“How Well Am I Doing?”Statement of Cash Flows

Chapter 15

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Purpose of the Statement of Cash Flows

Are cash flows sufficient to

support ongoing operations? Can we meet

our obligations to creditors?

Can we pay dividends?

Why is there a difference

between net income and net

cash flow?

Will the company have to borrow money to make

needed investments?

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Cash

The term cash on the statement of cash flows refers broadly to both currency and cash equivalents.

Cash

Treasury Bills

Money Market Funds

Commercial Paper

Currency and Bank Accounts

15-3

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

SourcesNet Income AlwaysNet LossChanges in noncash assets DecreasesChanges in liabilities* IncreasesChanges in capital stock accounts IncreasesDividends paid to stockholders

Total sources - Total uses = Net cash flow

* Contra asset accounts, such as the Accumulated Depreciation and Amortization account, follow the rules for liabilities.

Decreases

DecreasesAlways

Uses

AlwaysIncreases

15-4

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Example: Inventory is purchased on credit from

a supplier.

It is implied that cash was used to acquire the

inventory.

Increases in noncash assetnoncash assetaccounts imply usesuses of cash.

15-5

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

It is implied that an increase in a payable has the effect

of increasing cash available for other uses.

Increases in liabilityliability accounts imply sourcessources of cash.

Example: Inventory is purchased on credit from

a supplier.

15-6

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Decreases in noncash assetsnoncash assetsaccounts imply sourcessources of cash.

Example: Accounts receivable decreases when a customer

pays their bill.

When the customer pays the bill, the company’s cash

increases.

15-7

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Decreases in liabilityliability accounts imply usesuses of cash.

When the payment is made, cash decreases.

Example: A company pays a note payable held

by a creditor.

15-8

The Full-Fledged Statement of Cash Flows: Operating Activities

Operating activities are those activities that enter into the determination of

net income.

1. Transactions affecting current

assets

3. Changes in noncurrent

balance sheet accounts that

directly affect net income

2. Transactions affecting current

liabilities

15-9

The Full-Fledged Statement of Cash Flows: Investing Activities

Investing activities relate to transactions involving the acquiring or disposing of

noncurrent assets.

1. Acquiring or selling property,

plant and equipment

3. Lending money to another entity

and subsequently collecting on the

loan2. Acquiring or selling securities

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Financing activities relate to transactions involving borrowing

from creditors or repaying creditors and engaging in

transactions with the company’s owners.

1. Issuing stock and purchasing treasury stock

3. Payment of dividends (note that interest on

debt is classified as an operating

activity)2. Issuing long-term debt and

repayment of debt.

The Full-Fledged Statement of Cash Flows: Financing Activities

15-11

The Full-Fledged Statement of Cash Flows: An Overview

Operating Activities:Net incomeChanges in current assetsChanges in noncurrent assets that affect net income (e.g., depreciation)Changes in current liabilities (except for debts to lenders and dividends payable)Changes in noncurrent liabilities that affect net income

Investing Activities:Changes in noncurrent assets that are not included in net income

Financing Activities:Changes in the current liabilities that are debts to lenders rather than obligations to suppliers, employees, or the governmentChanges in noncurrent liabilities that are not included in net incomeChanges in capital stock accountsDividends

15-12

The Full-Fledged Statement of Cash Flows: An Overview

Operating Activities

Investing Activities

Financing Activities

Reconciliation of the beginning cash balance

with the ending cash balance

Noncash Investing and Financing

Activities15-13

Operating Activities

Sources of cash are added to net income and uses of cash are deducted from net income.

Impact on Net Cash Provided by Operating ActivitiesSources of Cash

(Add to Net Income)Uses of Cash

(Subtract from Net Income)Current

Noncash AssetsCurrent

Liabilities

Decreases

Increases

Increases

Decreases

15-14

Other Issues: Direct Method or Indirect Method?Two Formats for Reporting Operating Activities

Reports the cash effects of each operating

activity

Starts with accrual net income and converts to cash basis

Direct Method Indirect Method

No matter which format is used, the same amount of net cash provided by operating activities is generated.

15-15

A Full-Fledged Statement of Cash Flows: An Example

Let’s revisit the comparative

balance sheet account balances for Ed’s Pizza Hut.

Ed's Pizza HutComparative Balance Sheet Account Balances

3/31/2008 3/31/2007 ChangeDR (CR) DR (CR) Incr. (Decr.)

Cash 71,000$ 90,000$ (19,000)$ Accounts Receivable 23,000 40,000 (17,000) Inventory 322,000 300,000 22,000 Land 68,000 100,000 (32,000) Equipment 112,000 84,000 28,000 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)

-$ -$

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A Full-Fledged Statement of Cash Flows: An Example

note due to Joe Doe.

There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing

$32,000 for $32,000. During the year, Ed purchased equipment for

$28,000. During the year, Ed paid dividends of $3,000 to

the stockholders. Ed issued $50,000 of common stock to settle the

note due to Joe Doe.

Let’s also refresh our memory regarding the following additional information.

15-17

Operating ActivitiesNet Loss (27,000)$ Add: Decrease in A/R 17,000

Increase in A/P 11,000 Increase in Depr. Charges 6,000

Less: Increase in Inventory (22,000) Decrease in Salaries Payable (5,000)

Net Cash Provided by Operating Activities (20,000) Investing Activities

Proceeds from sale of Land 32,000 Purchase of equipment (28,000)

Net Cash Provided by Investing Activities 4,000 Financing Activities

Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending 71,000

Ed's Pizza HutStatement of Cash Flows

For the Period Ending 3/31/2008 In addition, on the face of the

statement or in a supplemental

schedule, disclosethe issuance of $50,000 of stock to a creditor, a

noncash financing activity.

Example – Indirect Method

15-18

Free Cash Flows

Free Cash Flow =Net Cash Provided by Operating Activities - Capital

Expenditures - Dividends

Free cash flow measures a company’s ability to fund its capital expenditures and dividends from

its net cash provided by operating activities.

15-19

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.

15-20

Similarities and Differences in Handling DataAdd (+) or

Deduct (-) to Adjust to a Cash Basis

Sales revenue (as reported)

Increases in accounts receivable -Decreases in accounts receivable +

Cost of goods sold (as reported)

Increase in merchandise inventory +Decrease in merchandise inventory -Increase in accounts payable -Decrease in accounts payable +

Operating expenses (as reported)

Increase in prepaid expenses +Decrease in prepaid expenses -Increase in accrued liabilities -Decrease in accrued liabilities +Period's depreciation, depletion and amortization charges

-

Income tax expense (as reported)

Increase in accrued taxes payable -Decrease in accrued taxes payable +Increase in deferred income taxes -Decrease in deferred income taxes +

Adjustments to a cash basis:

Revenue or Expense Item

Adjustments to a cash basis:

Adjustments to a cash basis:

Adjustments to a cash basis:

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.

15-21

The Direct Method: An Example

Operating ActivitiesCash received from customers 1,017,000$ Cash paid for purchases (761,000) Cash paid for operating expenses (276,000) Net Cash Provided by Operating Activities (20,000) Investing Activities

Proceeds from sale of land 32,000 Purchase of equipment (28,000)

Net Cash Provided by Investing Activities 4,000 Financing Activities

Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending 71,000$

Ed's Pizza HutStatement of Cash Flows

For the Period Ending 3/31/2008 Notice that the net cash

provided by operating

activities agreeswith that

computed using the indirect

method.

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End of Chapter 15

15-23