PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA Chapter 13 “How Well Am I Doing?” Statement of Cash Flows

Purpose of the Statement of Cash Flows Are cash flows sufficient to support ongoing operations? Can we meet our obligations to creditors? Can we pay dividends? Why is there a difference between net income and net cash flow? Will the company have to borrow money to make needed investments? 13-2

Learning Objective 1 Classify changes in noncash balance sheet accounts as sources or uses of cash. 13-3

Definition of Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Cash Treasury Bills Money Market Funds Commercial Paper Currency and Bank Accounts 13-4

Net Cash Flows for a Period 1. Net Income 5. Dividends Paid to Stockholders 2. Changes in Noncash Assets 3. Changes in Liabilities 4. Changes in Capital Stock Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts 13-5

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts 13-6

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Example: Inventory is purchased on credit from a supplier. It is implied that cash was used to acquire the inventory. noncash asset uses Increases in noncash asset accounts imply uses of cash. 13-7

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts It is implied that an increase in a payable has the effect of increasing cash available for other uses. liability sources Increases in liability accounts imply sources of cash. Example: Inventory is purchased on credit from a supplier. 13-8

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts noncash assets sources Decreases in noncash assets accounts imply sources of cash. Example: Accounts receivable decreases when a company pays its bill. The company’s cash increases accordingly. 13-9

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts liability uses Decreases in liability accounts imply uses of cash. The company’s cash balance decreases accordingly. Example: If a company makes a payment on a note payable

A Simplified Statement of Cash Flows 13-11

Additional Information:  There was a net loss for the year of $27,000.  Depreciation charges for the year were $6,000.  During the year, Ed sold land originally costing $32,000 for $32,000.  During the year, Ed purchased equipment for $28,000.  During the year, Ed paid dividends of $3,000 to the stockholders.  Ed issued $50,000 of common stock to settle the note due to Joe Doe. Additional Information:  There was a net loss for the year of $27,000.  Depreciation charges for the year were $6,000.  During the year, Ed sold land originally costing $32,000 for $32,000.  During the year, Ed purchased equipment for $28,000.  During the year, Ed paid dividends of $3,000 to the stockholders.  Ed issued $50,000 of common stock to settle the note due to Joe Doe. A Simplified Statement of Cash Flows 13-12

A Simplified Statement of Cash Flows Here is a summary of the sources of cash for Ed’s Pizza Hut

A Simplified Statement of Cash Flows Here is a summary of the uses of cash. The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses

A Simplified Statement of Cash Flows This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only

Learning Objective 2 Classify transactions as operating, investing, or financing activities

The Three Sections of the Statement of Cash Flows Operating activities are those activities that enter into the determination of net income. 1. Transactions affecting current assets 2. Transactions affecting current liabilities 3. Changes in noncurrent balance sheet accounts that directly affect net income 13-17

The Three Sections of the Statement of Cash Flows Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. 1. Acquiring or selling property, plant and equipment 2. Acquiring or selling securities held for long-term investments 3. Lending money to another entity and subsequently collecting on the loan 13-18

Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. 1. Issuing stock and purchasing treasury stock 3. Payment of dividends (note that interest on debt is classified as an operating activity) 2. Issuing long- term debt and repayment of debt The Three Sections of the Statement of Cash Flows 13-19

Format of the Statement of Cash Flows (Indirect Method) 13-20

Format of the Statement of Cash Flows (Indirect Method) Operating Activities Investing Activities Financing Activities Reconciliation of the beginning cash balance with the ending cash balance Noncash Investing and Financing Activities 13-21

Operating Activities Includes those activities that affect current assets, current liabilities, or net income. Net Income or Loss$ XXX Add:Decrease in current noncash assetsXXX Increase in current liabilitiesXXX Depreciation chargesXXX LossesXXX Less:Increase in current noncash assets(XXX) Decrease in current liabilities(XXX) Gains(XXX) Cash Flows from Operating Activities $ XXX 13-22

Operating Activities Sources of cash are added to and uses of cash are subtracted from net cash provided by operating activities

Net Income or Loss$ XXX Add:Decrease in current noncash assetsXXX Increase in current liabilitiesXXX Depreciation chargesXXX LossesXXX Less:Increase in current noncash assets(XXX) Decrease in current liabilities(XXX) Gains(XXX) Cash Flows from Operating Activities $ XXX Operating Activities 13-24

Net Income or Loss$ XXX Add:Decrease in current noncash assetsXXX Increase in current liabilitiesXXX Depreciation chargesXXX LossesXXX Less:Increase in current noncash assets(XXX) Decrease in current liabilities(XXX) Gains(XXX) Cash Flows from Operating Activities $ XXX Operating Activities 13-25

Net Income or Loss$ XXX Add:Decrease in current noncash assetsXXX Increase in current liabilitiesXXX Depreciation chargesXXX LossesXXX Less:Increase in current noncash assets(XXX) Decrease in current liabilities(XXX) Gains(XXX) Cash Flows from Operating Activities $ XXX Depreciation and Amortization charges are added back because they are decreases in noncash assets. Operating Activities 13-26

Net Income or Loss$ XXX Add:Decrease in current noncash assetsXXX Increase in current liabilitiesXXX Depreciation chargesXXX LossesXXX Less:Increase in current noncash assets(XXX) Decrease in current liabilities(XXX) Gains(XXX) Cash Flows from Operating Activities $ XXX Losses are added. Operating Activities Gains are subtracted

Includes transactions that involve the acquisition or disposal of noncurrent assets. Investing Activities 13-28

Includes transactions involving receipts from or payments to creditors and owners. Financing Activities 13-29

Cash Flows: Gross or Net? For investing and financing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts. Example: Assume Macy’s purchases $50 million in property during the year and sells other property for $30 million. Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions

Operating Activities: Direct or Indirect Method? Two Formats for Reporting Operating Activities Reports the cash effects of each operating activity Starts with accrual net income and adjusts it to the cash basis Direct MethodIndirect Method No matter which format is used, the same amount of net cash provided by operating activities is generated

Learning Objective 3 Prepare a statement of cash flows using the indirect method to determine the net cash provided by operating activities

Statement of Cash Flows: Indirect Method Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut

Statement of Cash Flows: Indirect Method  There was a net loss for the year of $27,000.  Depreciation charges for the year were $6,000.  During the year, Ed sold land originally costing $32,000 for $32,000.  During the year, Ed purchased equipment for $28,000.  During the year, Ed paid dividends of $3,000 to the stockholders.  Ed issued $50,000 of common stock to settle the note due to Joe Doe.  There was a net loss for the year of $27,000.  Depreciation charges for the year were $6,000.  During the year, Ed sold land originally costing $32,000 for $32,000.  During the year, Ed purchased equipment for $28,000.  During the year, Ed paid dividends of $3,000 to the stockholders.  Ed issued $50,000 of common stock to settle the note due to Joe Doe. Refresh your memory regarding the following additional information

Step 1 of 8 List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings

Step 2 of 8 Compute the change from the beginning balance to the ending balance for each account

Step 3 of 8 Code each entry on the worksheet as a source or use of cash. Recall that the transaction involving the Notes Payable and Common Stock was noncash. { 13-37

Step 4 of 8 Code sources of cash as positive numbers and uses of cash as negative numbers

Step 5 of 8 Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero. We need to make an adjustment for the noncash transaction relating to Notes Payable and Common Stock. { 13-39

Step 6 of 8 Classify each entry as operating, investing, or financing activity

Step 7 of 8 Copy the data from the worksheet into the Statement of Cash Flows section by section

Step 8 of 8 Prepare a cash reconciliation at the bottom of the statement

In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity. Statement of Cash Flows: Indirect Method 13-43

Interpretation of the Statement of Cash Flows Examine the operating activities section carefully. ▫ Ed’s Pizza Hut generated a negative net cash provided by operating activities of $20,000. This 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

Learning Objective 4 Compute free cash flow

Free Cash Flow Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities

Free Cash Flow Using the equation shown on the prior slide, the free cash flow for Ed’s Pizza Hut of ($51,000) is computed like this

PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA The Direct Method of Determining the Net Cash Provided by Operating Activities. Appendix 13A

Learning Objective 5 Use the direct method to determine the net cash provided by operating activities

Computing Net Cash Provided by Operating Activities The direct method computes net cash provided by operating activities by reconstructing the income statement on the cash basis from top to bottom. The amount of net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method. However 13-50

Similarities and Differences in Handling Data Adjustments for accounts that affect revenue are the same in the direct method and indirect methods. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods

Direct Method: Gains and Losses Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method

The Direct Method Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut

The Direct Method Let’s assume that Ed’s Pizza Hut prepared this income statement

The Direct Method Step 1: Translate sales revenue into cash collected from customers

The Direct Method Step 2: Translate cost of goods sold into cash disbursements for purchases

The Direct Method Step 3: Translate operating expenses into cash paid for operating expenses. There is not an adjustment needed for income taxes because Ed’s Pizza Hut has a net loss of $27,

The Direct Method Notice that the net cash provided by operating activities agrees with that computed using the indirect method

PowerPoint Authors: Jon A. Booker, Ph.D., CPA, CIA Charles W. Caldwell, D.B.A., CMA Susan Coomer Galbreath, Ph.D., CPA Appendix 13B The T-Account Approach to Preparing the Statement of Cash Flows

T-Account Approach: Statement of Cash Flows 13-60

Additional Information:  There was a net loss for the year of $27,000.  Depreciation charges for the year were $6,000.  During the year, Ed sold land originally costing $32,000 for $32,000.  During the year, Ed purchased equipment for $28,000.  During the year, Ed paid dividends of $3,000 to the stockholders.  Ed issued $50,000 of common stock to settle the note due to Joe Doe. Additional Information:  There was a net loss for the year of $27,000.  Depreciation charges for the year were $6,000.  During the year, Ed sold land originally costing $32,000 for $32,000.  During the year, Ed purchased equipment for $28,000.  During the year, Ed paid dividends of $3,000 to the stockholders.  Ed issued $50,000 of common stock to settle the note due to Joe Doe. T-Account Approach: Statement of Cash Flows 13-61

T-Account Approach Here is a summary of the sources of cash for Ed’s Pizza Hut

T-Account Approach Here is a summary of the uses of cash for Ed’s Pizza Hut. The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses

T- Account Approach 13-64

T-Account Approach 13-65

T-Account Approach 13-66

T-Account Approach 13-67

T-Account Approach 13-68

T-Account Approach No Effect in the Cash Account. What about the $50,000 issuance of common stock to settle the note payable to Joe Doe? However, this transactions would be disclosed in a supplemental schedule that accompanies the statement of cash flows

T-Account Approach The net effect of these transactions on the cash account is as shown. Notice, the net decrease in cash is $19,

In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity. The Statement of Cash Flows 13-71

End of Chapter