403MSBASOCF.ppt1 Statement of Cash Flows Links Balance Sheet and Income Statement elements to change in cash position. Integral part of “holy trinity” of financial statements … shows the ability of the firm to generate cash (given normal assumptions like continuity, stability etc.) “Undoes” some accrual accounting adjustments underlying the income statement. Presents cash flows logically organized by source or type of activity generating the cash flows.

403MSBASOCF.ppt2 Statement of Cash Flows Two ways to prepare: –Direct method: Start with cash collected from customers and cash paid for operating activities. Also shows reconciliation of net income to change in cash position as well. –Indirect method: Start with net income, add back non-cash expenses, adjust changes in assets and liabilities and end with net increase or decrease in cash.

403MSBASOCF.ppt3 Statement of Cash Flows Exhibit 5-4 of Brownlee et. al. lays out the differences in the two methods clearly. Main things to note are: Depreciation and other “non-cash charges” and adjustments for changes in assets and liabilities appear only in the indirect method SCF. Both statements are similar beyond the derivation of CFOPS.

403MSBASOCF.ppt4 Statement of Cash Flows In the US SCF has 3 sections: –Cash flow from operations Cash generated by selling goods & services –Cash flow from investing activities Cash used/generated by changes in long-term assets –Cash flow from financing activities Cash used/generated by changes in equity & debt.

403MSBASOCF.ppt5 Statement of Cash Flows Direct method requires more information/computation. E.g to compute cash collected from customers Cash collected = Credit Sales +/- Decrease/Increase in Accounts Receivable If cash and credit sales are/can not be separately identified in the problem, then replace “Credit Sales” in the equation with “Sales”.

403MSBASOCF.ppt6 Statement of Cash Flows To compute cash paid to suppliers, Cash paid = Purchases +/- Decrease/Increase in Accounts Payable If Purchases are/can not be separately identified in the problem, then need to compute purchases as: Ending Inventory + Cost of Goods Sold – Beginning Inventory.

403MSBASOCF.ppt7 Statement of Cash Flows To compute cash paid to suppliers, Cash paid = Purchases +/- Decrease/Increase in Accounts Payable If Purchases are/can not be separately identified in the problem, then need to compute purchases as: Ending Inventory + Cost of Goods Sold – Beginning Inventory.

403MSBASOCF.ppt8 Statement of Cash Flows Non-cash items (depreciation, amortization) are expenses that do not have to be “paid” to outside entities. Hence they are not a use of cash in the direct method. In the indirect method, depreciation has already been subtracted to compute net income, so we must add it back to compute cash from operations. Hence non-cash items are informally called “sources” of cash. This does not mean more deprecitation expense increases the cash balance.

403MSBASOCF.ppt9 Statement of Cash Flows In general, increases in assets is a use of cash – increases in current assets represent a use of cash in operations. Decreases in current assets are sources of cash from operations. In general increases in liabilities is a source of cash – increases in current liabilities represent a source of cash from operations. Decreases in current liabilities are uses of cash from operations.