College Accounting, by Heintz and Parry Chapter 24: Statement of Cash Flows

Nick seldom came to work in a bad mood, so Eddie was pretty surprised by his behavior that Thursday. “Rick Swagger isn’t going to finalize the deal to invest unless we can give his accountant a statement of cash flows. Here, I’ll make the statement: ‘Cash flows! It flows all the time.’ There’s his statement. What is he talking about, anyway? Is it something difficult?” “Not really, Nick. If you have the other statements, it’s largely a matter of recombining the numbers into a different format so that people can see what your sources and uses of cash are. I see why Rick’s accountant wants to have one. There are a lot of companies that are good at showing net income, but they end up going under because they don’t have any cash.” “Okay, well explain it to me as you do it. Curiosity killed my cat, Jingles, but it’s helped me stay in business.” n Stat e the mai n idea s you’ ll be talki ng abo ut

“A business is generally involved in three types of activities: 1) O perating activities are the transactions and events that occur day-to-day in the company’s efforts to generate revenue. Generally, these impact your current assets and liabilities. 2) I nvesting activities involve the buying and selling of your long-term assets (like your plant assets and your long-term investments in stocks or bonds). 3) F inancing activities are your transactions with your stockholders and creditors (people who loan you money). Most of the time, these impact your long-term liabilities and your owners’ equity accounts. A simple way to remember the three activities (and the order they go in) is to remember OIF, which is the sound you make when you accidentally get hit in the stomach.” n Stat e the mai n idea s you’ ll be talki ng abo ut

“There are also two methods for preparing a statement of cash flows. They only differ in how they report cash flows from operating activities: 1) The direct method converts the major revenue and expense categories into amounts of cash received or paid. 2) The indirect method starts by listing net income and then lists transactions that impact net income and cash flows in different ways. Because the direct method is the one preferred by the people who make the accounting rules, that’s the one we’ll use. n Stat e the mai n idea s you’ ll be talki ng abo ut

“The first line of the statement of cash flows is called “Cash received from customers.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Cash flows from operating activities: Cash received from customers $214,841 Cash received from customers is different from sales, because no cash is received from sales on account. Also, we received some money from customers this fiscal period for sales made in the last fiscal period. A formula to recognize these differences and convert sales into cash received from customers is: 6-month data Sales $215,569 + the decrease in accounts receivable (or - the increase in accounts receivable) = cash received from customers $214,841 You will need balance sheets from the last and the current fiscal period to calculate the change in accounts receivable. n Stat e the mai n idea s you’ ll be talki ng abo ut

“The second line of the statement of cash flows is called “Interest received.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Cash flows from operating activities: Cash received from customers $214,841 Interest received 628 Cash provided by operating activities $215,469 Interest received is different from interest revenue, because interest can be received in a different period from when it was earned. A formula to convert interest revenue into interest received is: 6-month data Interest revenue $693 + the decrease in interest receivable (or - the increase in interest receivable) - 65 = interest received $628 n Stat e the mai n idea s you’ ll be talki ng abo ut

“The following line is ‘Cash paid for merchandise.’” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Cash flows from operating activities: Cash received from customers $214,841 Interest received 628 Cash provided by operating activities $215,469 Cash paid for merchandise $(129,508) Cash paid for merchandise is not cost of goods sold for two reasons: we can purchase inventory in a different period from when we sell it, and we can pay for it in a different period from when we purchase it. The formula to convert cost of goods sold into cash paid for merchandise is: 6-month data Cost of Goods Sold $127,843 + the increase in inventory + 2,761 (or - the decrease in inventory) = cost of merchandise purchased $130,604 + the decrease in accounts payable (or - the increase in accounts payable) - 1,096 = cash paid for merchandise $129,508 n Stat e the mai n idea s you’ ll be talki ng abo ut

“The next line is ‘Cash paid for operating expenses.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Cash flows from operating activities: Cash received from customers $214,841 Interest received 628 Cash provided by operating activities $215,469 Cash paid for merchandise $(129,508) Cash paid for operating expenses (54,521) Cash paid for operating expenses is not equal to operating expenses for three reasons: 1) Supplies and prepayments can be paid in different periods than when they are used (and expensed). 2) Depreciation is an operating expense, but it usually does not involve the payment of cash in the current period (and the purchase of the assets is a financing activity, anyway). 3) Accrued and withheld payroll taxes are frequently accrued (expensed) in a different period than when they are paid. n Stat e the mai n idea s you’ ll be talki ng abo ut

The formula to convert operating expenses into cash paid for operating expenses is: 6-month data Operating Expenses $55,139 + the increase in supplies or prepayments (or - the decrease in supplies or prepayments) depreciation expense $55,017 + the decrease in accrued liabilities (or - the increase in accrued liabilities) = cash paid for operating expenses $54,521 n Stat e the mai n idea s you’ ll be talki ng abo ut

“The last disbursement for operating activities is ‘Interest paid.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Cash flows from operating activities: Cash received from customers $214,841 Interest received 628 Cash provided by operating activities $215,469 Cash paid for merchandise $(129,508) Cash paid for operating expenses (54,521) Interest paid (1,207) Total cash disbursed for op. activities (185,236) Net cash provided by op. activities $30,233 Interest paid is not interest expense when interest is paid in a different period from when it was accrued. The conversion formula is: 6-month data Interest Expense $1,295 + the decrease in interest payable (or - the increase in interest payable) - 88 = Interest paid $1,207 n Stat e the mai n idea s you’ ll be talki ng abo ut

“Once the operating activities are summarized, investing activities are listed. As a fairly new business, The CD Side of Town is not yet selling old plant assets. However, the purchase of the new point-of-sale computer system (and some new store equipment) represents cash used by investing activities.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Net cash provided by op. activities $30,233 Cash flows from investing activities: Purchased computer equipment $(4,500) Purchased store equipment (600) Net cash used by investing activities (5,100) n Stat e the mai n idea s you’ ll be talki ng abo ut

“The last section, financing activities, documents changes in debt or in owners’ equity (other than net income). At the CD Side of Town, we made some payments on our mortgage, and your withdrawals would also fall into this category, Nick.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Net cash provided by op. activities $30,233 Net cash used by investing activities (5,100) Cash flows from financing activities: Withdrawals by owner $(20,000) Principal payments on mortgage payable (848) Net cash used by financing activities (20,848) Net increase in cash and cash equivalents $4,285 n Stat e the mai n idea s you’ ll be talki ng abo ut

“At the bottom of the statement, the beginning and ending balances of cash and cash equivalents are used to confirm the accuracy of the net increase or decrease in cash. A cash equivalent, by the way, is a financial instrument so easily converted into cash that it is not informative to distinguish between them.” The CD Side of Town Statement of Cash Flows For Six Months Ended June 30, 2001 Net cash provided by op. activities $30,233 Net cash used by investing activities (5,100) Net cash used by financing activities (20,848) Net increase in cash and cash equivalents $4,285 Cash and cash equivalents, Jan. 1, ,383 Cash and cash equivalents, June 30, 2001 $12,668 n Stat e the mai n idea s you’ ll be talki ng abo ut

“Nick, you’ve certainly listened intently. Now we will see if you can pass the dreaded cash flow quiz: Question 1: What are the three types of activities on a statement of cash flows? Question 2: What balance sheet account is used to convert sales into cash received from customers? Question 3: What two balance sheet accounts are used to convert cost of goods sold into cash paid for merchandise? Question 4: The sale of new stock would be what type of activity? Question 5: The sale of an old building would be what type of activity?” n Stat e the mai n idea s you’ ll be talki ng abo ut

Answer 1: The three types of activities on a statement of cash flows are O perating, I nvesting, and F inancing (OIF). Answer 2: The balance sheet account used to convert sales into cash received from customers is accounts receivable. Answer 3: The two balance sheet accounts used to convert cost of goods sold into cash paid for merchandise are accounts payable and merchandise inventory. Answer 4: The sale of new stock would be a financing activity. Answer 5: The sale of an old building would be an investing activity. “Eddie, I only got three out of five. I guess I won’t be an expert on cash flow until I get some blood flow to my brain, ha ha.” n Stat e the mai n idea s you’ ll be talki ng abo ut