Chapter 6, cont d. The Statement of Cash Flows. (for a deeper analysis see chapter 18)

Transcription

1 Chapter 6, cont d The Statement of Cash Flows (for a deeper analysis see chapter 18) 1

2 Lecture outline Why a cash flow statement? Classifications of cash flows Preparation of cash flow statements Determining the change in cash Determining net cash from operating activities methods Sidestep: net income vs. net cash from operating activities Determining net cash from investing and financing activities 2

3 Purpose of cash flow statement Objective of a business enterprise: profit Corporations maximize profitability, RoE Essential constraint: solvency all liabilities can be paid out of liquid assets at due date otherwise Management loses control over assets Profitability Liquidity In the long-run you cannot maintain solvency without profitability and vice versa! 3

4 Profitability vs. liquidity the W. T. Grant Bankruptcy in 1975 Millions of Dollars Year at that time, largest bankruptcy filing in the U.S. (credit) sales increased steadily; profits were generated first cash shortages emerged in 1969 Income Cash Flow from Operations filing of bankruptcy on October 2,

5 Net income vs. net cash from operating activities in 2000 Company Net cash flow from Net income operating activities Ericsson kr kr CocaCola $3.585 $2.177 Microsoft $ $9.421 Motorola -$1.164 $1.318 Lufthansa BMW Note: all numbers in thousands / Source: various company reports 5

6 Substantial content information on sources and uses of cash during the accounting period independent of accounting discretion, more objective than income statement important to forecast the entity s ability to generate future cash flows, the entity s ability to pay dividends and meet obligations, thereasonsforthedifferencebetweennetincome and net cash flow from operating activities, and the cash and noncash investing and financing transactions during the period 6

7 Classification of Cash Flows Cash flows are the results of either Operating activities principal revenue-producing activities of the entity, and all other non-investing or non-financing activities Investing activities acquisition and disposal of long-term assets and other investments not included in cash equivalents Financing activities transactions that lead to changes in size and composition of the entity s equity capital and liabilities regular interest payments are operating? Bristol-Myers Squibb considers securities with maturities of less than three months to be cash equivalents. Would such securities be included in the cash account and reported on in the statement of cash flows or in the marketable securities account on the balance sheet? Why? 7

8 Graphical model of cash flows Funds tied up in... Investing Activities Operating Activities Financing Activities Cash 8 Investments Disinvestments Cash expediture for factor input Cash receipts from revenues Capital repaid Capital raised Range of Cash Flow Statement for a period

9 Format of the cash flow statement Company Name Statement of Cash Flows Period Covered Cash flows from operating activities Net income XXX Adjustments to reconcile net income to net cash provided by operating activities: (List of individual items) XX XX Net cash from operating activities XXX Cash flows from investing activities (List of individual items) Net cash provided (used) by investing activities Cash flows from financing activities (List of individual items) Net cash provided (used) by financing activities Net increase (decrease) in cash Cash at beginning of period Cash at end of period XX XX XXX XXX XXX XXX XXX 9

10 Cash flow statements and accounting regulation US-GAAP APB-Opinion No. 19, SFAS No. 95 IAS IAS 7 cash flow statements required under US-GAAP and IAS are an integral part of all sets of financial statements in Germany, such requirements only for consolidated statements voluntary disclosure? A depreciation charge of $ 53 million is included on the 2008 statement of cash flows for Imation, a global technology company. Does the company use the direct or indirect method of presenting the statement of cash flows? Why would an income statement expense like depreciation appear on the statement of cash flows? 10

11 Preparation of cash flow statements Sources of information: comparative balance sheet changes in assets, liabilities, and equities over a period current income statement operating profit selected transaction data additional information of cash provisions and uses during the period (e.g. dividends, share repurchases,...) Three steps from the data to statement of cash flow: 1. Determine change in cash 2. Determine net cash flow from operating activities 3. Determine net cash flows from investing and financing activities 11

12 Two methods to analyze and report cash from operating activities Direct method discloses major classes of gross cash receipts and gross cash payments directly derived directly from the cash account a respective account is not usually present in the accounting system easily implementable with EDP-based accounting Indirect method adjusting net income eliminate noncash revenues and expenses adjust for any deferrals or accruals of past or future operating cash receipts or payments adjust for items of income or expense associated with investing or financing cash flows 12

13 Direct method, Example: Northrop Grumman Corp Operating Activities Sources of Cash Cash received from customers Progress payments 3,102 1,438 Other collections 11,148 7,003 Interest received Income tax refunds received Other cash receipts Cash provided by operating activities 14,534 8,483 Uses of Cash Cash paid to suppliers and employees 13,251 7,250 Interest paid Income tax paid Other cash payments 7 1 Cash used in operating activities 13,717 7,473 Net cash provided by operating activities 817 1,010 Source: Penman, 2 nd ed. p

14 Example We use the following data to go through the preparation process: Dream Grades, Inc. Comparative Balance Sheet Change Assets Dec. 31, 2001 Jan. 1, 2001 Increase / (Decrease) Cash Accounts receivable Prepaid insurance Total Liabilities and stockholder's equity Accounts payable Long-term liability Unearned revenue Common stock ( 10 par) Retained earnings Total

15 Dream Grades, Inc. Income Statement For the year ended December 31, 2001 Revenues Operating expenses Income before taxes Income tax expense (35%) Net income Additional information The company obtained in cash through a bank loan; repayment of the loan is due in ten installment payments of and the first of them was due during the year. Cash dividends in a total amount of were paid during the year. 15

16 Example cont d Step 1 Determine the Change in Cash The balance in the cash account increased from zero to ; thus, we record a change in cash for 2001 that was an increase of Step 2 Determine Net Cash Flow from Operating Activities accrual accounting net income cash basis accounting net cash flow from operating activities 16

17 Example cont. direct method Cash collected from revenues Cash payment for expenses Income before income taxes Cash payments for income taxes Net cash used by operating activities Cash collected from revenues: Cash payment for expenses: Note: The issue of deferred taxes is neglected here. For example, prepaid expenses and unearned revenues would cause a difference betweentaxableincomeand financial income. See chapter

18 Indirect method, adjustments Additions: Net income Depreciation expense Amortization of intangibles and deferred charges Amortization of bond (payable) discount Increase in deferred income tax liability Loss on investment in common stock using equity method Loss on sale plant assets Loss on writedown of assets Decrease in receivables Decrease in prepaid expense Increase in accounts payable Increase in accrued liabilities Deductions: Net cash flow from operating activities Amortization of bond (payable) premium Decrease in deferred income tax liability Income on investment in common stock using equity method Gain on sale of plant assets Increase in receivables Increase in inventories Increase in prepaid expense Decrease in accounts payable Decrease in accrued liabilities Source: Kieso/Weygandt/Warfield, p

19 Example cont. indirect method Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable Increase in accounts payable Increase in prepayments Increase in unearned revenue Net cash used by operating activities Step 3 Determine net cash flows from investing and financing activities long-term loan of (net effect at year-end) dividend payment of issuance of common stock for cash,

20 Cash flow statement for the year 2001 Dream Grades, Inc. Statement of Cash Flows For the Year Ended December 31, 2001 Cash Flows from Operating Activities Net Income Adjustments to reconcile net income to net cash used by operating activities Increase in Account Receivable Increase in Prepaid Insurance Increase in Unearned Revenue Increase in Accounts Payable Net cash flows used by operating activities Cash Flows from Financing Activities Issuance of common stock Long-term borrowing Payment of cash dividend Net Cash Flows provided by Financing Activities Net Increase (Decrease) in Cash Cash, January 1, Cash, December 31,

21 Example cont d, next year Dream Grades, Inc. We continuecomparative with the Balance example: Sheet Change Assets Dec. 31, 2002 Jan. 1, 2002 Increase / (Decrease) Cash Accounts receivable Prepaid insurance Land Building Accumulated depreciation - building Equipment Accumulated depreciation - equipment Total Liabilities and stockholder's equity Accounts payable Long-term liability Unearned revenue Common stock ( 10 par) Retained earnings Total

22 Dream Grades, Inc. Income Statement For the year ended December 31, 2002 Revenues Operating expenses Income before taxes Income tax expense (35%) Net income Additional information 1 a cash dividend of was paid during the year. 2 the second installment payment on the long-term loan was made. 3 land, building, and equipment were acquired for cash. Step 1 Determine change in cash As indicated in the comparative balance sheet, cash increased during the year. 22

23 Step 2 Determine net cash from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable Increase in accounts payable Decrease in prepayments Decrease in unearned revenue Depreciation expense Net cash provided by operating activities Step 3 Determine net cash flows from investing and financing activities repayment on loan, dividend payment of purchase of land, building, and equipment,

24 Dream Grades, Inc. Statement of Cash Flows For the Year Ended December 31, 2002 Cash Flows from Operating Activities Net Income Adjustments to reconcile net income to net cash provided by operating activities Depreciation Expense Decrease in Prepaid Insurance Decrease in Account Receivable Decrease in Unearned Revenue Increase in Accounts Payable Net cash flows provided by operating activities Cash Flows from Investing Activities Purchase of land Purchase of building Purchase of equipment Net cash flows used by investing activities Cash Flows from Financing Activities Installment Payment on Long-Term Loan Payment of cash dividend Net cash flows used by financing activities Net Increase (Decrease) in Cash Cash, January 1, Cash, December 31,

25 How much cash is enough? Microsoft : $ 57 billion in cash and short-term investments (2004) Cisco Systems : $ 5 billion in cash (annual report 2000) Bayer : 767 million in cash and cash equivalents (annual report 2002) Ratio to assess cash levels operating expenses held in cash (OEHIC) OEHIC = Cash Daily operating expenses Ford... used to have a ratio of 80 Verizon.... appr. 10 Oregon Steel Mill... 3 WHX Holding