1. Statement of Cash Flows Chapter 12
Introduction to Managerial Accounting, Brewer, Garrison,Noreen
Power Points from website - adapted by Cynthia Fortin, CPA, CMA

2. This chapter explains how to prepare and interpret the statement of cash flows

3. Where did the cash go?
Warm up exercise
1 to 10

4. ..\Questions and problems to post\Day 2 chap 12 Rev.-FI5-Ex-Pr.docx

5. Statement of Cash Flows
Ongoing operations
Investments
Financing
Can we pay debts?
Can we pay dividends?
Can we keep investing?
The statement of cash flows can be used to answer crucial questions such as:
Is the company generating sufficient positive cash flows from its ongoing operations to remain viable?
Will the company be able to repay its debts?
Will the company be able to pay its usual dividend?
To what extent will the company have to borrow money in order to make needed investments?
Why do net income and net cash flow differ?

6. cash collected and cash paid Direct Method Indirect Method
Operating Activities
cash collected and cash paid
Direct Method
Adjusted net income to cash instead of accrual basis
Indirect Method
Used by 99% companies
U.S. GAAP and IFRS allow companies to compute the net amount of cash inflows and outflows resulting from operating activities using either the direct or indirect method. Both of these methods have the same purpose, which is to translate accrual-based net income to a cash basis. However, they approach this task in two different ways.
Under the direct method, the income statement is reconstructed on a cash basis from top to bottom. For example, the direct method lists cash collected from customers and payments to suppliers. In essence, cash receipts are counted as revenues and cash disbursements pertaining to operating activities are counted as expenses. The difference between the cash receipts and cash disbursements is the net cash provided by operating activities.
Under the indirect method, net income is adjusted to a cash basis. That is, rather than directly computing cash sales, cash expenses, and so forth, these amounts are derived indirectly by removing from net income any items that do not affect cash flows. The indirect method has an advantage over the direct method because it shows the reasons for any differences between net income and net cash provided by operating activities.
Both methods result in the exact same amount of cash provided by operating activities. Most companies (about 99%) use the indirect method. If a company uses the direct method, then it must also provide a supplementary report that uses the indirect method. However, if a company uses the indirect method, there is no requirement that it also report results using the direct method. Because the direct method requires more work, very few companies choose this approach. Therefore, we will cover the indirect method in the main body of the chapter and we will explain the direct method in Appendix 12A.
Used by 99% of companies

7. First
I like to start with calculating the change in Cash from period to period.
Because I know that the total changes of Operating + Investing + Financing
must equal the change in cash period to period.
I know where I’m heading!

8. Operating Activities Indirect Method
Step 1
Net Income +
Depreciation*
The indirect method adjusts net income to net cash provided by operating activities using a three-step process. The first step is to add depreciation charges to net income. The second step is to analyze net changes in noncash balance sheet accounts that impact net income. The third step is to adjust for gains and losses included in the income statement.
*Change in Accumulation depreciation ending balance plus accumulated depreciation debited as a result of disposals.

9. Operating Activities Indirect Method
Step 2
Analyze changes
Noncash Current Assets &
Liabilities
The indirect method adjusts net income to net cash provided by operating activities using a three-step process. The first step is to add depreciation charges to net income. The second step is to analyze net changes in noncash balance sheet accounts that impact net income. The third step is to adjust for gains and losses included in the income statement.

10. Let’s review the activities
This slide summarizes the most common types of cash inflows and outflows resulting from operating activities, investing activities, and financing activities.

11. Operating Activities Indirect Method
Step 3
Adjust
- Gains or + Losses
The indirect method adjusts net income to net cash provided by operating activities using a three-step process. The first step is to add depreciation charges to net income. The second step is to analyze net changes in noncash balance sheet accounts that impact net income. The third step is to adjust for gains and losses included in the income statement.
Under U.S. GAAP and IFRS rules, proceeds of asset disposals must be included in the investing activities . Under Operating activities substract gains and/or add losses of such asset disposals.

12. Day 2 Cash flow example Apparel.xlsx
Let’s look at an example
Day 2 Cash flow example Apparel.xlsx

13. Operating: related to revenue and expense affecting net income.
cash ins and cash outs
Operating: related to revenue and expense affecting net income.
Investing: related to acquiring
or disposing of noncurrent assets
Financing: related to borrowing and
repaying principal and
activities with the
stockholders
Here is Apparel’s statement of cash flows. All of the information on this slide was derived from our work on the previous slides for Apparel. Take a moment to trace the information on this statement. Notice, the net increase in cash and cash equivalents is $62 million, which agrees with the change in the Cash and Cash Equivalents account shown on Apparel’s balance sheet.
Change in cash balance

14. Summary of Key Concepts
Third, the indirect method requires three steps to compute net cash provided by operating activities. Fourth, record gross cash inflows and outflows in the investing and financing activities sections of the statement of cash flows.

15. Interpreting the Statement of Cash Flows
Within company’s context
Start-up
Comparing operating CF to sales
Comparing operating CF to current liabilities
We need to consider a company’s specific circumstances. For example, start-up companies often have negative net cash provided by operating activities, large spikes in net cash used for investing activities and net cash provided by financing activities. As start-up companies mature, the net cash provided operating activities should swing from a negative to a positive number. The net cash used for investing activities should decline somewhat and stabilize and the net cash provided by financing activities should decrease.
Some managers study their company’s trends in cash flow margins by comparing net cash provided by operating activities to sales. Managers also compare the net cash provided by operating activities to the ending balance of current liabilities to see if they generated enough cash flow to pay their bills at the end of the period.
Some managers compare the additions to property, plant, and equipment in the investing activities section of the statement to depreciation included in the operating activities section. If the additions to property, plant, and equipment are less than depreciation, it suggests the company is not investing enough money to maintain its noncurrent assets.

16. Ability to fund Capital expenditures With Operating net cash
Free Cash Flows
Ability to fund Capital expenditures
and
Pay dividends
With Operating net cash
Free cash flow looks at the relationship among three numbers from the statement of cash flows—net cash provided by operating activities, additions to property, plant, and equipment, and dividends. Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities.
The equation for computing free cash flow is net cash provided by operating activities minus capital expenditures and dividends.

17. Free Cash Flows
Using the equation for free cash flow, we can calculate the free cash flow of Apparel Inc. to be $93 million, indicating that Apparel generated enough cash flow from its operating activities to fund its capital expenditures and dividend payments.