The Statement of Cash Flows

The statement of cash flows reports the entity’s cash flows (cash receipts and cash payments) during the period. Purpose of The Statement of Cash Flows: Basic Concepts

Identify the purposes of the statement of cash flows. Objective 1

Purposes of the Statement of Cash Flows Statement of Retained Earnings 12/31/x1 For the Year Ended 12/31/x2 12/31/x2 (a point in time) (a period of time) (a point in time) Statement of Cash Flows Income Statement Balance Sheet Balance Sheet

Purposes of the Statement of Cash Flows l The statement of cash flows is designed to fulfill the following: – predict future cash flows – evaluate management decisions – determine the ability to pay dividends plus interest and principal – show the relationship of net income to changes in the firm’s cash

Cash Balance Includes... – cash on hand. – cash in the bank. – cash equivalents.

Cash Equivalents Are.... – short-term, highly liquid investments convertible into cash with little delay. – money market accounts. – Government Treasury bills.

Report cash flows from operating, investing, and financing activities. Objective 2

Basic Organization of the Statement of Cash Flows l A business may be evaluated in terms of three types of business activities: 1 Operating activities 2 Investing activities 3 Financing activities

Operating Activities Operating activities are related to the transactions that make up net income. Operating activities are related to the transactions that make up net income. Interest and dividends received are related to investing activities. Interest and dividends received are related to investing activities.

Investing activities increase and decrease the assets that are available to the business. Investing activities increase and decrease the assets that are available to the business. Investing Activities Investing activities are related to the Long-Term Asset accounts. Investing activities are related to the Long-Term Asset accounts.

These are transactions involving obtaining resources from the owners or returning resources to them. These are transactions involving obtaining resources from the owners or returning resources to them. Financing Activities It also involves obtaining resources from creditors and repaying the amount borrowed. It also involves obtaining resources from creditors and repaying the amount borrowed.

Format of the Statement of Cash Flows l ICAI in Accounting Standard 3 has approved two methods for reporting cash flows from operating activities. 1 Direct method 2 Indirect method

Format of the Statement of Cash Flows l The direct method lists cash receipts from specific operating activities and cash payments for each major operating activity. l The indirect method is a short-cut method for accrual systems.

Prepare a statement of cash flows by the direct method. Objective 3

Cash flows from operating activities: Receipts: Collections from customersRs. 271 Interest received on notes receivable 10 Dividends received on investments in stock 9 Total receiptsRs. 290 Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands) The Direct Method

Payments: To suppliersRs. 133 To employees 58 For interest 16 For income tax 15 Total payments 222 Net cash inflows from operating activities Rs. 68 The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

Cash flows from investing activities: Acquisition of plant assetsRs. (306) Loan to another company (11) Proceeds from sale of plant assets 62 Net cash outflow from investing activitiesRs. (255) The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

Cash flows from financing activities: Proceeds from issuance of common stock Rs. 101 Proceeds from issuance of long-term notes payable 94 Payment of long-term notes payable (11) Payment of dividends (17) Net cash inflow from financing activities Rs. 167 The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

Net cash inflows from operating activitiesRs. 68 Net Cash outflow from investing activities (255) Net Cash inflow from financing activities 167 Net (decrease in cash)Rs. (20) Cash balance, December 31, Cash balance, December 31, 2002Rs. 22 The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

Compute the cash effects of a wide variety of business transactions. Objective 4

Revenues or expenses from the income statement +–+– Adjusted for the change in the related balance sheet account(s) Amount for the statement of cash flows = Computing Individual Amounts for the Statement of Cash Flows

Revenues and gains: Sales revenueRs. 284 Interest revenue 12 Dividend revenue 9 Gain on sale of plant assets 8 Total revenues and gainsRs. 313 Computing Individual Amounts for the Statement of Cash Flows Income Statement Year Ended December 31, 2002 (Thousands)

Expenses: Cost of goods soldRs. 150 Salary expense 56 Depreciation expense 18 Other operating expense 17 Interest expense 16 Income tax expense 15 Total expensesRs. 272 Computing Individual Amounts for the Statement of Cash Flows

Total revenues and gainsRs. 313 Total expenses 272 Net incomeRs. 41 Computing Individual Amounts for the Statement of Cash Flows Income Statement Year Ended December 31, 2002 (Thousands)

Assets20x220x1 Inc./(Dec.) Current: CashRs (20) Accounts receivable Interest receivable Inventory (3) Prepaid expenses Long-term receivable 11 – 11 Plant assets, net Total assetsRs Comparative Balance Sheets

Liabilities 20x220x1 Inc./(Dec.) Current: Accounts payable Rs Salary payable 4 6 (2) Accrued liabilities 1 3 (2) Long-term notes payable Stockholders’ equity: Common stock Retained earnings Total liabilities and shareholders’ equityRs Comparative Balance Sheets

Computing Cash Collections from Customers l Collections can be computed by converting sales revenue to the cash basis. l Beginning Accounts Receivable balance + Sales on account – Collections = Ending Accounts Receivable balance

Computing Cash Collections from Customers l Rs.80,000 + Rs.284,000 – 93,000 = Rs.271,000 l Because Accounts Receivable increased by Rs.13,000, the business received Rs.13,000 less cash than its sales revenue for the period. l All collections of receivables are computed following the pattern illustrated for collections from customers.

Computing Payments to Suppliers l This computation includes two parts, payments for inventory and payments for expenses other than interest and income tax. l Payments for inventory are computed by converting cost of goods sold to the cash basis. l This is accomplished by analyzing the Inventory and Accounts Payable accounts.

Payments for Inventory Inventory Beg. inventory138,000 Purchasesx Cost of goods sold150,000 End. inventory135,000

Payments for Inventory l How much were the purchases? l Rs.138,000 + x – Rs.150,000 = Rs.135,000 l x = Rs.135,000 – Rs.138,000 + Rs.150,000 l Rs.147,000

Payments for Inventory Accounts Payable Payments for inventoryx Beg. balance 57,000 End. balance 91,000 Purchases147,000

Payments for Inventory l How much did the business pay for this inventory? l Rs.57,000 + Rs.147,000 – x = Rs.91,000 l x = Rs.57,000 + Rs.147,000 – Rs.91,000 l x = Rs.113,000

Payments for Operating Expenses l Increases in prepaid expenses require cash payments, and decreases indicate that payments were less than expenses. l Decreases in accrued liabilities can occur only from cash payments, and increases mean that cash was not paid.

Payments to Employees l Salary Payable was Rs.6,000 at the beginning of the year and Rs.4,000 at year end. l During the year Salary and Wages Expense was Rs.56,000. l How much did the business pay? l Rs.58,000

Acquisition and Sales of Plant Assets l The business had plant assets net of depreciation of Rs.219,000 at the beginning of the year and Rs.453,000 at year end. l Further, the acquisition of plant assets amounted to Rs.306,000 during the year.

Acquisition and Sales of Plant Assets l The income statement shows depreciation expense of Rs.18,000 and a Rs.8,000 gain on sale of plant assets. l What is the book value of the assets sold? l Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance

Acquisition and Sales of Plant Assets l Rs.219,000 + Rs.306,000 – Rs.18,000 – x = Rs.453,000 l x = Rs.219,000 + Rs.306,000 – Rs.18,000 – Rs.453,000 l x = Rs.54,000 (book value) l How much are the proceeds from the sale of plant assets?

Acquisition and Sales of Plant Assets l Book value + Gain or – Loss = Proceeds l Rs.54,000 + Rs.8,000 = Rs.62,000 l How do we determine acquisitions? l Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance

Computing the Cash Amounts of Financing Activities l Financing activities affect liability and stockholders’ equity accounts. – Notes Payable – Bonds Payable – Long-Term Debt – Common Stock – Paid-in Capital – Retained Earnings

Issuance and Payments of Long-Term Notes Payable l Beginning balance was Rs.77,000. l New debt amounting to Rs.94,000 was incurred during the year. l The ending balance for the Long-Term Notes Payable account was Rs.160,000. l How much was the payment? l Rs.11,000

Computing Dividend Payments l Dividend payments are computed by analyzing the Dividends Payable account. l Beginning balance + Dividends declared – Dividend payments = Ending balance

Noncash Investing and Financing Activities... – are not reported in the statement of cash flows. l The Accounting Standard 3 requires that significant non-cash investing and financing activities be shown in a separate schedule at the bottom of the statement.

Reconciling Net Income to Net Cash Flow l The Accounting Standard requires companies that format operating activities by the direct method to report a reconciliation from net income to net cash inflow (or outflow).

Prepare a statement of cash flows by the indirect method. Objective 5

Current Assets Add to Net Income if this account has decreased The Indirect Method Deduct from Net Income if this account has increased

Current Liabilities Add to Net Income if this account has increased The Indirect Method Deduct from Net Income if this account has decreased

Statement of Cash Flows (Indirect Method) Year Ended December 31, 2002 (Thousands) Cash flows from operating activities: Net Income 41 Add (deduct) items that affect net income and cash flows differently: Depreciation 18 Gain on sale of plant 8 Increase in accounts receivable (13) Increase in interest receivable (2) Decrease in inventory 3 The Indirect Method

Add (deduct) items that affect net income and cash flows differently: Increase in prepaid expenses (1) Increase in accounts payable 34 Decrease is salary payable (2) Decrease in accrued liabilities (2) Net cash inflow from operating activities 68 The Indirect Method Statement of Cash Flows (Indirect Method) Year Ended December 31, 2002 (Thousands)