Statement of Cash Flows Chapter 13 Financial Accounting

Highlights Purposes of a cash flow report Review of operating, financing and investing activities Preparation of the statement of cash flows Evaluation of a company’s cash flows

Why do we need a cash flow report? Outlines where cash came from and where it went Separates out inflows and outflows by activity type Helps identify ability to pay out dividends, and generate cash

Business Activity Review Operating Activities Cash effects of transactions that create revenues and expenses and Enter into determination of net earnings Keep in mind: Balance Sheet: Noncash Current Assets and Current Liabilities; Statement of Earnings Items

Business Activity Review Investing Activities Purchasing and disposing of investments and productive long-lived assets using cash and Lending money and collecting the loans Keep in mind: Balance Sheet: Investment and Long-Term Asset Items

Business Activity Review Financing Activities Obtaining cash from issuing debt and repaying the amounts borrowed and Obtaining cash from shareholders and paying them dividends Keep in mind: Balance Sheet: Long-Term Liability and Shareholders’ Equity Items

Statement of Cash Flow Sample COMPANY NAME Statement of Cash Flows Period Covered Cash flows from operating activities (List of individual items) XX Net cash provided (used) by operating activities XXX Cash flows from investing activities (List of individual items) XX Net cash provided (used) by investing activities XXX Cash flows from financing activities Net cash provided (used) by financing activities XXX Net increase (decrease) in cash XXX Cash at beginning of period XXX Cash at end of period XXX

Preparing a Statement of Cash Flows

Preparing a Statement of Cash Flows Next step look at the Statement of Earnings For the operations section – start off with the Net Income figure then adjust for all non-cash items (ie moving from accrual method to cash) Can use either the direct or indirect method for the Operations Section only will provide the same end results

Preparing a Statement of Cash Flows Also need comparative balance sheets (ie covering two years) Indirect method: Start off with net income Adjust for all noncash items on Earnings stmt (ie. depreciation & gains/loss on sale of assets) Add back or subtract normally all current items (both liabilities & assets – ie A/R, Inventory & A/P) Need to add or subtract the change from 1 yr to the next (ie if A/R goes up = deduct as not an increase in cash)

Preparing a Statement of Cash Flows Adjustments to Convert Net Earnings to Net Cash Provided (Used) by Operating Activities Add* Deduct* Change in Current Asset Account Balance Accounts Receivable Decrease Increase Inventory Decrease Increase Prepaid expenses Decrease Increase Other current assets Decrease Increase Change in Current Liability Account Balance Accounts payable Increase Decrease Accrued expenses payable Increase Decrease Other current liabilities Increase Decrease * Add (deduct) change in account balance to net earnings

Preparing a Statement of Cash Flows Adjustments to Convert Net Earnings to Net Cash Provided (Used) by Operating Activities Noncash Items on Statement of Earnings Amortization (of capital assets) expense Add Amortization of bond discount to interest expense Add Amortization of bond premium to interest expense Deduct Loss on sale of asset Add Gain on sale of asset Deduct Income from long-term equity investment Deduct

Preparing a Statement of Cash Flows - sample Food Sampling Services Statement of Cash Flows For the Year Ended December 31, 2002 Cash Flow from Operating Activities: Net Earnings $36,000 Adjustments to reconcile to cash: Amortization Expense $15,000 Loss on Sale of Equipment 3,000 Increase in A/R (2,000) Increase in Prepaid (1,000) Increase in A/R 20,000 38,000 Net Cash Provided by Operations $74,000

Indirect Method Used extensively in practice Most companies favour the indirect method for the following reasons Easier to prepare Focuses on the differences between net earnings and net cash flow from operating activities Reveals less company information to competitors

Direct Method CICA prefers the direct method but allows the use of either method Details cash receipts and payments Easier to understand

Direct Method Start off in the same way as the indirect method – with Net Income (Earnings) Breaks up the change in cash as related to Sales, COGS, operating exp and income tax expenses Next start off with your sales figure

Direct Method The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable is: Cash receipts from customers = Revenues from sales { + Decrease in accounts receivable or – Increase in accounts receivable

Direct Method The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is: Cash payments to suppliers = Cost of goods sold { + Increase in inventory or – Decrease in inventory + Decrease in accounts payable or – Increase in accounts payable

Direct Method The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is: Cash payments for services + Increase in Prepaid Expenses or – Decrease in Prepaid Expenses + Decrease in accrued expenses payable or – Increase in accrued expenses payable { Operating Expenses =

Statement of Cash Flows For the Year Ended December 31, 2002 Direct Method - sample New Suites Statement of Cash Flows For the Year Ended December 31, 2002 Cash Flows from Operating Activities: Cash Receipts from Customers $865,000 Cash Payments: To suppliers $550,000 To operating expenses $ 150,000 For income taxes $ 50,000 750,000 Net Cash Provided by Operations $1,615,000

Statement of Cash Flows Once operations section complete then move on to the Investing and Financing Sections

Investing Section Study the balance sheet to determine changes in investments and long-term assets Changes in each short-term investment (unless incorporated as part of cash definition) and long-term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

Financing Activities Study the balance sheet to determine changes in noncurrent liabilities and shareholders’ equity Changes in each noncurrent account are analyzed using selected transaction data to determine the effect, if any, the changes had on cash

Sample Net cash provided by operating 218,000 activities - continued Cash flows from investing activities Purchase of building ($160,000) Purchase of equipment ( 25,000) Sale of equipment 4,000 Net cash used by investing activities (181,000) Cash flows from financing activities Payment of cash dividends $ 15,000 Net cash used by financing activities ( 15,000) Net increase in cash 22,000 Cash at beginning of period 34,000 Cash at end of period $56,000

Evaluation of Cash Flows Liquidity Cash current debt coverage ratio Solvency Capital expenditure ratio Cash total debt coverage ratio Profitability Cash return on sales ratio

Evaluation of Cash Flows Accrual-based measures allow management discretion Getting back to the cash takes out some of the uncertainty

Cash Current Debt Coverage Ratio Since cash from operating activities involves the entire year rather than a balance at one point in time, the cash current debt coverage ratio is a better representation of liquidity than the current ratio Cash current debt coverage ratio = Cash provided by operating activities Average current liabilities

Capital Expenditure Ratio Indicator of company’s ability to generate sufficient cash to finance new capital assets (industry type has a significant effect on this ratio) Capital expenditure ratio = Cash provided by operating activities Capital expenditures

Cash Total Debt Coverage Ratio Measures a company’s ability to repay its liabilities from cash generated from operating activities Cash total debt coverage ratio = Cash provided by operating activities Average total liabilities

Cash Return on Sales Ratio Indicates ability to turn sales into cash Cash return on sales = Cash provided by operating activities Net sales

Chapter 13 Cash Flow Statement The end Chapter 13 Cash Flow Statement