Statement of Cash Flows - PDF Free Download

Today s Agenda n Cash Flow Statements n What Cash Flow Statements show us n Building a Cash Flow Statement

Statement of Cash Flows Income Statement Balance Sheet Statement of Cash Flows The statement of cash flows highlights the major activities that impact cash flows and,hence, affect the overall cash balance.

Cash Flow Statements n Cash Flow Statements present a company s n Cash position n Sources and uses of its cash n Changes in cash over a period of time n Is the company generating sufficient cash? n To maintain operations? n To re-pay its debts? n Pay dividends n Cash flows and net income differ

Purpose of the Statement of Cash Flows Are cash flows sufficient to support ongoing operations? Will the company have to borrow money to make needed investments? Can we pay debts? Can we pay dividends? Why is there a difference between net income and net cash flow? Accruals are non-cash entries

A Fundamental Principle n The Greek letter Delta, or Δ, can symbolize change Δ Cash Balance = Δ Noncash Balance Sheet Accounts This principle ensures that properly analyzing the changes in all noncash balance sheet accounts always quantifies the cash inflows and outflows that explain the change in the cash balance.

A Review of Basic Equations Basic Equation for Asset Accounts Beginning balance + Debits Credits = Ending balance n Eg, AR + increases in AR minus AR collected Basic Equation for Contra-Asset, Liability, and Stockholders Equity Accounts Beginning balance Debits + Credits = Ending balance n Eg, AP less amounts paid + unpaid purchases

Cash and Near Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Currency and Bank Accounts Cash Treasury Bills Commercial Paper Money Market Funds Cash Equivalents

Four Areas of Cash Sources and Uses n Profit & Loss n Net income or loss n Plus non-cash expenses - depreciation and amortization n Changes in working capital n Increases and decreases in current assets and current liabilities n Investment activities n Investments in and disposals of longer term assets n Financing activities n Issuance of or repayment/redemption of debt or equity n Dividends

Free Cash Flows Free cash flow measures a company s ability to fund its capital expenditures and dividends from its net cash provided by operating activities. Free Cash Flow = Net Cash Provided by Operating Activities Capital Expenditures Dividends

Organizing a Statement of Cash Flows Operating Activities Revenue and expense transactions that affect net income. Investing Activities Financing Activities Acquiring or disposing of noncurrent assets. Borrowing from and repaying principal to creditors and transactions with stockholders.

Constructing the Statement of Cash Flows Net Income Net Loss Changes in noncash assets Changes in liabilities* Changes in capital stock accounts Dividends paid to stockholders Sources Uses Always Always Decreases Increases Increases Decreases Increases Decreases Always Total sources - Total uses = Net cash flow * Contra asset accounts, such as the Accumulated Depreciation and Amortization account, follow the rules for liabilities.

Organizing a Statement of Cash Flows

Operating Activities: Direct or Indirect Method? Direct Method Reconstructs the income statement on a cash basis from top to bottom Indirect Method Accrual net income is adjusted to a cash basis; Used by 99% Both methods result in the exact same amount of cash provided by operating activities.

The Indirect Method: A Three-Step Process Step 1 Add depreciation charges to net income. Step 2 Analyze net changes in noncash balance sheet accounts. Step 3 Adjust for gains and losses.

Operating Activities: Net income Changes in current assets Changes in noncurrent assets that affect net income (e.g., depreciation) Cash flows payable) are divided into three categories. Organization of the Full-Fledged Statement of Cash Flows XYZ Company Cash Flow Statement For the Period Ending MM/DD/YY Changes in current liabilities (except for debts to lenders and dividends I. Operating Activities $ XXX Changes in noncurrent liabilities that affect net income II. Investing Activities XXX Investing Activities: Changes in noncurrent assets that are not included in net income III. Financing Activities XXX Net Cash Flows for the Period $ XXX Add: Beg. Cash Balance XXX Financing Activities: Changes in the current liabilities that are debts to lenders rather than obligations to suppliers, employees, Ending Cash or the Balance government Changes in noncurrent liabilities that are not included in net income Changes in capital stock accounts Dividends $ XXX

Summary of Key Concepts

Operating Activities Net Income (Loss) $ XXX Add: Decr. in Current Noncash Assets XXX Incr. in Current Liabilities XXX Depreciation Charges XXX Losses XXX Less: Incr. in Current Noncash Assets (XXX) Decr. in Current Liabilities (XXX) Gains (XXX) Net Cash Flows from Operating Activities $ XXX Includes those activities that enter into the determination of net income.

Investing Activities Add: Proceeds from sale of land, buildings, equipment, or other noncurrent assets Receipt of principal from investments Less: Payments to acquire land, buildings, equipment, or other noncurrent assets Payments to acquire investments Net Cash Flows from Investing Activities $ XXX XXX (XXX) (XXX) $ XXX Includes transactions that involve the acquisition or disposal of noncurrent assets.

Financing Activities Add: Proceeds from borrowings $ XXX Proceeds from issuing capital stock XXX Proceeds from sale of bonds XXX Less: Principal payments on borrowed funds (XXX) Payments related to bond maturities (XXX) Dividend payments (XXX) Net Cash Flows from Financing Activities $ XXX Includes transactions involving receipts from or payments to creditors and owners.

Earnings Quality Managers generally perceive that earnings are of higher quality when the earnings: q are not unduly influenced by inflation, q are computed using conservative accounting principles and estimates, and q are correlated with net cash provided by operating activities.

A Full-Fledged Statement of Cash Flows: Indirect Method Ed's Pizza Hut Comparative Balance Sheet Account Balances 3/31/2007 3/31/2006 Change DR (CR) DR (CR) Incr. (Decr.) Cash $ 71,000 $ 90,000 $ (19,000) Accounts Receivable 23,000 40,000 (17,000) Inventory 350,000 300,000 50,000 Land 68,000 100,000 (32,000) Equipment 84,000 84,000 - Accumulated Depr. (45,000) (39,000) 6,000 Accounts Payable (38,000) (27,000) 11,000 Salaries Payable (9,000) (14,000) (5,000) Note Payable - Joe Doe - (50,000) (50,000) Common Stock (500,000) (450,000) 50,000 Retained Earnings (4,000) (34,000) (30,000) $ - $ -

A Full-Fledged Statement of Cash Flows: Indirect Method Additional Information: v There was a net loss for the year of $27,000. v Depreciation charges for the year were $6,000. v During the year, Ed sold land originally costing $32,000 for $32,000. v During the year, Ed paid dividends of $3,000 to the stockholders. v Ed issued $50,000 of common stock to settle the note due to Joe Doe.

Preparing the Statement of Cash Flows: Step 1 Assets (except cash and Current assets Accounts receivable Inventory Noncurrent assets Land Equipment Contra Assets, Liabilities, Contra assets Accumulated depreciation Current liabilities Accounts payable Salaries payable Noncurrent liabilities Note payable Stockholders' equity Common stock Retained earnings Net loss Dividends Total (net cash flow) Ed's Pizza Hut Statement of Cash Flows Worksheet Change Source or Use? Cash Flow Effect Adjustments Adjusted Effect List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings. Classification

Preparing the Statement of Cash Flows: Step 2 Assets (except cash and Current assets Accounts receivable $ (17,000) Inventory 50,000 Noncurrent assets Land (32,000) Equipment - Contra Assets, Liabilities, Contra assets Accumulated depreciation 6,000 Current liabilities Accounts payable 11,000 Salaries payable (5,000) Noncurrent liabilities Note payable (50,000) Stockholders' equity Common stock 50,000 Retained earnings Net loss (27,000) Dividends 3,000 Total (net cash flow) Ed's Pizza Hut Statement of Cash Flows Worksheet Change Source or Use? Cash Flow Effect Adjustments Adjusted Effect Classification Compute the change from the beginning balance to the ending balance for each account.

Preparing the Statement of Cash Flows: Step 3 Ed's Pizza Hut Statement of Cash Flows Worksheet Change Source or Use? Cash Flow Effect Adjustments Assets (except cash and Current assets Accounts receivable $ (17,000) Source Inventory 50,000 Use Noncurrent assets Land (32,000) Source Equipment - Contra Assets, Liabilities, Contra assets Accumulated depreciation 6,000 Source Current liabilities Accounts payable 11,000 Source Salaries payable (5,000) Use Noncurrent liabilities Note payable (50,000) Use Stockholders' equity Common stock 50,000 Source Retained earnings Net loss (27,000) Use Dividends 3,000 Use Total (net cash flow) Adjusted Effect Classification Code each entry on the worksheet as a source or use of cash. Recall that the transaction involving the Note Payable and {Common Stock was noncash.

Ed's Pizza Hut Statement of Cash Flows Worksheet Change Source or Use? Cash Flow Effect Adjustments Assets (except cash and Current assets Accounts receivable $ (17,000) Source $ 17,000 Inventory 50,000 Use (50,000) Noncurrent assets Land (32,000) Source 32,000 Equipment - - Contra Assets, Liabilities, Contra assets Accumulated depreciation 6,000 Source 6,000 Current liabilities Accounts payable 11,000 Source 11,000 Salaries payable (5,000) Use (5,000) Noncurrent liabilities Note payable (50,000) Use (50,000) Stockholders' equity Common stock 50,000 Source 50,000 Retained earnings Net loss (27,000) Use (27,000) Dividends 3,000 Use (3,000) Total (net cash flow) $ (19,000) Preparing the Statement of Cash Flows: Step 4 Adjusted Effect Classification Code sources of cash as positive numbers and uses of cash as negative numbers.

Preparing the Statement of Cash Flows: Step 5 Ed's Pizza Hut Statement of Cash Flows Worksheet Change Source or Use? Cash Flow Effect Adjustments Adjusted Effect Assets (except cash and Current assets Accounts receivable $ (17,000) Source $ 17,000 - $ 17,000 Inventory 50,000 Use (50,000) - (50,000) Noncurrent assets Land (32,000) Source 32,000-32,000 Equipment - - - - Contra Assets, Liabilities, Contra assets Accumulated depreciation 6,000 Source 6,000-6,000 Current liabilities Accounts payable 11,000 Source 11,000-11,000 Salaries payable (5,000) Use (5,000) - (5,000) Noncurrent liabilities Note payable (50,000) Use (50,000) 50,000 - Stockholders' equity Common stock 50,000 Source 50,000 (50,000) - Retained earnings Net loss (27,000) Use (27,000) - (27,000) Dividends 3,000 Use (3,000) - (3,000) Total (net cash flow) $ (19,000) $ - $ (19,000) { Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero. Classification We need to make an adjustment for the noncash transaction.

Preparing the Statement of Cash Flows: Step 6 Ed's Pizza Hut Statement of Cash Flows Worksheet Change Source or Use? Cash Flow Effect Adjustments Adjusted Effect Classification Assets (except cash and Current assets Accounts receivable $ (17,000) Source $ 17,000 - $ 17,000 Operating Inventory 50,000 Use (50,000) - (50,000) Operating Noncurrent assets Land (32,000) Source 32,000-32,000 Investing Equipment - - - - Contra Assets, Liabilities, Contra assets Accumulated depreciation 6,000 Source 6,000-6,000 Operating Current liabilities Accounts payable 11,000 Source 11,000-11,000 Operating Salaries payable (5,000) Use (5,000) - (5,000) Operating Noncurrent liabilities Note payable (50,000) Use (50,000) 50,000 - Stockholders' equity Common stock 50,000 Source 50,000 (50,000) - Retained earnings Net loss (27,000) Use (27,000) - (27,000) Operating Dividends 3,000 Use (3,000) - (3,000) Financing Total (net cash flow) $ (19,000) $ - $ (19,000)

Preparing the Statement of Cash Flows: Step 7 Ed's Pizza Hut Statement of Cash Flows For the Period Ending 3/31/2007 Operating Activities Net loss $ (27,000) Add: Decrease in accounts receivable 17,000 Increase in accounts payable 11,000 Increase in depreciation charges 6,000 Less: Increase in inventory (50,000) Decrease in salaries payable (5,000) Net cash flow from operations (48,000) Investing Activities Proceeds from sale of land 32,000 Financing Activities Dividends paid (3,000) Net change in cash (19,000) Copy the data from the worksheet into the Statement of Cash Flows section by section.

Preparing the Statement of Cash Flows: Step 8 Ed's Pizza Hut Statement of Cash Flows For the Period Ending 3/31/2007 Operating Activities Net loss $ (27,000) Add: Decrease in accounts receivable 17,000 Increase in accounts payable 11,000 Increase in depreciation charges 6,000 Less: Increase in inventory (50,000) Decrease in salaries payable (5,000) Net cash flow from operations (48,000) Investing Activities Proceeds from sale of land 32,000 Financing Activities Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending $ 71,000 Prepare a cash reconciliation at the bottom of the statement.

Preparing the Statement of Cash Flows Ed's Pizza Hut Statement of Cash Flows For the Period Ending 3/31/2007 Operating Activities Net loss $ (27,000) Add: Decrease in accounts receivable 17,000 Increase in accounts payable 11,000 Increase in depreciation charges 6,000 Less: Increase in inventory (50,000) Decrease in salaries payable (5,000) Net cash flow from operations (48,000) Investing Activities Proceeds from sale of land 32,000 Financing Activities Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending $ 71,000 In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity.

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Similarities and Differences in Handling Data Add (+) or Deduct (-) to Adjust to a Revenue or Expense Item Cash Basis Sales revenue (as reported) Adjustments to a cash basis: 1 Increases in accounts receivable - 2 Decreases in accounts receivable + Cost of goods sold (as reported) Adjustments to a cash basis: 3 Increase in merchandise inventory + 4 Decrease in merchandise inventory - 5 Increase in accounts payable - 6 Decrease in accounts payable + Operating expenses (as reported) Adjustments to a cash basis: 7 Increase in prepaid expenses + 8 Decrease in prepaid expenses - 9 Increase in accrued liabilities - 10 Decrease in accrued liabilities + 11 Period's depreciation, depletion and - amortization charges Income tax expense (as reported) Adjustments to a cash basis: 12 Increase in accrued taxes payable - 13 Decrease in accrued taxes payable + 14 Increase in deferred income taxes - 15 Decrease in deferred income taxes + Adjustments for accounts that affect revenue are the same in the direct method and indirect methods. In either case, increases in the accounts are deducted and decreases in the accounts are added. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. In the indirect method, an increase in prepaid expenses is deducted from net income. However, in the direct method an increase in prepaid expenses is added to operating expenses.

Computing Net Cash Provided by Operating Activities The direct method computes net cash provided by operating activities by reconstructing the income statement on a cash basis from top to bottom. Net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method.

Similarities and Differences in Handling Data Adjustments for accounts that affect revenue are the same in the direct and indirect methods. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods.

Similarities and Differences in Handling Data Under the direct method, no adjustments for gains and losses on the sale of assets are needed.

Special Rules Direct and Indirect Methods Direct Method Requires a reconciliation between net income and the net cash provided by operating activities Indirect Method Requires disclosure of amount of interest and income taxes paid during the year