:

To suppliers $(75,000)For operating expenses (36,000)For income tax (10,000) (121,000)Net cash provided by operating activities (1,000)

Cash flows from investing activitiesPurchase of equipment $(10,000)

Net cash used by investing activities (10,000)Cash flows from financing activities

Issue of common shares $ 60,000Payment of cash dividends (15,000)

Net cash provided by financing activities 45,000Net increase in cash 34,000Cash, January 1 0Cash, December 31 $ 34,000

COMPUTER SERVICES CORPORATIONCash Flow Statement

For the Year Ended December 31, 2002

The cash flow statement shows that operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.

USING CASH FLOWS TO USING CASH FLOWS TO EVALUATE COMPANYEVALUATE COMPANY

• Liquidity– Cash current debt coverage ratio

• Profitability– Cash return on sales ratio

– Cash flow per share

• Solvency– Cash total debt coverage

These ratios are cash-based instead of accrual-based

CASH CURRENT DEBT COVERAGECASH CURRENT DEBT COVERAGE

• Cash current debt coverage indicates the amount of cash to pay off current debt that is generated from operating activities.

• The ratio provides a better picture of liquidity than using the current ratio because it uses cash provided by operating activities rather than the year-end asset balance.

Cash Provided

by Operating Activities

Average Current

Liabilities

Cash Current

Debt Coverage

CASH RETURN ON SALESCASH RETURN ON SALES

• Cash return on sales indicates how quickly sales are turned into cash.

• The company is efficient at turning sales into cash when its cash return on sales is greater than its accrual-based counterpart, the profit margin.

Cash Provided


Net Sales

Cash Return on Sales

CASH FLOW PER SHARECASH FLOW PER SHARE

• Cash flow per share indicates the cash flow generated for each common share.

Cash Flow from

Operating, Investing, and

Financing Activities

Number of Common

Shares

Cash Flow per Share

CASH TOTAL DEBT COVERAGECASH TOTAL DEBT COVERAGE

• Cash total debt coverage indicates the amount of cash to pay off total debt that is generated from operating activities.

• The ratio is the cash based counterpart to the debt to total assets ratio.

Cash Provided


Average Total

Liabilities

Cash Total Debt

Coverage

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statement of cash flows- accounting

Documents

cash equivalents

cash receipts

cash payments

amounts of cash

cash flow statementstep

net income decrease

significant noncash

net increase decrease