Copyright 2003 Prentice Hall Publishing Company1 Chapter 10 Preparing a Statement of Cash Flows

Copyright 2003 Prentice Hall Publishing Company2 Purpose of the Statement of Cash Flows l To show how the business acquired its cash during the current year l To show how the business spent its cash during the current year This information is crucial for decision makers predict future cash flows of the business.

Copyright 2003 Prentice Hall Publishing Company3 What Is Considered “CASH” For The Statement Of Cash Flows? l Cash includes cash and cash equivalents for purpose of the statement. l Cash Equivalents are n Short-term, highly liquid investments. n Easily convertible into known amounts of cash.

Copyright 2003 Prentice Hall Publishing Company4 Categories of Cash Flows Categories are based on activities related to cash flows: 1.Operating 1.Operating the business. 2.Investing 2.Investing in productive assets. 3.Financing 3.Financing the business. These are the sections of the Statement of Cash Flows.

Copyright 2003 Prentice Hall Publishing Company5 Cash Flows from Operating Activities Cash inflows and outflows that are directly related to income from normal operations. Inflows include: n Receipts from customers. n Interest on receivables. n Dividends received.

Copyright 2003 Prentice Hall Publishing Company6 Cash Flows from Operating Activities Cash inflows and outflows that are directly related to income from normal operations. Outflows include: n Payments to suppliers. n Interest paid on liabilities. n Income taxes paid. n Salary and wages payments to employees. Pay to the order of

Copyright 2003 Prentice Hall Publishing Company7 Cash Flows from Investing Activities l Cash inflows and outflows that are related to the purchase and sale of productive assets. l Inflows include proceeds from: n Sales of property, plant, and equipment. n Sales of investments in securities. n Collection of principal on loans made to others.

Copyright 2003 Prentice Hall Publishing Company8 l Cash inflows and outflows that are related to the purchase and sale of productive assets. l Outflows include payments for: n The purchase of property, plant and equipment. n The purchase of long-term investments. n Loans to others. Cash Flows from Investing Activities

Copyright 2003 Prentice Hall Publishing Company9 Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. Inflows include: n Proceeds from sale of stock. n Proceeds from sale of bonds and from borrowings. Cash Flows from Financing Activities

Copyright 2003 Prentice Hall Publishing Company10 Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. Outflows include: n Payments to purchase treasury stock. n Principal payments to retire bonds and loans. n Dividends paid to owners. Cash Flows from Financing Activities

Copyright 2003 Prentice Hall Publishing Company11 Preparing the Statement of Cash Flows The face of the statement includes: Net Cash Flows from Operating Activities +Net Cash Flows from Investing Activities +Net Cash Flows from Financing Activities =Net Cash Flows for the period + Beginning Cash Balance =End of period Cash Balance

Copyright 2003 Prentice Hall Publishing Company12 Two Alternative Approaches Indirect Method n Shows net cash inflow (outflow) from operations as an adjustment of net income. n Used by 97% of companies. Direct Method n Reports the components of cash from operations as gross receipts and payments. n Recommended by the FASB, but rarely used.

Copyright 2003 Prentice Hall Publishing Company13 Indirect Method  Net cash flows from operating activities are determined by... Starting with net income, then... Adding and subtracting items that reconcile net income to operating cash flows.  Requires an analysis of changes in all current asset and current liability accounts, except cash.

Copyright 2003 Prentice Hall Publishing Company14 Indirect Method  Noncash additions to net income:  Depreciation, depletion, and amortization.  All losses.  Noncash deductions from net income:  All gains.

Copyright 2003 Prentice Hall Publishing Company15 Summary of Differences Between Direct and Indirect Methods l The direct method provides more detail about cash from operating activities. n Shows individual operating cash flows. n Shows reconciliation of operating cash flows to net income in a supplemental schedule. l The investing and financing sections for the two methods are identical. l Net cash flow is the same for both methods.

Copyright 2003 Prentice Hall Publishing Company16 How Important Is The Statement Of Cash Flows? l It is crucial to the presentation of a complete picture of the financial status of a business. l Many businesses with great ideas and potential have failed due to their failure to manage their cash flows. l Remember, the statement is REQUIRED by GAAP.