“How Well Am I Doing?” Statement of Cash Flows Chapter 16 “How Well Am I Doing?” Statement of Cash Flows

Purpose of the Statement of Cash Flows Can we meet our obligations to creditors? Are cash flows sufficient to support ongoing operations? Why is there a difference between net income and net cash flow? Will the company have to borrow money to make needed investments? Can we pay dividends?

Currency and Bank Accounts Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Currency and Bank Accounts T-bills Cash Commercial Paper Money Market Funds

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Net Income Dividends Paid to Stockholders Changes in Noncash Assets Changes in Liabilities Changes in Capital Stock Net Cash Flows for a Period

Exh. 16-2 Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Increases in noncash asset accounts imply uses of cash. Example:Inventory is purchased on credit from a supplier. It is implied that cash was used to acquire the inventory.

Example: Inventory is purchased on credit from a supplier. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Increases in liability accounts imply sources of cash. Example: Inventory is purchased on credit from a supplier. It is implied that an increase in a payable has the effect of increasing cash available for other uses.

When the customer pays his bill, the company’s cash increases. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Decreases in noncash assets accounts imply sources of cash. Example: Accounts receivable decreases when a customer pays their bill. When the customer pays his bill, the company’s cash increases.

When the company makes the payment, cash decreases. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Decreases in liability accounts imply uses of cash. Example: The company made a payment on a note payable held by a creditor. I.O.U. When the company makes the payment, cash decreases.

Constructing a Simplified Statement of Cash Flows Cash flows are divided into three categories.

Constructing a Simplified Statement of Cash Flows A reconciliation of beginning cash to ending cash is also required. {

Operating Activities Includes those activities that enter into the determination of net income

Operating Activities Changes in current assets and current liabilities imply changes in cash, as indicated below.

Operating Activities

Operating Activities

Operating Activities Depreciation and Amortization charges are added back to net income because they are decreases in noncash assets.

Operating Activities Gains are subtracted from net income. Losses are added back to net income.

Investing Activities Includes transactions that involve the acquisition or disposal of noncurrent assets.

Financing Activities Includes transactions involving receipts from or payments to creditors and owners.

Other Cash Flow Issues For investing activities and financing activities, like-kind inflows and outflows of cash must be shown separately on the statement of cash flows. Example: XYZ sells an old building for $700,000 and purchases a new building for $1,000,000. The $700,000 inflow of cash and the $1,000,000 outflow of cash must be shown separately.

Direct Method or Indirect Method? Net income is reconciled to cash flow from operating activities. No supplemental schedule is required. Used by 99% of companies. Direct Method Net income is reconstructed on a cash basis. Requires a supplemental reconciliation of net income to cash flow from operating activities. Used by 1% of companies.

Such exchanges must be disclosed. Other Cash Flow Issues Direct exchange transactions occur when noncurrent balance sheet items are swapped. Such exchanges must be disclosed. Example: Bobo, Inc. acquires a building in exchange for 2,000 shares of common stock. This is reported in a separate supplemental schedule attached to the statement of cash flows.

Interpretation of the Statement of Cash Flows Examine the operating activities section carefully. Negative cash flow is usually a sign of fundamental difficulties. Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.

Example - Indirect Method Ed’s Hut is a local pizza restaurant. Ed has prepared an adjusted trial balance as of March 31, 2003. Ed needs help preparing the Statement of Cash Flows. Examine the information provided and prepare a Statement of Cash Flows using the indirect method.

Example - Indirect Method

Example - Indirect Method Additional Information: There was a net loss for the year of $27,000. Dividend charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.

Example - Indirect Method Always start with the net income or net loss for the period.

Example - Indirect Method

Example - Indirect Method Depreciation charges represent a decrease in a noncash asset that must be added back to net income.

Example - Indirect Method

Example - Indirect Method

Example - Indirect Method

Example - Indirect Method In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity.

Now, this is what I call CA$H FLOW! End of Chapter 16 Now, this is what I call CA$H FLOW!