Cash Flow Statement Chapter 14

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-2 Explains how a company obtained and used cash during a period of time. Helps managers answers questions such as: Are ongoing operations generating sufficient cash flows to remain viable? Cash Flow Statement Will we be able to meet our financial obligations? Will we be able to pay the usual dividend? Why is there a difference between net income and net cash flow? Will we have to borrow funds to make needed investments?

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-3 Cash Flow Statement Classifies cash inflows and outflows into three categories. Also includes reconciliation of beginning cash to ending cash.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-4 Direct Method or Indirect Method? 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 less than 5% of companies. Indirect Method Net income is reconciled to cash flow from operating activities. No supplemental schedule is required. Used by more than 95% of companies.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-5 Increases in noncash asset accounts imply uses of cash. Example:The inventory balance increases. It is implied that cash was used to acquire the additional inventory. Cash Flow Statement

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-6 Increases in liability accounts imply sources of cash. Example:Accounts payable increases due to purchases on credit from a supplier. It is implied that an increase in a payable has the effect of increasing cash available for other uses. Cash Flow Statement

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-7 Decreases in noncash assets accounts imply sources of cash. Example:A customer paid his bill. Cash Flow Statement When the customer pays his bill, the company’s cash increases.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-8 Decreases in liability accounts imply uses of cash. When the company makes the payment, its cash decreases. I.O.U. Example:The company made a payment on a note payable held by a creditor. Cash Flow Statement

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 14-9 Includes those activities that enter into the determination of net income Operating Activities

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Changes in current assets and current liabilities imply changes in cash. Changes in current assets and current liabilities are treated as indicated below: Operating Activities

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Operating Activities

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Operating Activities

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Amortization expense is added back to net income because it is a non- cash expense. Operating Activities

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Losses are added back to net income. Gains are subtracted from net income. Operating Activities

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Investing Activities Includes transactions that involve the acquisition or disposal of noncurrent assets

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Financing Activities Includes transactions involving receipts from or payments to creditors and owners

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 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. 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. Direct exchange transactions occur when noncurrent balance sheet items are swapped. Such exchanges must be disclosed. Noncash Investing and Financing Transactions

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement Let’s prepare a Cash Flow Statement using the T-account method.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-2

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-2

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-3

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-4

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-4

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-5

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Exhibit 14-5

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement-Indirect Method The previous statement of cash flow was presented under the direct method, a method recommended by the Canadian Institute of Chartered Accountants. Most companies, however, use the indirect method. The main difference is in the presentation of the operating activities section. The indirect method  starts with net income as reported on the income statement; then,  shows the adjustments necessary to convert the accrual-based net income figure to a cash-basis equivalent.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement-Indirect Method The conversion process is accomplished by the application of three basic rules. Rule 1: Increases in current assets are deducted from net income, and decreases in current assets are added to net income. Rule 2: Increases in current liabilities are added to net income, and decreases in current liabilities are deducted from net income. Rule 3: All noncash expenses and losses are added to net income, and all noncash revenue and gains are subtracted from net income.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement Let’s prepare a Cash Flow Statement using the indirect method.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Al’s Bakery supplies a variety of pastry products to restaurants in a large city. Al’s Bakery has prepared an adjusted trial balance as of 12/31/X1 and needs help preparing the Cash Flow Statement. Examine the information provided and prepare a Cash Flow Statement using the indirect method. Cash Flow Statement – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Statement of Cash Flows – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Additional Information During the year, Al’s Bakery: Sold land originally costing $32,000 for $32,000. Paid dividends of $20,000 to the stockholders. Issued $50,000 of common stock to settle the note due to Smith Supplies. Cash Flow Statement – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method Always start with the net income or net loss for the period. NL = Revenue – Expenses NL = $727,000 – ($748,000 + $6,000) NL = $727,000 – $754,000 NL = $27,000 Loss NL = Revenue – Expenses NL = $727,000 – ($748,000 + $6,000) NL = $727,000 – $754,000 NL = $27,000 Loss

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Depreciation expense is a noncash expense that must be added back to net income. Cash Flow Statement – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method The Statement of Cash Flows has three major sections and shows a reconciliation of beginning cash with ending cash.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method Cash flow from operating activities comes from the schedule just prepared.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method Cash flows from financing and investing activities may come from sources other than the trial balance.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash Flow Statement – Indirect Method These amounts come from the trial balance and can be used as “check figures” to verify the completeness of the statement.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Importance of Cash Flow From Operations Negative cash flow from operations 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.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Cash T-bills Money Market Funds Commercial Paper Currency and Bank Accounts

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada This is my kind of CA$H FLOW! End of Chapter 14