1. “How Well Am I Doing?” Statement of Cash Flows Chapter 15 McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Purpose of the Statement of Cash Flows Are cash flows sufficient to support ongoing operations? Can we meet our obligations to creditors? Can we pay dividends? Why is there a difference between net income and net cash flow? Will the company have to borrow money to make needed investments? 15-2

3. Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Cash Treasury Bills Money Market Funds Commercial Paper Currency and Bank Accounts 15-3

4. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts 15-4

5. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Example: Inventory is purchased on credit from a supplier. It is implied that cash was used to acquire the inventory. noncash asset uses Increases in noncash asset accounts imply uses of cash. 15-5

6. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts It is implied that an increase in a payable has the effect of increasing cash available for other uses. liability sources Increases in liability accounts imply sources of cash. Example: Inventory is purchased on credit from a supplier. 15-6

7. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts noncash assets sources Decreases in noncash assets accounts imply sources of cash. Example: Accounts receivable decreases when a customer pays their bill. When the customer pays the bill, the company’s cash increases. 15-7

8. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts liability uses Decreases in liability accounts imply uses of cash. When the payment is made, cash decreases. Example: A company pays a note payable held by a creditor. 15-8

9. The Full-Fledged Statement of Cash Flows: Operating Activities Operating activities are those activities that enter into the determination of net income. 1. Transactions affecting current assets 3. Changes in noncurrent balance sheet accounts that directly affect net income 2. Transactions affecting current liabilities 15-9

10. The Full-Fledged Statement of Cash Flows: Investing Activities Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. 1. Acquiring or selling property, plant and equipment 3. Lending money to another entity and subsequently collecting on the loan 2. Acquiring or selling securities 15-10

11. Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. 1. Issuing stock and purchasing treasury stock 3. Payment of dividends (note that interest on debt is classified as an operating activity) 2. Issuing long- term debt and repayment of debt. The Full-Fledged Statement of Cash Flows: Financing Activities 15-11

12. The Full-Fledged Statement of Cash Flows: An Overview 15-12

13. The Full-Fledged Statement of Cash Flows: An Overview Operating Activities Investing Activities Financing Activities Reconciliation of the beginning cash balance with the ending cash balance Noncash Investing and Financing Activities 15-13

14. Operating Activities Sources of cash are added to net income and uses of cash are deducted from net income. 15-14

15. Other Issues: Direct Method or Indirect Method? Two Formats for Reporting Operating Activities Reports the cash effects of each operating activity Starts with accrual net income and converts to cash basis Direct Method Indirect Method No matter which format is used, the same amount of net cash provided by operating activities is generated. 15-15

16. A Full-Fledged Statement of Cash Flows: An Example Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut. 15-16

17. A Full-Fledged Statement of Cash Flows: An Example  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 purchased equipment for $28,000.  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.  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 purchased equipment for $28,000.  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. Let’s also refresh our memory regarding the following additional information. 15-17

18. 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. Example – Indirect Method 15-18

19. Free Cash Flows Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities. 15-19

20. 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. Net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method. 15-20

21. Similarities and Differences in Handling Data Adjustments for accounts that affect revenue are the same in the direct and indirect methods. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. 15-21

22. The Direct Method: An Example Notice that the net cash provided by operating activities agrees with that computed using the indirect method. 15-22

23. End of Chapter 15 15-23