“How Well Am I Doing?” Statement of Cash Flows

“How Well Am I Doing?” Statement of Cash Flows
Chapter 13 “How Well Am I Doing?” Statement of Cash Flows Chapter 13: “How Well An I Doing?” Statement of Cash Flows. This chapter explains how to classify transactions as operating, investing, or financing activities, and it explains how to create a statement of cash flows. The indirect method of determining the net cash provided by operating activities is illustrated within the chapter and the direct method is demonstrated in Appendix 13A. Appendix 13B describes the T-account approach to preparing the statement of cash flows.

Statement of Cash Flows
Are cash flows sufficient to support ongoing operations? Will the company be able to repay its debts? Why do net income and net cash flow differ? Will the company be able to pay its usual dividend? To what extent will the company have to borrow money to make needed investments? The Statement of Cash Flows is important because it helps us answer crucial questions such as: Are cash flows sufficient to support ongoing operations? Will the company be able to repay its debts? Will the company be able to pay its usual dividend? Why do net income and net cash flow differ? To what extent will the company have to borrow money to make needed investments?

Learning Objective 1 Classify changes in noncash balance sheet accounts as sources or uses of cash. Learning objective number 1 is to classify changes in noncash balance sheet accounts as sources or uses of cash.

Currency and Bank Accounts
Definition of Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Currency and Bank Accounts T-bills In a statement of cash flows, cash is broadly defined to include both cash and cash equivalents. Cash equivalents consist of short-term (usually less than ninety days to maturity) highly liquid investments, such as Treasury Bills, commercial paper, and money market funds. Commercial paper is a term used to describe short-term notes issued by highly secure corporations. Only the financially secure and well managed companies have access to the commercial paper market. Cash Commercial Paper Money Market Funds

Constructing the Statement of Cash Flows
Net Income Dividends Paid to Stockholders Changes in Noncash Assets Changes in Liabilities Changes in Capital Stock Net Cash Flows for a Period The net cash flow for a period is a function of the following: Net income Changes in noncash assets Changes in liabilities Changes in capital stock accounts Dividends paid to stockholders

Changes in these accounts can be classified as either sources or uses of cash as shown on this slide. Net income is always a source of cash, while a net loss is always a use of cash. Decreases in noncash asset accounts are always sources of cash and increases are uses of cash. Increases in liability accounts are always sources of cash and decreases are uses of cash. Contra-assets follow the rules for liabilities. Increases in capital stock accounts are always sources of cash and decreases are uses of cash. Dividends paid to stockholders are always uses of cash.

Increases in noncash asset accounts imply uses of cash. Example: Inventory is purchased on credit from a supplier. Increases in noncash asset accounts imply uses of cash. For example, when inventory is purchased on credit from a supplier, it is implied that cash was used to acquire the inventory. It is implied that cash was used to acquire the inventory.

Increases in liability accounts imply sources of cash. Example: Inventory is purchased on credit from a supplier. Increases in liability accounts imply sources of cash. For example, when inventory is purchased on credit from a supplier, it is implied that an increase in a payable account has the effect of increasing cash available for other uses. It is implied that an increase in a payable has the effect of increasing cash available for other uses.

Decreases in noncash assets accounts imply sources of cash. Example: Accounts receivable decreases when a customer pays their bill. Decreases in noncash asset accounts imply sources of cash. For example, accounts receivable decrease when a customer pays his bill, and the company’s cash balance increases accordingly. When the customer pays the bill, the company’s cash increases.

Decreases in liability accounts imply uses of cash. Example: A company pays a note payable held by a creditor. Decreases in liability accounts imply uses of cash. For example, if a company makes a payment on a note payable, the company’s cash balance decreases accordingly. When the payment is made, cash decreases.

A Simplified Statement of Cash Flows
Comparative balance sheet accounts for Ed’s Pizza Hut are as shown. During 2007, the cash account has decreased by $19,000.

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 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 is provided by Ed: 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 paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.

Here is a summary of the sources of cash for Ed’s Pizza Hut. A summary of the sources of cash is as shown. The total sources of cash are $66,000.

Here is a summary of the uses of cash for Ed’s Pizza Hut. A summary of the uses of cash and the net cash flow is as shown. The total uses of cash are $85,000. The net cash flow is negative $19,000. This amount agrees with the change in the cash account shown earlier, when we looked at comparative balance sheet accounts. The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.

This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only. 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 activities, investing activities, or financing activities. Learning objective number 2 is to classify transactions as operating activities, investing activities, or financing activities.

The Full-Fledged Statement of Cash Flows: Operating Activities
Operating activities are those activities that enter into the determination of net income. Changes in noncurrent balance sheet accounts that directly affect net income Transactions affecting current assets Operating activities are those activities that enter into the determination of net income. Generally speaking, this includes: All transactions affecting current assets. All transactions affecting current liabilities (except for issuing and repaying a note payable or dividends). All changes in noncurrent balance sheet accounts that directly affect net income, such as the Accumulated Depreciation and Amortization. Transactions affecting current liabilities

The Full-Fledged Statement of Cash Flows: Investing Activities
Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. Acquiring or selling property, plant and equipment Lending money to another entity and subsequently collecting on the loan Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. These transactions include: Acquiring or selling property, plant and equipment. Acquiring or selling securities (such as bonds and stocks of other companies) held for long-term investments. Lending money to another entity, and subsequently collecting the principle of the loan. Acquiring or selling investment securities

The Full-Fledged Statement of Cash Flows: Financing Activities
Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. Transactions with creditors that affect net income, such as interest on debt, are classified as operating activities. Interest on debt is classified as an operating activity

Organization of the Full-Fledged Statement of Cash Flows
Cash flows are divided into three categories. Part I Cash flows are divided into three categories – operating, investing, and financing activities. Part II Here is a summary which can be used to classify transactions as operating, investing, and financing activities. Generally, operating activities are those activities that enter into the determination of net income. Technically, the FASB defines operating activities as all transactions that are not classified as investing or financing activities. Investing activities include transactions that involve acquiring or disposing of noncurrent assets. Financing activities include transactions that involve borrowing from or repaying creditors, as well as transactions with the company's owners.

Organization of the Full-Fledged Statement of Cash Flows
Operating Activities The beginning cash balance is reconciled with the ending cash balance. Investing Activities Financing Activities In addition to the three primary classifications on the statement of cash flows, there are two other requirements: (1) the reconciliation of the net increase or decrease in cash with the change in the balance of the cash account, and (2) reporting noncash investing and financing activities.

Operating Activities The general format for the operating activities section of the statement is as shown. It includes those activities that enter into the determination of net income. Includes those activities that enter into the determination of net income.

Operating Activities Sources of cash are added to net income and uses of cash are subtracted from net income. As a reminder, sources of cash are added to net income and uses of cash are deducted from net income.

Operating Activities Decreases in current noncash assets are added to net income. Increases in current liabilities are added to net income.

Operating Activities Increases in current noncash assets are subtracted from net income. Decreases in current liabilities are subtracted from net income.

Operating Activities Depreciation charges are treated the same as current liabilities, thus they are added to net income. Remember that depreciation charges are non-cash transactions. Since depreciation was subtracted to arrive at net income, we add it back to net income. Depreciation and Amortization charges are added back to net income because they are decreases in noncash assets.

Operating Activities Gains are subtracted from net income.
Gains are subtracted from net income and losses are added to net income. Gains are subtracted from net income. Losses are added back to net income.

Investing Activities The general format for the investing activities section of the statement is as shown. It includes those transactions that involve the acquisition or disposal of noncurrent assets. Includes transactions that involve the acquisition or disposal of noncurrent assets.

Financing Activities The general format for the financing activities section of the statement is as shown. It includes those transactions that involve the receipts from or payments to creditors and owners. Includes transactions involving receipts from or payments to creditors and owners.

Other Issues: Gross or Net?
For financing investing and 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. For both financing and investing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts. For example: If Macy’s Department Stores purchases $50,000,000 in property during the year and sells other property for $30,000,000, instead of showing the net change of $20,000,000, the company must report the gross amounts of both transactions. The gross method of reporting does not extend to operating activities, where debits and credits to an account are netted against each other.

Operating Activities: Direct or Indirect Method?
Two Formats for Reporting Operating Activities Reports the cash effects of each operating activity Direct Method Starts with accrual net income and converts to cash basis Indirect Method Part I There are two acceptable formats for presenting the cash flows from operating activities. The direct method reconstructs the income statement on a cash basis from top to bottom. For example: Cash collected from customers is used instead of revenue, and payments to suppliers is used instead of cost of sales. Part II The indirect method (also known as the reconciliation method) constructs the operating activities section of the statement of cash flows by starting with net income and adjusting it to a cash basis. Items that do not affect cash flows are removed from net income, thereby summarizing the items that differ from net cash provided by operating activities. When using the indirect method, the operating section starts with accrual net income and coverts it to cash basis. The FASB encourages the use of the direct method. However, if the direct method is used it must be accompanied by a supplementary reconciliation of net income with operating cash flows. In other words, the indirect method must also be shown. If a company decides to use the indirect method for determining net cash flows from operating activities, there is no requirement that it also report the results using the direct method. Not surprisingly, only about 1% of companies use the direct method to construct the statement of cash flows for external reports. Part III Note that no matter which format is used, the same amount of net cash flows from operating activities is generated. Note that no matter which format is used, the same amount of net cash flows from 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. Learning objective number 3 is to prepare a statement of cash flows using the indirect method to determine the net cash provided by operating activities.

A Full-Fledged Statement of Cash Flows: Indirect Method
Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut. Let’s revisit the comparative balance sheet accounts for Ed’s Pizza Hut as shown.

A Full-Fledged Statement of Cash Flows: Indirect Method
Let’s also refresh our memory regarding the following additional information. 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 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 provided by Ed: 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 paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.

Preparing the Statement of Cash Flows: Step 1
List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings. There are eight steps to preparing the statement of cash flows. The first step is to copy on to a worksheet the title of each account appearing on the comparative balance sheets, except for cash and cash equivalents and retained earnings. Contra-asset accounts, like accumulated depreciation, should be listed with the liabilities.

Compute the change from the beginning balance to the ending balance for each account. The second step is to compute the change from the beginning balance to the ending balance in each balance sheet account. Separate the change in retained earnings into net income and dividends.

Code each entry on the worksheet as a source or use of cash. The third step is to code each entry on the worksheet as a source or use of cash. The noncash assets are coded as shown. The liabilities and depreciation are coded as shown. The capital stock account is coded as shown. The net income/loss and dividends are coded as shown. Recall that the transaction involving the Note Payable and Common Stock was noncash. Recall that the transaction involving the Note Payable and Common Stock was noncash. {

Code sources of cash as positive numbers and uses of cash as negative numbers. The fourth step is to code sources of cash as positive numbers and uses of cash as negative numbers as shown.

Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero. Part I The fifth step is to make any necessary adjustments – including adjustments for gains and losses. The net effect of these adjustments should equal zero. Part II Ed’s Pizza Hut’s only adjustment was for the noncash transaction relating to the exchange of a Note Payable and Common Stock. The net effect of these adjustments should equal zero. We need to make an adjustment for the noncash transaction. {

Classify each entry as operating, investing or financing activity. The sixth step is to classify each entry on the worksheet as an operating, investing, or financing activity as shown.

Copy the data from the worksheet into the Statement of Cash Flows section by section. The seventh step is to copy the data from the worksheet into the statement of cash flows section by section. The net cash flow from operations, investing and financing activities would appear as shown. Remember that the depreciation is added back to net income to cancel out the reduction in net income caused by including this noncash expense in the income statement.

Prepare a cash reconciliation at the bottom of the statement. The eighth step is to prepare a cash reconciliation at the bottom of the statement as shown. The complete statement of cash flows with cash reconciliation would appear as shown.

Preparing the Statement of Cash Flows
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. As a supplement to this statement, Ed’s Pizza Hut would also disclose the issuance of $50,000 of stock to a creditor as a noncash financing activity. This amount was adjusted out of the worksheet in step 5.

Interpretation of the Statement of Cash Flows
Examine the operating activities section carefully. Ed’s Pizza Hut generated a net cash flow from operations of ($48,000). 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. Ed’s Pizza Hut generated a net cash flow from operations of negative $48,000. This suggests that the company may not be generating sufficient cash flows on a continuing basis to sustain the business, without liquidating assets or borrowing money.

Appendix 13A The Direct Method of Determining the Net Cash Provided by Operating Activities Appendix 13A: The Direct Method of Determining the Net Cash Provided by Operating Activities.

Learning Objective 4 Use the direct method to determine the net cash provided by operating activities. (Appendix 13A) Learning objective number 4 is to use the direct method to determine the net cash provided by operating activities. (Appendix 13A)

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

Similarities and Differences in Handling Data
Adjustments for accounts that affect revenue are the same in the direct method and indirect methods. In either case, increases in the accounts are deducted and decreases in the accounts are added. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. In the indirect method, an increase in prepaid expenses is deducted from net income. However, in the direct method an increase in prepaid expenses is added to operating expenses. Part I The adjustments for accounts that affect revenue are the same in the direct and indirect methods. In either case, increases in the accounts are deducted and decreases in the accounts are added. Part II The adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. Under the indirect method, the adjustments are made to net income, whereas, under the direct method, the adjustments are made directly against the expense accounts. For example, in the indirect method, an increase in prepaid expenses is deducted from net income. However, in the direct method an increase in prepaid expenses is added to operating expenses.

Direct Method: Gains and Losses
Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method. Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method. These gains and losses are ignored, since they are not part of sales, cost of goods sold, operating expenses, or income taxes These gains and losses are ignored since they are not part of sales, cost of goods sold, operating expenses, or income taxes.

The Direct Method: An Example
Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut. Let’s revisit the comparative balance sheet accounts for Ed’s Pizza Hut as shown.

Let’s assume that Ed’s Pizza Hut prepared this income statement.
The Direct Method Let’s assume that Ed’s Pizza Hut prepared this income statement. Let’s also assume that Ed’s Pizza Hut prepared the income statement as shown.

The Direct Method Step 1: Translate sales revenue into cash collected from customers. The first step is to translate sales revenue ($1,000,000) into cash collections from customers ($1,017,000).

The Direct Method Step 2: Translate cost of goods sold into cash disbursements for purchases. The second step is to translate cost of goods sold ($750,000) into cash disbursements for purchases ($789,000).

The Direct Method Step 3: Translate operating expenses into cash paid for operating expenses. The third step is to translate operating expenses ($277,000) into cash paid for operating expenses ($276,000). There is no adjustment for income taxes because Ed’s Pizza Hut has a net loss of $27,000. There is no adjustment for income taxes because Ed’s Pizza Hut has a net loss of $27,000.

The Direct Method Notice that the net cash provided by operating activities agrees with that computed using the indirect method. The net cash provided by operating activities is negative $48,000. This agrees with the net cash provided by operating activities that was computed using the indirect method.

The T-Account Approach to Preparing the Statement of Cash Flows
Appendix 13B The T-Account Approach to Preparing the Statement of Cash Flows Appendix 13B: The T-Account Approach to Preparing the Statement of Cash Flows The T-account approach is an alternative technique that is sometimes used to prepare the statement of cash flows. We will demonstrate this approach using the data from Ed’s Pizza Hut.

Learning Objective 5 Prepare a statement of cash flows using the T-account approach. (Appendix 13B) Learning objective number 5 is to prepare a statement of cash flows using the T-account approach. (Appendix 13B)

T-Account Approach Let’s revisit the comparative balance sheet accounts for Ed’s Pizza Hut as shown. Notice, the cash balance has decreased by $19,000.

T-Account Approach 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 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 provided Ed: 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 paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.

Here is a summary of the sources of cash for Ed’s Pizza Hut.
T-Account Approach Here is a summary of the sources of cash for Ed’s Pizza Hut. A summary of the sources of cash is as shown. The total sources of cash are $66,000.

Here is a summary of the uses of cash for Ed’s Pizza Hut.
T-Account Approach Here is a summary of the uses of cash for Ed’s Pizza Hut. A summary of the uses of cash and the net cash flow is as shown. The total uses of cash are $85,000. The net cash flow is negative $19,000. This amount agrees with the change in cash shown earlier when we looked at comparative balance sheet accounts. The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.

The Journal Entries The entry to record the $27,000 net loss for the period and its effect on cash would be to debit Retained Earnings –Net Loss and credit Cash - Used. The entry to record the $3,000 dividends paid and its effect on cash would be to debit Retained Earnings – Dividends and credit Cash – Used.

T-Account Approach The entry to record the $17,000 decrease in accounts receivable and its effect on cash would be to debit Cash – Provided and credit Accounts Receivable. The entry to record the $50,000 increase in inventory and its effect on cash would be to debit Inventory and credit Cash – Used.

T-Account Approach The entry to record the $32,000 sale of land and its effect on cash would be to debit Cash – Provided and credit Land. The entry to record the $6,000 depreciation expense for the year would be to debit Cash – Provided and credit Accumulated Depreciation.

T-Account Approach The entry to record the $11,000 increase in accounts payable and its effect on cash would be to debit Cash – Provided and credit Accounts Payable. The entry to record the $5,000 decrease in salaries payable and its effect on cash would be to debit Salaries Payable and credit Cash – Used.

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

T-Account Approach The net effect of these transactions on the cash account is as shown. Notice, the net decrease in cash is $19,000. The net effect of these transactions on the cash account is as shown. Notice, the net decrease in cash is $19,000.

Preparing the Statement of Cash Flows
The technique used to gather and organize data does not affect the format of the statement of cash flows. The final statement of cash flows prepared using the T-account method would appear as shown. Each transaction has been properly disclosed in the operating, investing, and financing sections of the statement. The technique used to gather and organize data does not affect the format of the statement of cash flows. The final statement of cash flows prepared using the T-account method would appear as shown. Notice that each transaction has been properly disclosed in the operating, investing or financing sections of the statement. As a supplement to this statement, Ed’s Pizza Hut would also disclose the issuance of $50,000 of stock to a creditor as a noncash financing activity.

End of Chapter 13 End of chapter 13.

“How Well Am I Doing?” Statement of Cash Flows

Similar presentations

Presentation on theme: "“How Well Am I Doing?” Statement of Cash Flows"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

“How Well Am I Doing?” Statement of Cash Flows

Similar presentations

Presentation on theme: "“How Well Am I Doing?” Statement of Cash Flows"— Presentation transcript:

Similar presentations

About project

Feedback