1. Cash Flow Statement CHAPTER 13

2. Ability to generate future cash flowAbility to generate future cash flow Ability to pay dividends and meet obligationsAbility to pay dividends and meet obligations Reasons for the difference between net earnings and net cash provided (used) by operating activitiesReasons for the difference between net earnings and net cash provided (used) by operating activities Investing and financing transactions during the periodInvesting and financing transactions during the period Purpose of Cash Flow Statement

3. Include:Include: –Cash effects of transactions that create revenues and expenses –These enter into determination of net earnings On the balance sheet, operating activities items include:On the balance sheet, operating activities items include: –Noncash current assets and current liabilities –Statement of earnings items Operating Activities

4. Include:Include: –Purchasing and disposing of investments and productive long-lived assets using cash –Lending money and collecting the loans On the balance sheet, investing activities items include:On the balance sheet, investing activities items include: –Investments –Long-term asset items Investing Activities

5. Include:Include: –Obtaining cash from issuing debt and repaying the amounts borrowed –Obtaining cash from shareholders and paying them dividends On the balance sheet, financing activities items include:On the balance sheet, financing activities items include: –Notes payable –Long-term liabilities –Shareholders’ equity items Financing Activities

6. If it does not affect cash, do NOT report in cash flow statementIf it does not affect cash, do NOT report in cash flow statement Report in separate note or supplementary schedule to the financial statementsReport in separate note or supplementary schedule to the financial statements Significant Noncash Activities

7. Format of Cash Flow Statement COMPANY NAME Cash Flow Statement Period Covered Operating activities (List of individual items)$XX Net cash provided (used) by operating activities $XXX Investing activities (List of individual items) $XX Net cash provided (used) by investing activitiesXXX Financing activities (List of individual items) $XX Net cash provided (used) by financing activitiesXXX Net increase (decrease) in cashXXX Cash, beginning of periodXXX Cash, end of period $XXX Cash flows from the three activities – operating, investing, and financing – constitute the general format of the cash flow statement

8. Preparing the Cash Flow Statement Step: 1

9. Definition of Cash Cash includes cash and cash equivalentsCash includes cash and cash equivalents Cash equivalents are short-term, highly liquid investments that are readily converted to cash within a short period of timeCash equivalents are short-term, highly liquid investments that are readily converted to cash within a short period of time Examples include:Examples include: –Treasury bills –Money market funds –Short-term investments –Short-term debt Because the definition of “cash” varies, companies must clearly define cash equivalents

10. Preparation of the Operating Activities Section Net earnings must be converted from an accrual basis to a cash basis in the operating activities sectionNet earnings must be converted from an accrual basis to a cash basis in the operating activities section Conversion may be done by two methods:Conversion may be done by two methods: –Indirect –Direct

11. Indirect and Direct Methods Both methods arrive at the same total amount of cash provided (used) by operating activitiesBoth methods arrive at the same total amount of cash provided (used) by operating activities Methods differ in disclosing the items that make up the total amountMethods differ in disclosing the items that make up the total amount Choice of methods affects only the operating activities section, the investing and financing activities sections are the sameChoice of methods affects only the operating activities section, the investing and financing activities sections are the same

12. Indirect Method Used extensivelyUsed extensively Most companies favour the indirect method for the following reasonsMost companies favour the indirect method for the following reasons –Easier to prepare –Focuses on the differences between net earnings and net cash flow from operating activities –Reveals less company information to competitors

13. Direct Method CICA prefers the direct method but allows the use of either methodCICA prefers the direct method but allows the use of either method Details cash receipts and paymentsDetails cash receipts and payments Easier to understandEasier to understand

14. Preparing the Cash Flow Statement Step: 2

15. Net Earnings to Net Cash Provided (Used) by Operating Activities Cash flow statement prepared by the indirect method starts with net earnings and adds or deducts items not affecting cash in order to arrive at net cash provided (used) by operating activitiesCash flow statement prepared by the indirect method starts with net earnings and adds or deducts items not affecting cash in order to arrive at net cash provided (used) by operating activities –Changes in specific noncash current assets and current liabilities and –Noncash items reported in the statement of earnings

16. Net Earnings to Net Cash Provided (Used) by Operating Activities (Balance Sheet: Noncash Current Assets and Current Liabilities) Adjustments to Convert Net Earnings to Net Cash Provided (Used) by Operating Activities Add*Deduct* Change in Current Asset Account Balance Accounts receivable Decrease Increase Inventory Decrease Increase Prepaid expenses Decrease Increase Other current assets Decrease Increase Change in Current Liability Account Balance Accounts payable Increase Decrease Accrued expenses payable Increase Decrease Other current liabilities Increase Decrease * Add (deduct) change in account balance to net earnings

17. Net Earnings to Net Cash Provided (Used) by Operating Activities (Statement of Earnings: Noncash Items) Adjustments to Convert Net Earnings to Net Cash Provided (Used) by Operating Activities Noncash Items on Statement of Earnings Amortization expenseAdd Loss on sale of assetAdd Gain on sale of asset Deduct Earnings from long-term equity investment Deduct

18. Net Cash Provided (Used) by Operating Activities Indirect Method –Sample Format ANY CORPORATION Cash Flow Statement (Partial) — Indirect Method Year Ended December 31, 2004 Operating activities Net earnings Net earnings$139,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Adjustments to reconcile net earnings to net cash provided by operating activities: Amortization expense Amortization expense $15,000 $15,000 Loss on sale of equipment Loss on sale of equipment 3,000 3,000 Decrease in accounts receivable Decrease in accounts receivable 10,000 10,000 Increase in prepaid expenses Increase in prepaid expenses (4,000) (4,000) Increase in accrued expenses payable Increase in accrued expenses payable 55,000 55,000 79,000 79,000 Net cash provided by operating activities Net cash provided by operating activities$218,000

19. Illustration 13-17 Cash Receipts and Cash Payments (Direct Method)

20. Cash Receipts from Customers The relationship among cash receipts from customers, revenues from sales, and changes in accounts receivable is:The relationship among cash receipts from customers, revenues from sales, and changes in accounts receivable is: Cash receipts from customers = Sales revenue { + Decrease in accounts receivable or – Increase in accounts receivable

21. Cash payments to suppliers = Cost of goods sold { + Increase in inventory or – Decrease in inventory { + Decrease in accounts payable or – Increase in accounts payable Cash Payments to Suppliers The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:

22. Cash payments for operating expenses + Decrease in accrued expenses payable or – Increase in accrued expenses payable + Increase in prepaid expenses or – Decrease in prepaid expenses { Operating expenses { = Cash Payments for Operating Expenses The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:

23. Cash payments for income taxes { = Income tax expense + Decrease in income tax payable or – Increase in income tax payable Cash Payments for Income Taxes The relationship among cash payments for income taxes, income tax expense, and changes in income taxes payable is:The relationship among cash payments for income taxes, income tax expense, and changes in income taxes payable is:

24. Net Cash Provided (Used) by Operating Activities Direct Method –Sample Format ANY CORPORATION Cash Flow Statement (Partial) — Direct Method Year Ended December 31, 2004 Operating activities Cash receipts from customers Cash receipts from customers$517,000 Cash payments: Cash payments: For operating expenses For operating expenses$(210,000) For income taxes For income taxes (89,000) (89,000)(299,000) Net cash provided by operating activities Net cash provided by operating activities218,000

25. Preparing Cash Flow Statement: Step 3

26. Study the balance sheet to determine changes in investments and long-term assetsStudy the balance sheet to determine changes in investments and long-term assets Changes in each short-term investment (unless incorporated as part of cash definition) and long- term account are analysed using selected transaction data to determine the effect, if any, the changes had on cashChanges in each short-term investment (unless incorporated as part of cash definition) and long- term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash Net Cash Provided (Used) by Investing Activities

27. Net Cash Provided (Used) By Financing Activities Examine the balance sheet to determine changes in noncurrent liabilities and shareholders’ equityExamine the balance sheet to determine changes in noncurrent liabilities and shareholders’ equity Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cashChanges in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

28. ANY CORPORATION Cash Flow Statement (Partial) Year Ended December 31, 2004 (Sample Format) Net cash provided by operating activities (Continued) $218,000 Investing activities Purchase of building Purchase of building $(160,000) $(160,000) Purchase of equipment Purchase of equipment (25,000) (25,000) Sale of equipment Sale of equipment 4,000 4,000 Net cash used by investing activities Net cash used by investing activities (181,000) Financing activities Financing activities Payment of cash dividends Payment of cash dividends $15,000 $15,000 Net cash used by financing activities Net cash used by financing activities (15,000) (15,000) Net increase in cash 22,000 22,000 Cash, January 1 34,000 34,000 Cash, December 31 $ 56,000

29. Using Cash Flows to Evaluate a Company –Cash provided by operating activities does not consider that a company must invest in new assets –Free cash flow is a solvency-based measure that helps to evaluate a company’s discretionary cash flow –This ratio is cash-based instead of accrual- based

30. Free Cash Flow Cash Provided by Operating Activities - Capital Expenditures - Dividends Paid = Free Cash Flow