1. The Statement of Cash Flows

2. Learning Objectives
Describe the circumstances in which the cash flow statement is a particularly important companion of the income statement.
Outline the structure of and information reported in the three main categories of the cash flow statement: operating, investing, and financing.

3. Learning Objectives
Appreciate the historical process involved in the development of the modern statement of cash flows.
Compute cash flow from operations using either the direct or the indirect method.
Prepare a complete statement of cash flows and provide the required supplemental disclosures.

4. Learning Objectives
Understand the differences among cash flow statements prepared according to U.S. GAAP, U.K. GAAP, and International Accounting Standards.
Assess a firm’s financial strength by analyzing the relationships among cash flows from operating, investing, and financing activities and by computing financial ratios based on cash flow data.

5. Learning Objectives
Use knowledge of how the three primary financial statements tie together in order to prepare a forecasted statement of cash flows.
EXPANDED MATERIAL
Use a T-account or work sheet approach to prepare a statement of cash flows.

6. What Good Is a Cash Flow Statement?
Does a statement of cash flows tell us anything we don’t already know from other statements?

7. What Good Is a Cash Flow Statement?
Finally, a statement of cash flows is an excellent forecasting tool.
Yes, because there are situations where net income does not give us an accurate picture.
Also, everything you want to know about a company is summarized in this one statement.

8. Purposes of Cash Flow Statement
Statement of Cash Flows--The primary financial statement that summarizes an entity’s cash receipts and payments during a period.
Predicts an entity’s ability to:
generate positive future cash flows.
meet current and long-term obligations.
pay future dividends. 3 2

9. Cash Equivalent
It must be readily convertible to cash and it must be so near to maturity that there is insignificant risks of changes in value due to changes in interest rate.
It is a short-term, highly liquid investment.
What is a cash equivalent?

10. Three Categories of Cash Flows
Cash Inflows
Operating
Activities
Investing
Financing 35

11. Cash Flow Categories
Operating Activities--Transactions and events that enter into the determination of net income.
Investing Activities--Transactions and events that involve the purchase and sale of securities, property, plant, equipment, and other assets not generally held for resale, and the making and collecting of loans.
Financing Activities--Transactions and events whereby cash is obtained from or repaid to owners and creditors. 6 5

12. General Format of a Statement of Cash Flows
Cash Provided by or Used in:
Operating Activities $XXX
Investing Activities XXX
Financing Activities XXX
Net Increase (Decrease) in Cash $XXX
Cash--Beginning of Year XXX
Cash--End of Year $XXX 12 6

13. Operating Activities Cash Inflow Cash Outflow Cash Receipt of Sales
Collection of Receivables
Interest Revenue
Dividend Revenue
Cash Outflow
Inventory Payments
Interest Payments
Wages
Utilities
Rent 13 7

14. Investing Activities Cash Inflow Cash Outflow Sale of plant assets
Sale of securities, other than trading securities
Collection of principal on loans
Cash Outflow
Purchase of plant assets
Purchase of securities, other than trading securities
Making of loans with other entities 15 9

15. Financing Activities Cash Inflow Cash Outflow Issuance of own stock
Borrowings
Cash Outflow
Dividend payments
Repayment of loans
Treasury stock purchase 17 11

16. Noncash Transactions
Noncash Transactions--Investing and financing activities that do not affect an entity’s cash flow.
Significant transactions should be disclosed separately.
These transactions do not affect the statement of cash flows. 19 13

17. Reporting Operating Cash Flows
Direct Method--A method of reporting net cash flows from operations that shows cash receipts and payments for a period of time. This method is more straight forward.
Indirect Method--A method of reporting net cash flow from operations that involves reconciling net income to a cash basis. It shows how noncash flows affect net income. 20 14

18. The Direct Method
This method reports directly the major classes of operating cash receipts and payments of an entity during a period.
Accrual-basis revenues and expenses must be converted to equivalent cash receipts and payments.
The amount of cash actually collected or paid is determined. 33 21

19. Example: Cash Receipts
Sales and Cash Collected from Customers:
Beginning accounts receivable $140
+ Sales
= Cash available for collection $190
- Ending accounts receivable
= Cash collected from customers $130 64 37

20. Example: Inventory Cost of Goods Sold and Cash Paid for Inventory:
Ending inventory $ 75
+ Cost of goods sold 80
= Required inventory $155
- Beginning inventory 100
= Cash paid for inventory this year $ 55

21. Example: Wages Wages Expense and Cash Paid for Wages:
Beginning wages payable $ 7
+ Wages expense 25
= Total obligation to employee $32
- Ending wages payable 10 = Cash paid for wages $22

22. Indirect Method The indirect method makes the following adjustments:
Adjustments for receivables and other current operating assets.
Adjustments for payables and other current liabilities.
Adjustments for depreciation and other noncash items.
Adjustments for gains and losses. 21 15

23. Adjustments for Gains and Losses
Gains or losses do not represent the cash effect of the transaction.
Adjustment to
Account Net Income
Losses
Gains
These adjustments are made to net income since the sale of an investment is an investing activity, not an operating activity. 32 20

24. Adjustments for Receivables
Changes in accounts directly affect revenues recorded on an accrual basis.
Account Adjustment to
Account Change Net Income
Accounts Receivable 25 17

25. Adjustments for Payables
Changes in liabilities mean the reverse of changes in current operating asset accounts.
Account Adjustment to
Account Change Net Income
Accounts Payable 28 18

26. Noncash Adjustments
Depreciation and similar noncash items do not affect cash and are not reported on the statement of cash flows.
Any noncash item that reduces net income should be added back to net income in the indirect method.
Any noncash item that increases net income should be subtracted from net income in the indirect method. 29 19

27. Relationship Between Net Income and Operating Cash Flow
Business engages in operating activities
Cash is received and disbursed
Operating cash flow
Net income
Apply accrual accounting rules
“Undo” accrual accounting to get back to cash flow 16

28. Steps for Preparing a Cash Flow Statement
Compute how much the cash balance changed during the year.
Convert the income statement from an accrual-basis to a cash-basis summary of operations.
a. Eliminate expenses that do not involve the outflow of cash, such as depreciation.
b. Eliminate gains and losses associated with investing or financing activities.
c. Adjust for changes in the balances of current assets and current liabilities. 49 22

29. Steps for Preparing a Cash Flow Statement
Analyze the long-term assets to identify the cash flow effects of investing activities.
Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions.
Make sure that the total net cash flow from operating, investing, and financing activities is equal to the net increase or decrease in cash as computed in Step 1. Then, prepare a formal statement of cash flows.
Prepare supplement disclosure of significant noncash transactions.

30. Example: Comparative Balance Sheet
Assets
Cash and Cash Equivalents
Accounts Receivable
Inventory
Equipment
Accumulated Depreciation
Total Assets
$ 82
180
170
200
(72)
$560
$ 40
150
200
140
(60)
$470
Liabilities and Equity
Accounts Payable
Long-Term Notes Payable
Common Stock
Retained Earnings
Total Liabilities and Equity
$100
100
250
110
$560
$ 80 50
250 90
$470 50 23

31. Income Statement, 20X1 Sales Expenses: Cost of Goods Sold
Selling and General Expense
Depreciation
Interest Expense
Operating Income
Gain from Sale of Equipment
Income before Income Taxes
Income Tax Expense
Net Income
$345
$120 58 20
$145 5
$140 30
$110 51 24

32. Step 1 Determine change in cash and cash equivalents:
Cash 20X $ 40
Cash 20X
Change in Cash $ 42 53 26

33. (T-account or work sheet entry)
Step 2
Convert from an accrual-basis to a cash-basis summary of operations:
EXAMPLE: Eliminate depreciation expense, $44, because it does not require the use of cash.
Cash Provided by Operations 44
Accumulated Depreciation 44
(T-account or work sheet entry)

34. Add back $5 to cash provided by operations.
Step 2
Convert from an accrual-basis to a cash-basis summary of operations:
EXAMPLE: Eliminate the $5 gain from selling equipment.
Cash 33
Accumulated Depreciation 32
Equipment 60
Gain on Sale of Equipment 5
Add back $5 to cash provided by operations.

35. Step 3
Analyze the long-term assets to identify the cash flow effects of investing activities.
Expenditures for Property, Plant, and Equipment:
Beginning equipment $140
- Equipment sold during the year
= $ 80
- Ending equipment
= Expenditures for equipment during
year $120

36. Step 4
Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions:
Expenditures for Long-Term Debt:
Beginning L-T notes payable balance $ 50
- Notes reacquired during the year
= $ 50
- Ending L-T notes payable balance
= L-T notes payable issued during year $ 50

37. Step 4
Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions:
Payment of Dividends:
Beginning retained earnings balance $ 90
+ Net income 110
= $200
- Ending retained earnings balance
= Dividends paid $ 90

38. Steps 5 and 6
Steps 5 and 6 relate to actually preparing the formal and supplementary statements.

39. Operating Activities Section: Indirect Method
Cash Flows from Operating Activities:
Net Income $110
Adjustments:
Depreciation Expense
Gain on Sale of Equipment (5)
Increase in Accounts Receivable (30)
Decrease in Inventory
Increase in Accounts Payable
Net Cash Provided by Operating
Activities $169
Continued on slide 42 61 34

40. Operating Activities Section: Direct Method
4040
Cash Flows from Operating Activities:
Cash Collected from Customers $ 414
Cash Payments for:
Inventory (155) Selling & General Expenses (58)
Interest (2)
Income Taxes (30) $(245)
Net Cash Provided by Operating
Activities $169
Continued on slide 42 68 41

41. Investing and Financing Activities Sections
The investing and financing sections are the same whether the direct or indirect approach is used.

42. Investing and Financing Activities Sections
Cash Flows from Investing Activities:
Proceeds from Sale of Equipment $ 33
Purchase of equipment (120)
Net Cash Provided by Investing
Activities $(87)
Cash Flows from Financing Activities:
Issuance of Long-Term Notes Payable 50
Payment of Cash Dividends (90)
Net Cash Used for Financing Activities $(40)
Net Increase in Cash $ 42
Cash, January 1,
Cash, December 31, 2001 $ 82
Continued from either slide 39 or 40

43. The End