Statement of Cash Flows (SCF)

Transcription

1 Statement of Cash Flows (SCF) The statement of cash flows (SCF) or cash flow statement reports a corporation's significant cash inflows and outflows that occurred during an accounting period. This financial statement is needed because many investors and financial analysts believe that "cash is king" and use cash amounts for various analyzes. The SCF is also important because the income statement is prepared using the accrual method of accounting (as opposed to the cash method). In effect the statement of cash flows highlights the major reasons for the changes in a corporation's cash and cash equivalents from one balance sheet date to another. Hence the SCF for the year 2016 reports the major cash inflows and cash outflows that caused the corporation's cash and cash equivalents to change between December 31, 2015 and December 31, The cash inflows are the cash amounts that were received or have a favorable effect on a corporation's cash balance. Hence, they will appear as positive amounts. The cash outflows are the cash amounts that were used or have an unfavorable effect on a corporation's cash balance. Hence, they will appear in parentheses to indicate that they had a negative effect. The major cash flows occurring during an accounting period are reported under the following headings or sections of the SCF: 1. cash flows provided or used in operating activities 2. cash flows provided or used in investing activities 3. cash flows provided or used in financing activities In addition, the following supplementary or supplemental information must be disclosed: interest paid income taxes paid significant activities involving investing and/or financing that did not involve cash (such as the exchange of common stock for long-term debt, or the exchange of common stock for land) Cash Flows from Operating Activities The first section of a SCF is described as the cash flows from operations or cash flows from operating activities. Basically this section presents the cash flows that are not considered to be investing or financing activities. The following is a brief example of the cash flows from operating activities prepared using the indirect method, which is used by nearly all corporations:

2 Under the indirect method, the first amount shown is the corporation's net income (or net earnings) from the income statement. Assuming the net income was $100,000 it will be listed first and will be followed by many adjustments to convert the net income from the accrual method of accounting to the approximate amount of cash. The first adjustment to the net income is the amount of depreciation expense that had reduced net income. Assuming the depreciation expense was $30,000, this amount will be added back to the net income. The reason is that it was an expense that did not use cash. (It was merely an adjusting entry that debited Depreciation Expense and credited Accumulated Depreciation.) Many of the other adjustments in the operating activities section of SCF reflect the changes in the balances of the current assets and current liabilities. For example, if accounts receivable decreased by $5,000, the corporation must have collected more than the current period's credit sales that were included in the income statement. Since the decrease in the balance of accounts receivable is favorable for the corporation's cash, the $5,000 decrease will be a positive amount on the SCF. If accounts payable decreased by $9,000 the corporation must have paid more than the amount of expenses that were included in the income statement. Paying more than the amount in the income statement is unfavorable for the corporation's cash balance. As a result the $9,000 decrease in accounts payable will appear in parentheses on the SCF. Experienced financial people will review the net cash provided from operating activities. If there are negative amounts, they will ask "Why?" For instance, if inventory increases, the amount of the increase will be shown as a negative amount on the SCF since it assumed to have used the corporation's cash. The negative amount may lead to the question "Was there a decline in the demand for the corporation's products?" Perhaps some of the corporation's items in inventory have become obsolete. You can gain additional insights regarding the cash flows from operating activities from our Explanation of the Cash Flow Statement. Cash Flows from Investing Activities The second section of SCF reports 1) the cash outflows that were used to acquire noncurrent assets, and 2) the cash inflows received from the sale of noncurrent assets. The cash outflows spent for noncurrent assets are reported as negative amounts since the payments have an unfavorable effect on the corporation's cash balance. A common outflow is connected to a corporation's capital expenditures. This is the property, plant and equipment that was acquired during the accounting period and will be used in the business.

3 The positive amounts in this section of SCF indicate the cash inflows or proceeds from the sale of property, plant and equipment and/or other long-term assets. Here is an example of what might be reported in the second section of the statement of cash flows: Note that the $95,000 appears as a negative amount because the outflow of cash for capital expenditures has an unfavorable or negative effect on the corporation's cash balance. The $15,000 is a positive amount since the money received has a favorable effect on the corporation's cash balance. The $30,000 received from selling an investment also had a favorable effect on the corporation's cash balance. Cash Flows from Financing Activities The third section of the statement of cash flows reports the cash received when the corporation borrowed money or issued securities such as stock and/or bonds. Since the cash received is favorable for the corporation's cash balance, the cash inflows received will be reported as positive amounts on the SCF. Cash outflows used to repay debt, to retire shares of stock, and/or to pay dividends to stockholders are unfavorable for the corporation's cash balance. As a result the cash paid out will be shown as negative amounts. Here is an example of what might appear in the third section of the statement of cash flows: In the above illustration we see that the payment of cash dividends of $10,000 had an unfavorable effect on the corporation's cash balance. This is also true of the $20,000 of cash that was used to repay short-term debt and to purchase treasury stock for $2,000. On the other hand, the borrowing of $60,000 had a favorable or positive effect on the corporation's cash balance. The net result of the four financing activities caused cash and cash equivalents to increase by $28,000. Format of a Complete SCF

4 The following shows all three sections of the statement of cash flows: Note that near the bottom of the SCF there is a reconciliation of the cash and cash equivalents between the beginning and the end of the year. In addition, the SCF must disclose the following supplementary information: amount of interest paid, amount of income taxes paid, and significant noncash transactions such as the exchange of shares of stock for bonds payable, or common stock for land. Free Cash Flow Some financial analysts also calculate what is known as free cash flow. This is defined as the amount of cash from operating activities minus the amount of cash required for capital expenditures. Some people also subtract the corporation's cash dividends when the dividends are viewed as a necessity.

5 Using the amounts from above, the ABC Corporation had free cash flow of $31,000 (which is the $126,000 of net cash provided from operating activities minus the capital expenditures of $95,000). If dividends are considered a required cash outflow, the free cash flow would be $21,000.