1. HUANGHUAI UNIVERSITY & BANGOR UNIVERSITY Lecture 9 Statement of Cash Flows DR. AZIZ JAAFAR

2. Statement of Cash Flows – Background
Required presentation since 1987
Cash and cash equivalents
Cash on hand
Cash on deposit
Investments in short-term, highly liquid securities

3. Statement Use Internal users External users Determine dividend policy
Evaluate cash generated by operations
Review investing and financing policy
External users
Assess firm’s ability to increase dividends
Assess firm’s ability to pay debt from operations
Assess firm’s relationship of cash from operations to total cash

4. Statement Structure Cash flows from operations
+ Cash flows from investing activities
+ Cash flows from financing activities
= Change in cash
+ Beginning cash balance
= Ending cash balance
Supplemental disclosure: non-cash financing and investing activities

5. Operating Activities
The cash effects of transactions and other events that enter into the determination of net income:
Cash inflows from
Sale of goods or services
Returns on loans (interest)
Return on equity securities (dividends)
Cash outflows for
Payments for acquisitions of inventory
Payments to employees
Payments for taxes
Payments for interest
Payments for other expenses

6. Investing Activities
Lending money and collecting on those loans and acquiring and selling investments and productive long-term assets:
Cash inflows from
Receipts for loans collected
Sales of debt or equity securities
Sales of plant, property, and equipment
Cash outflows for
Loans to other entities
Investment in debt or equity securities
Purchase of plant, property, and equipment

7. Financing Activities
Borrowing and repaying long-term loans; issuing equity securities; payment of dividends to shareholders:
Cash inflows from
Sale of equity securities
Sale of bonds, mortgages, notes, and other short- and long-term borrowings
Cash outflows for
Payment of dividends
Reacquisition of capital stock
Payment of amounts borrowed

8. Cash Flows From Operations
Alternative presentations:
Direct method
Presents the income statement on a cash basis
Encouraged by FASB 95
Supplemental information required: reconciliation of net income to cash provided by operations
Indirect method
Adjusts net income for items that affected net income but did not affect cash
Supplemental information required: cash paid for income taxes and for interest

9. Cash Flows From Operations: Direct Method
Presents the income statement on a cash basis

10. Cash Flows From Operations: Indirect Method
Adjusts net income for items that affected net income but did not affect cash

11. Cash Flows From Operations
Direct
Indirect

12. Cash Flows From Investing Activities

13. Cash Flows From Financing Activities

14. Statement of Cash Flows – Direct Method (supplemental disclosures not illustrated)

15. Statement of Cash Flows – Indirect Method (supplemental disclosures not illustrated)

16. Alternative Cash Flow Analysis

17. Financial Ratios and the Statement of Cash Flows
Statement of cash flows is relatively new
Required presentation began in 1987
Cash flow financial ratios were slowly developed
Traditional ratios relate balance sheet to income statement

18. Operating Cash Flow/Current Maturities of Long-Term Debt and Current Notes Payable
Indicates a firm’s abilities to meet its current maturities of debt
Higher ratio indicates better liquidity

19. Operating Cash Flow to Total Debt
Indicates a firm’s ability to cover total debt with the yearly operating cash flow
Conservative approach is to include all possible balance sheet debt

20. Operating Cash Flow per Share
A better indication of a firm’s ability to make capital expenditure decisions and pay dividends than is earnings per share
Does not reflect firm’s profitability
Firms are prohibited from reporting this statistic in financial statements or in the notes thereto

21. Operating Cash Flow to Cash Dividends
Indicates a firm’s ability to cover cash dividends with the yearly operating cash flow

22. Alternative Cash Flow No standard definition of cash flow
Alternative definition
Net income plus depreciation expense
Less useful than the net cash flow from operating activities

23. Procedures to Develop the Statement of Cash Flows
Analyze all balance sheet accounts other than cash and cash equivalents.
Increase
Decrease
Current assets
Operating outflow
Operating inflow
Noncurrent assets
Investing outflow
Investing inflow
Current liabilities
Long-term liabilities
Financing inflow
Financing outflow
Stockholders’ equity

24. Procedures to Develop the Statement of Cash Flows (cont’d)
Determine change in cash and cash equivalents
Compute the change in all other balance sheet accounts
Classify as operating, investing, and financing

25. Procedures to Develop Direct Operating Cash Flows
Operating section describes income statement accounts as receipts or payments
Cash receipts
From customers
From other operating sources
Cash payments
For merchandise
To employees
For other operating expenses

26. Procedures to Develop Indirect Operating Cash Flows
Begin with net income
Eliminate gains and losses that relate to investing and financing activities
Add back or deduct adjustments to change accrual-based net income to cash basis
Current noncash assets
Current liabilities