FINANCIAL ACCOUNTING A USER PERSPECTIVE Hoskin Fizzell Davidson Second Canadian Edition

Cash Flow Statement Chapter Five

Ajax Widget Company Product Line –Ajax Widget company sells widgets Supplier Credit –Widgets cost Ajax $4 each. –All inventory must be paid in cash when it is ordered.

Ajax Widget Company Sales/Customer Credit –Ajax sells the widgets for $5 each –Ajax allows customers up to 30 days to pay –Assume: customers pay 30 days after a sale

Ajax Widget Company Inventory Policy –Ajax must maintain sufficient inventory for customer purchases –Ajax’ inventory at the end of a period is equal to 50% of the current month’s sales

Ajax Widget Company

Net income is growing Increased level of sales is shown in: –Accounts receivable –Inventory

Ajax Widget Company

Cash-to-Cash Cycle Cash Inventory Purchase (cash outflow) Sale of Widget Collection (cash inflow)

Cash-to-Cash Cycle Lead/lag relationship between –cash paid out to buy inventory, and –cash coming in from collections of accounts receivable

Income Statement –measures performance at a point in the cycle –ignores timing differences between revenues and expenses and the related cash flows –not useful in tracking cash flows

Income and Cash Flow Statements Income Statement –summarizes the profitability of the company’s operations Cash Flow Statement –summarizes the cash flows

Ajax Widget Company

Cash flow has been negative for the first three months March 31 cash balance: $900. Will the company run out of cash? What will it do to continue doing business?

Ajax Widget Company Net Income, Cash Flow, and Cash Balance Forecast

Ajax Widget Company Net cash flow will be negative for the next three months The trend is improving What will happen in July? Should the company take out a loan, or establish a line of credit, with the bank?

Cash Flow Solutions Capitalization –the amount of cash the company starts with Start-up companies tend to be under-capitalized How should start-up companies manage their cash flows?

Cash Flow Solutions Growth –Slow down the rate of growth of sales May be detrimental in the long run May divert customers to competitors

Cash Flow Solutions Capitalization –Start with a larger amount of cash Issue additional shares borrow the cash (debt)

Cash Flow Solutions Lead/Lag Relationships –change the relationships between cash inflows and outflows change the policies regarding accounts receivable, accounts payable, or inventory

Cash Flow Statement Cash and Cash Equivalents –short-term, highly liquid investments that are readily convertible into known amounts of cash

Cash Flow Statement Financing Activities Investing Activities Operating Activities

Cash Flow Statement Financing activities –obtaining and repaying resources from shareholders and lenders –Examples: shares, bonds, mortgages, notes, dividends

Cash Flow Statement Investing Activities –investment, sale or disposal of long-term assets –Examples: property, plant, equipment, long-term marketable securities

Cash Flow Statement Operating Activities –sale of goods and services to customers –changes to current assets and current liabilities

Cash Flow Statement Approaches –Direct approach theoretically informative rarely used –Indirect approach normally used in published statements

Cash Flow Statement Direct and Indirect Approaches –differ only in format and content of the Operating Activities section –Investing Activities and Financing Activities sections are the same

Cash Flow Statement Indirect approach –shows only net cash flows from operating activities –then shows adjustments to net income to arrive at net cash flows from operations

Cash Flow Statement Indirect approach –Adjustments: Items from the income statement that do not involve cash flows –Amortization, deferred income taxes, loss on sale of capital assets Net changes in noncash working capital –current assets and current liabilities

Cash Flow Statement Change in the Current Account Current Asset Current Liability Subtract Increase Decrease SubtractAdd

Preparation of the Cash Flow Statement (Indirect Approach) Using T-Accounts –need balance sheet, income statement, and additional information –objective is to reconstruct all transactions affecting cash

Preparation of the Cash Flow Statement (Indirect Approach)

Operating: (1) Net income: $12,480

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (2) Decrease in A/R: $10,000

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (3) Increase in Inventory: $10,000

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (4) Increase in Prepaid Rent: $100

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (5) Increase in A/P: $5,000

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (6) Increase in Acc.Sal.: $100

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (7) Amortization: $20,000

Preparation of the Cash Flow Statement (Indirect Approach) Operating: (8) Gain on sale of equip.: $300 Financing: (8) Sale of equipment: $500

Preparation of the Cash Flow Statement (Indirect Approach) Investing:(9) Purchase of PP&E: $60,000

Preparation of the Cash Flow Statement (Indirect Approach) Financing:(10) Proceeds from note: $100

Preparation of the Cash Flow Statement (Indirect Approach) Financing:(11) Proceeds from bond: $8,000

Preparation of the Cash Flow Statement (Indirect Approach) Financing:(12) Repayment of bond: $2,000

Preparation of the Cash Flow Statement (Indirect Approach) Financing:(13) Issue of shares: $4,000

Preparation of the Cash Flow Statement (Indirect Approach) Financing: (14) Pmt. of dividends: $1,230 Declaration of dividends: $1,400

Preparation of the Cash Flow Statement (Indirect Approach)

Huskies Industries Ltd. Cash Flow Statement For the Year Ended December 31, 2001 Operating activities: Net income$12,480 Add back items not representing cash flows: Amortization 20,000 Gain on disposal (300) (Continued)

Huskies Industries Ltd. Cash Flow Statement For the Year Ended December 31, 2001 Operating activities: Adjustments for working capital items: Decrease in Accounts Receivable 10,000 Increase in Inventory (10,000) Increase in Prepaid Rent (100) Increase in Accounts Payable 5,000 Increase in Salaries Payable 100 Cash from operating activities 37,180

Huskies Industries Ltd. Cash Flow Statement For the Year Ended December 31, 2001 Financing activities: Issue of Notes Payable 100 Issue of Common Shares 4,000 Issue of Bonds Payable 8,000 Payment of Bonds Payable (2,000) Payment of Dividends (1,230) Cash from operating activities 8,870

Huskies Industries Ltd. Cash Flow Statement For the Year Ended December 31, 2001 Investing activities: Purchase of Property, Plant and Equipment (60,000) Sale of Property, Plant and Equipment 500 Cash used for operating activities (59,500)

Huskies Industries Ltd. Cash Flow Statement For the Year Ended December 31, 2001 Decrease in Cash (13,450) Cash - beginning of the year 19,500 Cash - end of the year $ 6,050