Chapter 13 Cash Flow Statement

The Cash Flow Statement Provides information about cash receipts, cash payments, and the net change in cash during the period Chapter 13

Purpose of Cash Flow Statement Helps users assess Reasons for the difference between net earnings and net cash provided (used) by operating activities Investing and financing transactions during the period Company’s ability to generate future cash flows Chapter 13

Definition of Cash Cash may include cash equivalents (although not likely to in future) Cash equivalents are short-term, highly liquid investments that are readily converted to cash within a short period of time Chapter 13

Definition of Cash Examples include: Treasury bills Money market funds Short-term investments Short-term debt Because the definition of “cash” varies, companies must clearly define cash if “cash equivalents” are included Chapter 13

Format of Cash Flow Statement The format is designed around the three main activities of the business: Operating activities Investing activities Financing activities Chapter 13

Operating Activities Cash effects of transactions that create revenues and expenses that enter into determination of net earnings Balance sheet Includes noncash current assets and current liabilities on balance sheet Statement of earnings items Chapter 13

Investing Activities Purchasing and disposing of investments and productive long-lived assets using cash Lending money and collecting the loans Balance sheet Includes short-term investments and long-term asset items Chapter 13

Financing Activities Obtaining cash from issuing debt and repaying the amounts borrowed Obtaining cash from shareholders and paying them dividends Balance sheet Includes short-term notes payable, long-term liabilities, and shareholders’ equity items Chapter 13

Significant Noncash Activities If it does not affect cash, do NOT report in cash flow statement Report in separate note or supplementary schedule to the financial statements Chapter 13

Format of Cash Flow Statement COMPANY NAME Cash Flow Statement Period Covered Operating activities (List of individual items) $XX Net cash provided (used) by operating activities $XXX Investing activities (List of individual items) $XX Net cash provided (used) by investing activities XXX Financing activities Net cash provided (used) by financing activities XXX Net increase (decrease) in cash XXX Cash, beginning of period XXX Cash, end of period $xxx Chapter 13

Preparation of the Cash Flow Statement Step 1: Operating activities Determine the net cash provided (used) by operating activities by converting net earnings from an accrual basis to a cash basis Chapter 13

Preparation of the Cash Flow Statement Step 2: Investing activities Determine the net cash provided (used) by investing activities by analyzing changes in short-term investment and long-term asset accounts Chapter 13

Preparation of the Cash Flow Statement Step 3: Financing Activities Determine the net cash provided (used) by financing activities by analyzing changes in short-term notes payable and long-term liability and equity accounts Chapter 13

Preparation of the Cash Flow Statement Step 4: Cash Flow Statement Complete the cash flow statement and determine the net increase (decrease) in cash Chapter 13

Operating Activities ─Step 1 Net earnings must be converted from an accrual basis to a cash basis Conversion may be done by two methods: Indirect Direct Chapter 13

Indirect and Direct Methods Affects only operating activities section Arrive at the same total amount of cash provided (used) by operating activities Differ in disclosing the items that make up the total amount Investing and financing activities sections are the same Chapter 13

Indirect Method 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 Chapter 13

Convert Net Earnings to Net Cash Provided (Used) by Operating Activities Starts with net earnings and adds or deducts items not affecting cash to arrive at net cash provided (used) by operating activities Noncash expenses on statement of earnings Gains and losses on statement of earnings Changes in noncash current assets and current liabilities on balance sheet Chapter 13

Convert Net Earnings to Net Cash Provided (Used) by Operating Activities ─Indirect Method Chapter 13

Net Cash Provided (Used) by Operating Activities ANY CORPORATION Cash Flow Statement (Partial) — Indirect Method Year Ended December 31, 2009 Operating activities Net earnings $139,000 Adjustments to reconcile net earnings to net cash provided (used) by operating activities: Depreciation expense $15,000 Loss on sale of equipment 3,000 Decrease in accounts receivable 10,000 Increase in prepaid expenses (4,000) Increase in accrued expenses payable 55,000 79,000 Net cash provided by operating activities 218,000 Chapter 13

Direct Method CICA/IASB prefers the direct method but allows the use of either method Details cash receipts and payments Easier to understand Chapter 13

Cash Receipts from Customers The relationship among cash receipts from customers, revenues from sales, and changes in accounts receivable is: Chapter 13

Cash Payments to Suppliers The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is: Chapter 13

Cash Payments for Operating Expenses The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is: Chapter 13

Cash Payments for Income Taxes The relationship among cash payments for income taxes, income tax expense, and changes in income taxes payable is: Chapter 13

Summary of Conversion of Net Cash Provided (Used) by Operating Activities ─Direct Method Chapter 13

Net Cash Provided (Used) by Operating Activities ANY CORPORATION Cash Flow Statement (Partial) — Direct Method Year Ended December 31, 2009 Operating activities Cash receipts from customers $517,000 Cash payments For operating expenses $(210,000) For income taxes (89,000) (299,000) Net cash provided by operating activities 218,000 Chapter 13

Investing Activities ─Step 2 Examine the balance sheet to determine changes in short-term investments and long-term assets Chapter 13

Financing Activities ─Step 3 Examine the balance sheet to determine changes in short-term notes payable, noncurrent liabilities and shareholders’ equity accounts (except net earnings) Chapter 13

Cash Flow Statement ─Step 4 Complete the cash flow statement Determine increase (decrease) in cash Ensure ending cash balance agrees to that reported on balance sheet Identify any noncash disclosures Chapter 13

Discussion Question If a company acquired a piece of equipment by issuing common shares how would this be reported in the cash flow statement? Discussion points: Transaction should be disclosed in the notes as a non-cash investing/financing activity. Chapter 13

ANY CORPORATION Cash Flow Statement (Partial) Year Ended December 31, 2009 (Sample Format) Net cash provided by operating activities (Continued) $218,000 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) Financing activities Payment of cash dividends $15,000 Net cash used by financing activities (15,000) Net increase in cash 22,000 Cash, January 1 34,000 Cash, December 31 $ 56,000 Chapter 13

Using Cash Flows to Evaluate a Company Liquidity Cash current debt coverage Solvency Cash total debt coverage Chapter 13

Cash Current Debt Coverage Ratio Measures short-term debt paying ability (cash basis) Cash provided (used) by operating activities Average current liabilities Higher is better Chapter 13

Cash Total Debt Coverage Ratio Measures long-term debt paying ability (cash basis) Cash provided (used) by operating activities Average total liabilities Higher is better Chapter 13

Discussion Question What accrual-based ratios should the cash coverage ratios be compared to? Discussion points: The cash current debt coverage ratio should be compared to the current ratio. The cash total debt coverage ratio should be compared to the debt to total assets ratio. Any significant discrepancies between the cash-based ratios and the accrual-based ratios could indicate a significant amount of accruals. Chapter 13

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