1. Chapter 4 Statement of Cash Flows
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2. Why Cash Flow is Important: An Example
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3. Why Cash Flow is Important: An Example
The company reported rising amounts of net income.
The company failed to generate any cash from its operations.
These deficits were offset by borrowings.
The company went bankrupt in
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4. Why Cash Flow is Important: An Example
It is possible for a company to post a healthy net income but not have cash needed to pay its employees, suppliers, and bankers.
Positive net income on the income statement is ultimately insignificant unless a company can translate its earnings into cash.
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5. Why Cash Flow is Important: An Example
The statement of cash flows provides information about cash inflows and outflows during an accounting period and over time.
It is extremely important as an analytical tool.
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6. Why Cash Flow is Important: An Example
Cash flows are segregated by:
operating activities,
investing activities, and
financing activities.
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7. Statement of Cash Flows: Basic Principle
The statement of cash flows is another way of presenting the balance sheet of the company.
The balance sheet shows amounts at the end of the accounting period.
The statement of cash flows shows changes in the balance sheet accounts between periods.
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8. Statement of Cash Flows: Basic Principle
Change in cash between periods is explained by changes in all other balance sheet accounts.
Each balance sheet account is related either to an operating activity, an investing activity, or a financing activity.
Change in cash between periods is equal to cash flow from operating activities, investing activities, or financing activities.
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9. Statement of Cash Flows: Basic Principle
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10. Statement of Cash Flows: Basic Principle
Cash account increased by $1,299 million between November 30, 2006 and 2007.
Operations used cash (net outflow) of $45,945 million.
Investing activities used cash (net outflow) of $1,698 million.
The company borrowed (net inflow) $48,592 million.
The company borrowed to cover the cash deficit in operations and capital expenditures.
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11. Preparing a Statement of Cash Flows
Begins with a return to the balance sheet
Requires reordering of the information presented on a balance sheet
Shows changes over time rather than the absolute dollar amount of the accounts at a point in time
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12. Preparing a Statement of Cash Flows
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13. Preparing a Statement of Cash Flows
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14. Preparing a Statement of Cash Flows
Four parts of a statement of cash flows
Cash
Operating activities
Investing activities
Financing activities
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15. Preparing a Statement of Cash Flows
Highly liquid short-term marketable securities (cash equivalents)
Short-term investments
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16. Preparing a Statement of Cash Flows
Operating activities
Delivering or producing goods for sale
Providing services
Cash effects of transactions and other events that enter into the determination of income
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17. Preparing a Statement of Cash Flows
Investing activities
Acquiring and selling (or otherwise disposing of) securities that are not cash equivalents or productive assets that are expected to benefit the firm for long periods
Lending money and collecting on loans
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18. Preparing a Statement of Cash Flows
Financing activities
Borrowing from creditors and repaying principal
Obtaining resources from owners and providing them with a return on the investment
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19. Preparing a Statement of Cash Flows
Calculate the changes in all of the balance sheet accounts, including cash.
List the changes in all of the accounts except cash as inflows or outflows.
Categorize the flows by operating, financing, or investing activities.
The inflows less the outflows balance to and explain the change in cash.
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20. Preparing a Statement of Cash Flows
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21. Preparing a Statement of Cash Flows
Next, transfer the account changes to the appropriate area of a statement of cash flows.
In doing so, a determination must be made of what constitutes an inflow and what constitutes an outflow.
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22. Preparing a Statement of Cash Flows
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23. Preparing a Statement of Cash Flows
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24. Preparing a Statement of Cash Flows
Exhibit 4.2 – inflows
Decrease in other assets
Increase in long-term debt
Increase in common stock and additional paid-in capital
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25. Preparing a Statement of Cash Flows
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26. Preparing a Statement of Cash Flows
Exhibit 4.2 – outflows
Increase in inventories
Decrease in notes payable
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27. Preparing a Statement of Cash Flows
Accumulated depreciation
Appears in the asset section
Is actually a contra-asset
Reduces the amount of total assets
Shown in parentheses on the balance sheet
Has the same effect as a liability account
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28. Preparing a Statement of Cash Flows
Other complications
Two transactions in one account
Multiple transactions affecting other accounts
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29. Calculating Cash Flow from Operating Activities
Operating activities represent cash generated internally.
Investing and financing activities provide cash from external sources.
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30. Calculating Cash Flow from Operating Activities
Firms may use one of two methods to calculate cash flow from operating activities:
Direct Method
Indirect Method
Direct and indirect methods yield identical figures for net cash flow from operating activities.
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31. Calculating Cash Flow from Operating Activities
Direct Method
Cash collection from customers
Interest and dividends collected
Other operating cash receipts
Cash paid to suppliers
Interest paid
Taxes paid
Other operating cash payments
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32. Calculating Cash Flow from Operating Activities
The indirect method starts with net income and adjusts for
deferrals
accruals
noncash items
nonoperating items
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33. Calculating Cash Flow from Operating Activities
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34. Calculating Cash Flow from Operating Activities
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35. Calculating Cash Flow from Operating Activities
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36. Calculating Cash Flow from Operating Activities
Indirect method – Sage Inc.
Depreciation and amortization are added to net income.
Increase in deferred tax liability account is added to net income.
Increase in accounts receivable is deducted.
Increase in inventory is deducted.
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37. Calculating Cash Flow from Operating Activities
Indirect method – Sage Inc.
Decrease in prepaid expenses is added.
Increase in accounts payable is added.
Decrease in accrued liabilities is subtracted.
Increase in income taxes payable is added.
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38. Cash Flow from Investing Activities
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39. Cash Flow from Investing Activities
Additions to property, plant, and equipment represent a cash outflow of $14.1 million.
Decrease in other assets represents a cash inflow of $295 thousand.
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40. Cash Flow from Financing Activities
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41. Cash Flow from Financing Activities
Sage Inc. issued new shares of stock during 2016.
The total cash generated from stock sales amounted to $256 thousand.
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42. Cash Flow from Financing Activities
Short-term debt and current maturities of long-term debt jointly explain Sage Inc.’s net reduction in short-term borrowings:
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43. Cash Flow from Financing Activities
Long-term borrowings should be segregated into two components:
Additions to long-term borrowings
Reduction of long-term borrowings
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44. Cash Flow from Financing Activities
Additions to long-term borrowings and reductions of long-term borrowings on the Sage Inc. statement of cash flows reconcile the change in the long-term debt account on the balance sheet.
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45. Cash Flow from Financing Activities
Change in retained earnings results from net income recognition and the payment of cash dividends.
Payment of cash dividends is financing outflow.
Declaration of a cash dividend would not affect cash.
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46. Cash Flow from Financing Activities
This information is provided in the Sage Inc. Statement of Stockholders’ Equity.
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47. Change in Cash
Net cash provided by operating activities, less the net cash used by investing activities, plus the net cash provided by financing activities produced a net decrease in cash and cash equivalents for Sage Inc.:
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48. Change in Cash
The cash flows provided (used) by operating, investing, and financing activities vary considerably depending on
the company,
its performance,
its ability to generate cash,
its financing and investing strategies, and
its success in implementing financing and investing strategies.
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49. Change in Cash
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50. Analyzing the Statement of Cash Flows
The statement of cash flows helps the analyst determine the following:
Ability to generate cash flows in the future
Capacity to meet cash obligations
Future external financing needs
Success in productively managing investing activities
Effectiveness in implementing financing and investing strategies.
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51. Analyzing the Statement of Cash Flows
Cash Flow from Operations
It is possible for a firm to be highly profitable and
not be able to pay dividends
not be able to invest in new equipment
not be able to service debt
go bankrupt
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52. Analyzing the Statement of Cash Flows
Cash Flow from Operations
Ongoing operation depends on success in generating cash from operations.
Firms need cash to satisfy creditors and investors.
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53. Analyzing the Statement of Cash Flows
Cash Flow from Operations
Temporary shortfalls of cash can be satisfied by borrowing or other means, but ultimately a firm must generate cash.
Periods of high interest rates and inflation contributed to the enhanced attention paid to cash flow by investors and creditors.
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54. Analyzing the Statement of Cash Flows
Nocash Corporation
Nocash Corporation had sales of $50,000 in its first year of operations.
Nocash Corporation had sales of $100,000 in its second year of operations.
Nocash Corporation had expenses of $40,000 in its first year of operations.
Nocash Corporation had expenses of $70,000 in its second year of operations.
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55. Analyzing the Statement of Cash Flows
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56. Analyzing the Statement of Cash Flows
Nocash Corporation
The income statement does not show several relevant facts.
Nocash eased its credit policies and attracted lower quality customers.
Nocash purchased a new line of inventory near the end of Year 1 and had to sell it below cost.
Rumors regarding problems with accounts receivable and inventory management prompted some suppliers to refuse the sale of goods on credit to Nocash.
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57. Analyzing the Statement of Cash Flows
Nocash Corporation
The effects of these factors can be found on the balance sheet:
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58. Analyzing the Statement of Cash Flows
Nocash Corporation
If Nocash’s net income is recalculated on a cash basis, the following adjustments would be made:
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59. Analyzing the Statement of Cash Flows
Nocash Corporation
More sales revenue was recognized in computing net income than was collected in cash.
The increase in accounts receivable is subtracted.
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60. Analyzing the Statement of Cash Flows
Nocash Corporation
The increase in inventory is deducted, reflecting the cash outflow for inventory purchases in excess of the expense recognized through cost of goods sold.
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61. Analyzing the Statement of Cash Flows
Nocash Corporation
Cash payments to suppliers in Year 2 were greater than the amount of expense recorded.
The decrease in accounts payable is deducted.
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62. Analyzing the Statement of Cash Flows
Nocash Corporation
Appearance of $10,000 note payable indicates that borrowing has enabled Nocash to operate.
Unless Nocash can generate cash, its problems will compound.
Bankers refer to this problem as a company’s “selling itself out of business.”
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63. Sage Inc.: Analysis of the Statement of Cash Flows
An analysis of the statement of cash flows should cover the following areas:
Analysis of cash flow from operating activities
Analysis of cash inflows
Analysis of cash outflows
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64. Sage Inc.: Analysis of the Statement of Cash Flows
Cash Flow from Operating Activities
The statement of cash flows provides the net cash flow from operating activities.
The analyst should be concerned with
the success or failure of generating cash from operations,
the underlying causes of operating cash flow,
the magnitude of operating cash flow, and
fluctuations in cash flow from operations.
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65. Sage Inc.: Analysis of the Statement of Cash Flows
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66. Sage Inc.: Analysis of the Statement of Cash Flows
Cash Flow from Operating Activities – Sage Inc.
Negative cash flow from operations in 2015
Positive net income in 2015
Apparent cause was substantial growth in accounts receivable and inventories.
Positive cash flow in 2016
It will be necessary to monitor cash flow operations and the management of inventories.
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67. Sage Inc.: Analysis of the Statement of Cash Flows
Summary Analysis of the Statement of Cash Flows
Provides an approach to analyzing the statement of cash flows
Provides comparative cash flow data
Underlines the importance of internal cash generation from operations
Highlights the implications for investing and financing activities when cash is not generated from operations
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68. Sage Inc.: Analysis of the Statement of Cash Flows
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69. Sage Inc.: Analysis of the Statement of Cash Flows
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70. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Inflows – Sage Inc.
Operations supplied 62% of needed cash in 2016 and 73% in 2014.
The firm had to borrow heavily in 2015, with debt accounting for 98% of cash inflows.
Sage Inc. also borrowed in 2016 and to obtain needed cash not supplied by operations.
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71. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Inflows
Generating cash from operations is the preferred method for obtaining cash.
Using external sources to generate the majority of cash year after year should be further investigated.
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72. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Outflows – Sage Inc.
Purchases of property, plant, and equipment decreased in 2015 compared to 2014.
Capital expenditures increased in dollars from 2015 to 2014 but not in percentage due to negative cash flow from operations.
Dividends paid increased from 2014 to and decreased from 2015 to 2016, but percentages declined each year due to cash outflows.
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73. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Outflows – Sage Inc.
Capital expenditures in 2014 were covered by cash from operations.
Capital expenditures in 2015 were covered by borrowing.
Capital expenditures in 2016 were covered by both cash from operations and borrowing.
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74. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Outflows
When analyzing cash outflows, the analyst should consider
the necessity of the outflow and
how the outflow was financed.
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75. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Outflows
Generally, it is best to finance
short-term assets with short-term debt and
long-term assets with long-term debt or issuance of stock.
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76. Sage Inc.: Analysis of the Statement of Cash Flows
Analysis of Cash Outflows
Repayment of debt is a necessary outflow.
Notes to the financial statements are useful in assessing how much cash will be needed in upcoming years to repay outstanding debt.
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77. Sage Inc.: Analysis of the Statement of Cash Flows
Firms should only pay dividends if the company has excess cash not needed for
expansion,
property, plant, or equipment, or
repayment of debt.
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78. Qualitative Issues Relating to the Statement of Cash Flows
Recording operating expenses as capital expenditures
Management of current asset and liability accounts
Accounting for vendor financing transactions
Recording of purchases and sales of trading securities for nonfinancial companies
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79. Appendix 4A: Statement of Cash Flows – Direct Method
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80. Appendix 4A: Statement of Cash Flows – Direct Method
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81. Appendix 4A: Statement of Cash Flows – Direct Method
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82. Copyright Notice
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
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