Cash Flow Statement

Why Cash Flow Statement? Shareholder value is now widely accepted as an appropriate standard for performance in US business. The stock market sends a clear message that earning per share is not the most important measure. Now is growth for growths sake. What matters is long-term cash generation. (Werner & LeBer, Managing for Shareholder Value--From Top to Bottom, Harvard Busines Review, Nov.- Dec pp )

Basic Form of Cash Flow Statement Cash Flow From Operating Activities –Direct method or indirect method (direct requires also a reconciliation of net income to cash flow from operating activities) Cash Flow from investing activities Cash Flow from financing activities Total (positive or negative) cash flow is added to beginning cash balance and should result in ending cash balance

Flow from Operating Activities Includes: –Current assets except Marketable securities and s-term notes receivable which are investing –Current Liabilities except s-t notes payable which are financing –Revenue and Expenses (includes interest expense and revenue, and dividends received)

Flow from Investing Activities Includes: –Short-term and long-term investments –Short-term and long term notes receivable –Property, Plant and Equipment (depreciation affects operating activities) –Intangible Assets

Flow from Financing Activities Includes: –Short-term and long-term loans –Capital Stock and Paid in Capital in excess of par –Retained earnings (net income aspect is operating) –Dividends Paid

General Theory Take revenue or expense account (includes cash and accrual) adjust out accrual amounts Result is net cash in or out. Too expensive to classify all cash transactions into operating, financing, investing activities. Cheaper to use accrual systems and adjust out accrual information

Operating Activities Indirect Method Net Income + Depreciation exp (noncash exp) + Losses from sale of assets –(full amount of sale already included in investing section) - Gains from sale of assets –(full amount of sale already included in investing section) - increases in current assets + decreases in current assets + increases in current liabilities - decreases in current liabilities = Net cash from operating activities

Operating Activities Direct Method + Cash Received from Customers - Cash paid for inventory - Cash paid for operating expenses - Cash paid for income taxes - Cash paid for interest + Cash received from dividends and interest = Net cash from operating activities

Cash Received from Customers Sales - Increase in A/R (receive less cash) OR + Decreases in A/R (receive more cash) - writeoffs ( beg allowance + bad debt exp. - ending allow ance) + Increase in unearned revenue (receive more cash) OR - Decrease in unearned revenue (receive less cash) = Cash Received from Customers

Cash Received from Customers (other variations) Sales + Beg Net A/R - End Net A/R - Bad debt exp adj - Beg unearned rev + End undearned rev = Cash from Customers Sales + Beg A/R - End A/R - writeoffs –= beg allowance + bad debt exp. - ending allowance - Beg unearned rev + End unearned rev = Cash from Customers

Cash Paid For Inventory Cost of Goods Sold + End Inventory - Beginning Inventory = Purchases + Beg A/P - End A/P = Cash paid for inventory

Cash Paid for Operating Expenses Operating Expenses (do not include interest exp., depreciation exp., nor gains & losses from sale of investments) - Beg prepaids + End prepaids + Beg accrued exp - End accrued exp = Cash paid for operating expenses

Cash Paid for Income Taxes Income Tax Exp + Beg tax payable - End tax payable = Cash paid for income Taxes

Cash Paid for Interest Interest Exp + Beg interest payable - End interest payable = Cash paid for interest

Cash Received from dividends and interest Dividend and Interest Income + Beg interest receivable - End interest receivable = Cash Received from dividends and interest

Cash Flow from Investing Activities Cash received (sale) or paid (purchase) for: –short term investments –long-term investments –property plant and equipment Whole cash amount received or paid. Look at change in investment and fixed asset accounts but may need more specific information

Example Equipment Balance Sheet Amount Change: Beg $300,000, Ending $400,000 Can your just say net cash out for equipment was $100,000? Why?

Example Equipment Continued Sold Equipment for $65,000 cash that had book value of $40,000 (original cost $100,000) Bought equipment $200,000 with $80,000 down and the rest on a long term note payable Accumulated depreciation increased by $50,000

Example Equipment Results on Cash Flow Statement Cash from sale of equipment $65,000 Gain on sale $25,000 subtracted from NI on indirect method (make sure amt is not included in direct method either) Depreciation exp $110,000 ($50,000 increase in accum deprec from B/S + $60,000 acum depr reduced when sold equip added back in indirect method (make sure amt is not included in direct method operating expenses Cash paid for purchase of equipment $80,000 Noncash investing & financing Activities –Issued long-term note payable for some equipment $120,000

Equipment Example Think about journal entries Cash 65,000 Accum Depr 60,000 Equip100,000 Gain 25,000 Sale of equipment Depr Exp110,00 Accum. Depr 110,000 Year end Adj J/E for equip depr. Equipment200,000 Cash 80,000 L-T Note Payable 120,000 Equip Purchase

Financing Activities Cash received from: –sale of stock –issuance of debt Cash paid for –Payment of debt (principle only, interest is in operating activities) –Payment of dividends Look at change in stock, debt and retained earnings (May need more details) (for R/E only dividends portion applies to financing activities while net income portion should tie into indirect method in operating activities)

Ways to Check Your Work Indirect and Direct methods must equal each other Net cash flow added to beginning cash balance must equal ending cash balance (Marketable securities are most often included as part of these cash balances.) In template must account for every change in B/S accounts and every item on income statement (some noncash items are adjusted out or not included in cash flow calculations)