Statement of Cash Flows Management Accounting: The Cornerstone for Business Decisions Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

Learning Objectives 1.Explain the basic elements of a statement of cash flows. 2.Prepare a statement of cash flows using the indirect method. 3.Calculate operating cash flows using the direct method. 4.Prepare a statement of cash flows using a worksheet approach.

Define Cash

The Statement of Cash Flows ◙ Provides information regarding ◙ Sources of funds – Where funds come from – referred to as Cash Inflows ◙ Uses of funds- Where they go – referred to as Cash Outflows ◙ They are organized into one of three groupings ◙ Cash flows from operating activities ◙ Cash flows from investing activities ◙ Cash flows from financing activities

How to classify activities and identify them as sources or uses of cash. Operating activities are the ongoing, day-to-day, revenue generating activities of an organization. Cash inflows from operating activities come from the collection of sales revenues. Cash outflows are caused by the payment of operating costs. The difference between the two produces the net cash inflow (outflow) from operations. Investing activities are those activities that involve the acquisition or sale of long-term assets. Long-term assets may be productive assets (e.g., acquiring new equipment) or long-term activities (e.g., acquiring stock in another company). 15-1

Financing activities are those activities that raise or (provide) cash from (to) creditors and owners. Although interest payments could be seen as financing outflows, the statement includes these payments in the operating activities. REQUIRED: Classify the following major activities as belonging to the operating, investing, or financing categories. Identify them as sources or uses of cash. How to classify activities and identify them as sources or uses of cash. 15-1

How to classify activities and identify them as sources or uses of cash. Calculation: 1.Issuing capital stock - Financing - Source 2.Retiring capital stock – Financing - Use 3.Purchasing long-term assets – Investing - Use 4.Reporting unprofitable operations – Operating – Use 5.Issuing long-term debt- Financing - Source 6.Selling long-term assets (e.g., plant, equipment, and securities) – Investing - Source 7.Reporting profitable operations – Operating - Source 8.Reducing long-term debt – Financing - Use 9.Paying cash dividends – Financing - Use 15-1

Illustration of Sources and Uses of Cash

Define Indirect & Direct Method of Calculating Operating Cash Flows ◙ Indirect method ◙ Computes operating cash flows by adjusting net income for items that do not affect cash flows ◙ Direct method ◙ Computes operating cash flows by adjusting each line on the income statement to reflect it as if the income statement were prepared on a cash basis

What are the five steps to prepare the statement of cash flows? 1.Compute the change in cash for the period 2.Compute the cash from operating activities 3.Identify the cash flows from investing activities 4.Identify the cash flows from financing activities 5.Prepare the statement of cash flows based on the previous four steps

Lemmons Company Comparative Balance Sheets for the Years Ended December 31, 2008 and 2009 Net Change DebitCredit Assets Cash $175,000 $210,000 $ 35,000 A/R 112, ,500 15,000 Invent. 60,000 70,000 10,000 P & E 410, ,000 40,000 A/D (210,000) (235,000) 25,000 Land 287,500 Tot. Assets $835,000 $910,000

Lemmons Company Comparative Balance Sheets for the Years Ended December 31, 2008 and 2009 Net Change DebitCredit L & S. E. A/P $ 95,000 $110,000 15,000 Mort. Pay 100,000 90,000 10,000 Comm. Stk 75,000 CCIEP 100,000 RE 465, , ,000 Tot L&SE $835,000 $910,000 $110,000

How to compute the change in cash flow. From the prior two slides, we extract the information on cash and cash equivalents: Net Changes Assets DebitsCredits Cash$175,000$210,000$35,000 REQUIRED: Calculate the change in cash flow. Calculation: The change in cash flow is simply the difference in the ending and beginning cash flows. $210,000 - $175,000 = $35,

Four Types of Adjustments ◙ Type A Adjustment ◙ Decreases in non-cash current assets or increases in current liabilities added to cash ◙ Type B Adjustment ◙ Increases in non-cash current assets or decreases in current liabilities deducted from cash ◙ Type C Adjustment ◙ Expense deductions that do not require the outlay of cash added as increases in cash (Add back non-cash items) ◙ Typed D Adjustment ◙ Elimination of any income items that belong in either the investing or financing section.

How to compute operating cash flows: indirect method. 1.Four types of adjustments from prior slide. 2.Current assets and liabilities extracted from Lemmons Company Net Changes CA DebitsCredits A/R$112,500$127,500$15,000 Invent.60,00070,00010,000 CL A/P$95,000$110,000$15,

Lemmons Company Income Statement For the Year Ended December 31, 2009 Revenues$400,000 Gain on sale of equipment10,000 Less: Cost of goods sold(230,000) Less: Depreciation expense(50,000) Less: Interest expense(10,000) Net income$12,000 Dividends of $50,000 were paid. REQUIRED: Calculate operating cash flows using the indirect method. How to compute operating cash flows: indirect method. 15-3

Calculation: Operating net income$120,000 Add (deduct) adjusting items: Increase in A/R(15,000)(B) Increase in Inventories(10,000)(B) Increase in A/P15,000(A) Depreciation expense50,000(C) Gain on sale of equipment(10,000)(D) Net cash from operating activities $150,000 How to compute operating cash flows: indirect method. 15-3

How to compute investing cash flows. a.Equipment with a net book value of $75,000 was sold for $85,000 (original purchase price cost was $100,000). New equipment was purchased. b.Information extracted from the comparative balance sheets of the Lemmons Company. Long-Term AssetsNetChanges DebitCredit P & E$410,000$450,000$40,000 A/D(210,000)(235,000)25,000 Land287,500287,500 REQUIRED: Calculate the investing cash flows. 15-4

Calculation: Sale of equipment$ 85,000 Purchase of equipment(140,000) Net cash from investing activities $(55,000) How to compute investing cash flows Beginning P & E $410,000 Purchase of Equipment? Less: Sale of Equipment100,000 Ending balance, P & E$450,000 ? = $450,000 + $100,000 - $410,000 = $140,000

How to compute financing cash flows. a.Net income of $120,000 was earned, while cash dividends of $50,000 were paid in b.Information extracted from the comparative balance sheets of the Lemmons Company. NetChanges DebitCredit Mort. Pay$100,000$90,000$10,000 CCIEP100,000100,000 RE465,000535,00070,000 REQUIRED: Calculate the financing cash flows. 15-5

Calculation: Payment of mortgage principle$(10,000) Payment of dividends(50,000) Net cash from financing activities $(60,000) How to compute financing cash flows Retained Earnings, End of 2008 $465,000 Net income (2008)120,000 Total$585,000 Less: Retained Earnings, End of ,000 Dividends paid in 2009$ 50,000

How to prepare the statement of cash flows. Cornerstones 15-2; 15-3; 15-4; 15-5 REQUIRED: Prepare a statement of cash flows for the Lemmons Company. Calculations: Lemmons Company Statement of Cash Flows For the Year Ended December 31,

How to prepare the statement of cash flows Cash flows from operating activities: Net income $ 120,000 Add (deduct) adjusting items: Increase in accounts receivable (15,000) Increase in inventory (10,000) Increase in accounts payable 15,000 Depreciation expense 50,000 Gain on sale of equipment (10,000) Net operating cash $ 150,000

How to prepare the statement of cash flows Cash flows from investing activities Sale of equipment Purchase of equipment (140,000) Net cash from investing activities (140,000) Cash flows from financing activities Payment of mortgage principle $ (10,000) Payment of dividends (50,000) Net cash from financing activities (60,000) Net increase in cash $ (50,000)

How to calculate cash flows using the direct method a. Current assets and liabilities extracted from Lemmons Company Net Changes CA DebitsCredits A/R$112,500$127,500$15,000 Invent.60,00070,00010,000 CL A/P$95,000$110,000$15,000

b. The income statement for Lemmons Company. Lemmons Company Income Statement For the Year Ended December 31, 2009 Revenues$400,000 Gain on sale of equipment10,000 Less: Cost of goods sold(230,000) Less: Depreciation expense(50,000) Less: Interest expense(10,000) Net income$12,000 REQUIRED: Calculate operating cash flows using the direct method. How to calculate cash flows using the direct method. 15-7

Calculation:IncomeCash StatementAdjustmentsFlows Revenues$400,000($15,000)$385,000 Gain on Sale 10,000(10,000) Less: COGS(230,000)15,000(225,000) (10,000) Less: Depn. Exp.(50,000)50,000 Less: Int. Exp.(10,000)(10,000) Net income$120,000 Net operating cash$150,000 How to calculate cash flows using the direct method. 15-7

Worksheet Approach to the Statement of Cash Flows ◙ As the transactions increase and become more complex a worksheet is a handy tool to organize in preparing a statement of cash flows. ◙ It uses a spreadsheet format, that is efficient and logical means to organize the data to proceed from to prepare a statement of cash flows. ◙ It is a tool for preparing a statement of cash flows. It is not the actual statement of cash flows.