The Statement of Cash Flows Chapter 14 ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-1

Learning Objective 1 Identify the purposes of the statement of cash flows and distinguish among operating, investing, and financing cash flows ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-2

Purpose of the Statement of Cash Flows Reports on the cash flows of a business. Reports why cash increased or decreased during the period. Covers the same period of time as the income statement. Can be used to: Predict future cash flows. Evaluate management decisions. Predict ability of the company to pay debts and dividends. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-3

Timing of the Financial Statements

Classification of Cash Flows Cash Flows From: Operating Activities Investing Activities Financing Activities Cash receipts and disbursements related to revenue or expense activities. Includes cash flows related to: interest income and expense dividend revenue income tax expense ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-5

Classification of Cash Flows Cash Flows From: Operating Activities Investing Activities Financing Activities Cash receipts and disbursements related to increases and decrease in long-term assets, including: PP&E Notes Receivable Investments ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-6

Classification of Cash Flows Cash Flows From: Operating Activities Investing Activities Financing Activities Cash receipts and disbursements related to increases and decreases in long-term liabilities and equity. Includes: BorrowingBorrowing Issuing stockIssuing stock Paying dividendsPaying dividends ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-7

©2014 Pearson Education, Inc. Publishing as Prentice Hall14-8 Most Important Category Generate revenues, expenses, gains, and losses Affect net income on the income statement Affect current assets and current liabilities on the balance sheet

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Two Formats for Operating Activities Indirect Method Starts with accrual net income. Adjusts net income to net cash from operations using known relationships. Direct Method Restates the Income Statement in terms of cash Shows actual cash receipts and cash disbursements. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-10

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Learning Objective 2 Prepare the statement of cash flows by the indirect method ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-17

Preparing a Statement of Cash Flows with the Indirect Method Information Needed: Current Income Statement Current Balance Sheet Immediate past Balance Sheet Changes in long-term assets and long-term liabilities Changes in equity To compute Cash Flows from Operations, we need: Net Income Non-cash expenses Gains/Losses Changes in current assets and current liabilities ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-18

Computing Cash Flows from Operating Activities ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-19

Changes in Current Assets (other than cash) and Current Liabilities Change Effect on cash Current assets Current liabilities 20

Comparative Balance Sheet Net decrease in cash. The answer you are working towards.

Computing Cash Flows from Operating Activities Smart Touch Learning’s Net Income for 2015 is $40,000 ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-22

Computing Cash Flows from Operating Activities Non-cash expense include Depreciation, Depletion and Amortization. Depreciation is $20,000. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-23

Computing Cash Flows from Operating Activities Smart Touch Learning has no Losses, but has a $10,000 Gain on Disposal of Plant Assets. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-24

Computing Cash Flows from Operating Activities Smart Touch Learning’s Inventory decreased by $2,000 during 2015, and A/R increased by $17,000. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-25

Computing Cash Flows from Operating Activities Smart Touch Learning’s Accounts Payable increased by $40,000 during ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-26

Computing Cash Flows from Operating Activities Smart Touch Learning’s Accrued Liabilities decreased by $5,000 during ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-27

Reporting Cash Flows from Operating Activities ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-28

Computing Cash Flows from Investing Activities Smart Touch Learning’s records indicate: $310,000 in plant assets were purchased with cash during The $10,000 gain resulted from selling plant assets with a cost of $55,000 and accumulated depreciation of $15,000 for $50,000. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-29

Reporting Cash Flows from Investing Activities ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-30

Computing Cash Flows from Financing Activities Smart Touch Learning’s records indicate: $90,000 was borrowed on a note payable. $10,000 was paid to retire old notes. $120,000 was received from issuing shares of common stock. $20,000 was paid to acquire treasury stock. $10,000 in dividends were paid. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-31

Reporting Cash Flows from Financing Activities ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-32

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©2014 Pearson Education, Inc. Publishing as Prentice Hall14-34 I O F F O I O O

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Learning Objective 3 Use free cash flow to evaluate business performance ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-36

Free Cash Flow Measures the amount of cash flow available for unexpected opportunities. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-37

Free Cash Flow Smart Touch Learning expects operating cash flow of $200,000. They plan to spend $160,000 to modernize its production facilities, and to pay $15,000 in cash dividends. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-38

Learning Objective 4 Prepare the statement of cash flows by the direct method (Appendix 14A) ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-39

Cash Flows from Operating Activities Each item on the income statement will be converted from the accrual basis to cash basis. Most of the amounts will be adjusted based on changes in current asset amounts and current liability amounts. Non-cash expenses and gains and losses will be ignored. ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-40

Gather Income Statement Items from the income statement not affecting cash

Comparative Balance Sheet

Cash Flows from Operating Activities Cash Collections from CustomersCash Collections from Customers $269,000 = 286, ,000-90,000 Cash Receipts of InterestCash Receipts of Interest 12,000 = 12, – 0 ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-43

Cash Flows from Operating Activities Cash Receipts of DividendsCash Receipts of Dividends ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-44 Cash collections from dividends is $9,000 since there is no beginning or ending receivable balance related to dividends

Cash Flows from Operating Activities Payments to SuppliersPayments to Suppliers 14-45©2014 Pearson Education, Inc. Publishing as Prentice Hall Purchases = $156,000 (cogs) - $2,000 = $ 154,000 Cash Paid for inventory = Purchases + beg A/P – end A/P $154, ,000 – 90,000 = $114,000

Cash Flows from Operating Activities Payments to EmployeesPayments to Employees $56,000 = $56, – 0 Payments for Interest Expense and Tax ExpensePayments for Interest Expense and Tax Expense ©2014 Pearson Education, Inc. Publishing as Prentice Hall14-46

Net Cash Provided by Operating Activities Add them all together

Indirect Format Direct Format