STATEMENT OF CASH FLOWS Chapter 13 STATEMENT OF CASH FLOWS 2

Purpose of the Statement of Cash Flows Provides information about the cash receipts and cash payments of a business entity during the accounting period. Helps investors with questions about the company’s: Ability to generate positive cash flows. Ability to meet its obligations and to pay dividends. Need for external financing. Investing and financing transactions for the period.

Classification of Cash Flows The Statement of Cash Flows must include the following three sections: Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities

Cash Flows from Operating Activities Inflows from: Sales to customers. Interest and dividends received. + _ Cash Flows from Operating Activities Outflows to: Suppliers of merchandise and services. Employees. Lenders for interest. Governments for taxes.

Cash Flows from Investing Activities Inflows from: Selling investments and plant assets. Collecting of principal on loans. + _ Cash Flows from Investing Activities Outflows to: Payments to acquire investments and plant assets. Purchase debt or equity investments. Make loans.

Cash Flows from Financing Activities Inflows from: Short-term and long-term borrowing. Owners (for example, from issuing stock). + _ Cash Flows from Financing Activities Outflows to: Repayments of borrowed funds. Owners for dividends. Purchase treasury stock.

Cash and Cash Equivalents Currency Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes.

The operating cash flows section can be prepared using either the direct method or the indirect method. Let’s look at the Direct Method for preparing the Statement of Cash Flows.

Direct Method Cash Received from Customers Accrual basis revenue includes sales that did not result in cash inflows. Can be computed as: Decrease in receivables + = Cash Received from Customers Net Sales Increase in receivables – =

Direct Method Cash Received from Customers The A/R balance was $80,000 on 12/31/02 and $110,000 on 12/31/03. If accrual sales revenue for 2003 was $900,000, what was cash basis revenue? Decrease in receivables + = Net Sales $900,000 Cash Received from Customers Increase in receivables – =

Direct Method Cash Received from Customers The A/R balance was $80,000 on 12/31/02 and $110,000 on 12/31/03. If accrual sales revenue for 2003 was $900,000, what was cash basis revenue? Decrease in receivables Net Sales $900,000 Cash Received from Customers = $870,000 $30,000 Increase in receivables – =

Now that we understand the process, let’s look at some simplified formulas for computing direct method cash flows.

Direct Method Interest and Dividends Received

Direct Method Cash Paid for Merchandise Step 1 Step 2

Direct Method Cash Paid for Merchandise How much did Lug Lite pay for inventory in 2003? a. $900,000 b. $923,000 c. $947,000 d. $877,000 Purchases for 2003 were $935,000. Purchases = $900,000 + $35,000 Cash Paid for Merchandise in 2003 was $923,000. Cash Paid = $935,000 - $12,000

Direct Method Cash Payments for Expenses After deducting depreciation and other noncash expenses, the cash paid for expenses is affected by (1) whether the expense was prepaid, and (2) whether the expense was accrued. Cash Paid for Expenses = + Increase in prepaid expenses - Decrease accrued liabilities {

Now, let’s prepare a direct method Statement of Cash Flows for Grate Big Company.

Direct Method - Example

Direct Method - Example

Direct Method - Example

Direct Method - Example Additional Information Trading Securities were purchased during 2003 at a cost of $25,000. Equipment with a book value of $40,000 was sold during the year for $43,000. Equipment with a book value of $30,000 was destroyed during a freak flood in 2003. There was no insurance. Grate Big holds a 25% investment in Tiny Co. and accounts for it using the Equity Method.

Direct Method - Example Additional Information Grate Big’s tax rate is 40%. The Notes Payable to Bob’s Bank carry a 12% rate. The payments are due on the first day of each month. The Bonds Payable carry a 9% rate. Interest is payable semiannually on July 1 & Jan. 1. Grate Big sold stock during 2001 for $50,000. Grate Big received $10,000 dividends from Tiny Co.

Direct Method - Example Cash Received from Customers Cash Paid to Employees

Direct Method - Example Cash Paid for Inventory Cash Paid for Interest

Direct Method - Example Cash Paid for Taxes Other Operating Cash Flows

Direct Method - Example Cash Flows From Operating Activities

Equipment with a book value of $40,000 was sold for $43,000. Bonds Payable decreased from $250,000 to $150,000 during 2003. Notes Payable decreased from $70,000 to $60,000 during 2003.

Notice that the Ending Cash Balance per the Statement of Cash Flows agrees with the 12/31/03 Cash balance on the Balance Sheet.

Let’s look at the Indirect Method that is used by over 97% of all companies.

Indirect Method Cash Flows from Operating Activities Net Income Changes in current assets and current liabilities as shown on the following table. Cash Flows from Operating Activities Net Income + Losses and - Gains + Noncash expenses such as depreciation and amortization.

Use this table when adjusting Net Income to Operating Cash Flows. Indirect Method Use this table when adjusting Net Income to Operating Cash Flows.

Let’s prepare a complete Statement of Cash Flows using the Indirect Method.

Indirect Method - Example Joe’s Place has prepared the Balance Sheet as of March 31, 2003, and March 31, 2002. The Income Statement for the year ended 3/31/03 has also been prepared. Joe needs help preparing the Statement of Cash Flows. Joe’s Place

Indirect Method - Example The $8,000 gain was the result of selling land costing $32,000 for $40,000 during the period.

Indirect Method - Example

Indirect Method - Example Joe’s Place issued $50,000 of no par common stock to settle the $50,000 note payable.

Indirect Method - Example

Indirect Method - Example With the indirect method, always start with the net income or net loss for the period.

Indirect Method - Example

Indirect Method - Example Accounts receivable decreased. 3/31/03 3/31/02 $23,000 - $40,000 = $(17,000)

Indirect Method - Example Accounts payable increased. 3/31/03 3/31/02 $38,000 - $27,000 = $11,000

Indirect Method - Example Inventory increased. 3/31/03 3/31/02 $350,000 - $300,000 = $50,000

Indirect Method - Example Salaries payable decreased. 3/31/03 3/31/02 $ 9,000 - $14,000 = $(5,000)

Indirect Method - Example Add back non-cash expenses.

Indirect Method - Example Subtract gains.

Indirect Method - Example The operating cash flows amount comes from the schedule just prepared.

Indirect Method - Example Land originally costing $32,000 was sold for $40,000.

Indirect Method - Example Dividends of $20,000 were paid to owners during the year.

Indirect Method - Example Compute the net change in cash for the period.

Indirect Method - Example Complete the Statement of Cash Flows by reconciling beginning cash to ending cash.

Indirect Method - Example Note that the ending cash amount ties back to the Joe’s Place Balance Sheet at 3/31/03.

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

Indirect Method - Example In addition, cash interest payments and cash tax payments must also be disclosed separately.

Managing Cash Flows Cash Budgets are used by management to plan and forecast future cash flows.

Managing Cash Flows Increase collection of accounts receivables. Keep inventory low. Delay payment of liabilities. Plan timing of major expenditures. Invest idle cash.

Cash Budgeting The ending cash balance of one month becomes the beginning cash balance of the next month.

Cash Budgeting Financing is needed in June because the company must maintain a minimum cash balance of $10,000.

End of Chapter 13 Chester, ol’ buddy, I wonder if you could help me with a little cash flow problem I’m having?