STATEMENT OF CASH FLOWS Accounting ASW Summer 2007

Overview of statement of cash flows Explains changes in “Cash” during the period “Cash” is cash plus cash equivalents - Equivalents are highly liquid short-term investments - E.g., bank accounts, certificates of deposits, treasury bills and uncashed checks There are typically no “SCF” accounts - infer SCF amounts from income statement and balance sheet - typically prepared after the other statements - hardest statement to interpret

Uses of SCF Assess liquidity Alternate measure of performance Helpful in predicting free cash flows

Free Cash Flows Free cash flows=Cash from Operations + Cash from Investing Popular valuation approaches uses FCF - Firm value = net present value of future FCF However, net income is the best predictor of future free cash flows

Relation between NI and FCF In general, over the life of the firm Total(FCF) = Total(NI) The only difference is timing Most differences between NI and FCF reverse quickly - E.g., credit sales CF now < NI now CF late r > NI later

Classification on the SCF Specified by the FASB Follows the structure of the firm - Operating - Investing - Financing

Components of the Statement of Cash Flows Operating Cash Inflows Cash Outflows Collect from customers Pay suppliers Collect interest and dividends Pay interest Other operating receipts Other operating payments Pay taxes Pay employees

Investing Cash Inflows Sell PP&E Sell securities owned Receive loan repayments Cash Outflows Purchase PP&E Purchase securities Make loans

Financing Cash Inflows Borrow from creditors Issue equity securities Cash Outflows Repay amounts borrowed Repurchase stock Pay dividends

Formats for SCF Both direct and indirect are allowed In both formats –investing and financing formats are the same list sources and uses of cash –total operating cash flows is the same format for getting there differs

Direct method also lists sources and uses of cash for operating –preferred by FASB –rare in practice Indirect method operating section starts with net income –explains why cash from operations  NI –uses changes in other accounts to explain

When CF  NI, slack is picked up by changes in other balance sheet accounts –if sales > cash receipts, Accts. Receivable  s –if sales < cash receipts, Accts. Receivable  s –if purchases > cash paid, Accts. Payable  s –if purchases < cash paid, Accts. Payable  s –if purchases > cost of goods sold, Inventory  s –if purchases < cost of goods sold, Inventory  s

Preparing SCF (Indirect Method) Start with attached worksheet with beginning and ending balances of non-cash accounts at ends & change in middle As you work through, note each change that you’ve accounted for If every change is accounted for, it must add

Preparing the Statement of Cash Flows Changes in Assets Operating Investing Financing (1) Accounts Receivable x(-) (2) Inventories x(-) (3) Other Current Assets (Usually) x(-) (4) Investments in Securities 1 x(-) Property, Plant & Equipment (5) Cost 2 (Purchases) x(-) (6) Acc. Depr. 2 (Current Yr’s Depr.) x(+) (7) Other Noncurrent Assets (Usually) 1 x(-)

Changes in Liabilities and Shareholders’ Equity Operating Investing Financing (8) Accounts Payable x(+) (9) Notes Payable 1 x(+) (10) Current Portion of Long- Term Debt 3 x(+) (11) Other Current Liabilities (Usually) x(+) (12) Long-Term Debt 1 x(+) (13) Deferred income Taxes x(+) (14) Other Noncurrent Liabilities (Usually) 1 x(+) (15) Contributed Capital x(+)

Changes in Liabilities and Shareholders’ Equity Operating Investing Financing (16) Retained Earnings x(Net Inc)(+) x (Div.)(-) (17) Treasure Stock __________ _________ x(-) (18) Cash 1 Increases and decreases are generally disclosed separately. 2 For sales of PP&E (or other investments), profits are subtracted from net income in the operating section and the entire proceeds is included as a source of cash in the investing section. 3 Generally combined with long-term debt. Problem 4-26

Formats for the SCF Indirect Format (most common) Cash From Operations Net Income +Depreciation -Gain on Sale of PP&E -Increase in Accounts Receivable -Increase in Inventory -Increase in Other Current Assets +Increase in Accounts Payable +Increase in Other Current Liab. + Increase in Def. Income Taxes

Cash From Investing -Investments in Securities +Proceeds from Sales of Sec. -Investments in PP&E +Proceeds from Sales of PP&E -Invest. in Other NC Assets +Proceeds from Other NC Assets

Cash From Financing +Issuance of Notes Payable -Repayments of Notes Payable +Issuance of Long-Term Debt -Repayments of Long-Term Debt +Issuance of Common Stock -Dividends Paid -Repurchase of Common Stock

Sales of PP&E Recreate the journal entry CashSelling Price Acc. Depr.AD on Asset PP&EHC on Asset Gain on SalePlug goal is for only selling price to appear in investing to do that, subtract gain (add loss) in operating show selling price as a source of investing cash that takes care of the AD and PP&E on worksheet Problem 4-34, etc.

Direct Format (rare) Financing and investing sections are the same as in the indirect method The operating section is stated in terms of sources and uses of cash

Cash From Operations Cash Inflows +Collections from Customers +Interest and Dividends Received +Other Operating Receipts Cash Outflows -Payments to Suppliers -Payments to Employees -Interest Paid -Taxes Paid - Other Operating Cash Payments