1. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 12 Reporting and Interpreting the Statement of Cash Flows

2. 12-2 Learning Objective 1 Identify cash flows arising from operating, investing, and financing activities.

3. 12-3 The statement focuses attention on: Ability to generate cash from its operations. Management of current assets and current liabilities. Expenditures for long-term assets. Amount received from external financing. Business Activities and Cash Flows

4. 12-4 The statement helps to answer these questions:  Is there enough cash to pay short-term debt?  Are accounts receivable and inventory adequately managed?  Has the company purchased sufficient equipment and other long-term assets?  Did the company generate enough cash internally to finance the purchases, or did it rely on external financing?  Is the company changing the source of its external financing? The statement helps to answer these questions:  Is there enough cash to pay short-term debt?  Are accounts receivable and inventory adequately managed?  Has the company purchased sufficient equipment and other long-term assets?  Did the company generate enough cash internally to finance the purchases, or did it rely on external financing?  Is the company changing the source of its external financing? Business Activities and Cash Flows

5. 12-5 Cash Checking and Savings Accounts Currency Cash Equivalents Highly liquid short-term investments within three months of maturity. Cash Equivalents Highly liquid short-term investments within three months of maturity. Business Activities and Cash Flows

6. 12-6 The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95: Operating Activities Investing Activities Financing Activities Classifying Cash Flows

7. 12-7 Classifying Cash Flows

8. 12-8 Cash inflows and outflows that directly relate to revenues and expenses reported on the income statement. Operating Activities

9. 12-9 Cash Flows from Operating Activities Inflows from: Sales to customers. Interest and dividends received. Inflows from: Sales to customers. Interest and dividends received. + Outflows to: Purchase of goods for resale and services. Salaries and wages. Income taxes. Interest on liabilities. Outflows to: Purchase of goods for resale and services. Salaries and wages. Income taxes. Interest on liabilities. _ Operating Activities

10. 12-10 Cash Flows from Investing Activities + Inflows from: Sale or disposal of property, plant, and equipment. Sale or maturity of investments in securities. Inflows from: Sale or disposal of property, plant, and equipment. Sale or maturity of investments in securities. _ Outflows to: Purchase property, plant, and equipment. Purchase investments in securities. Outflows to: Purchase property, plant, and equipment. Purchase investments in securities. Investing Activities

11. 12-11 Cash Flows from Financing Activities + Inflows from: Borrowing on notes, mortgages, bonds, etc. from creditors. Issuing stock to owners. Inflows from: Borrowing on notes, mortgages, bonds, etc. from creditors. Issuing stock to owners. _ Outflows to: Repay principal to creditors (excluding interest). Repurchase stock from owners. Dividends to owners. Outflows to: Repay principal to creditors (excluding interest). Repurchase stock from owners. Dividends to owners. Financing Activities

12. 12-12 Relationships Between Balance Sheet and Cash flow Categories

13. 12-13 Relationship With Other Financial Statements Information needed to prepare a statement of cash flows: Comparative Balance Sheets. Income Statement. Additional details concerning selected accounts. Information needed to prepare a statement of cash flows: Comparative Balance Sheets. Income Statement. Additional details concerning selected accounts.

14. 12-14 Assets = Liabilities  Stockholders’ Equity  Cash =  Liabilities  Stockholders’ Equity  Noncash Assets From this basic balance sheet equation, we develop our model to solve for the change in cash: Recall that the basic balance sheet equation is: Relationship With Other Financial Statements

15. 12-15 Learning Objective 2a Report cash flows from operating activities, using the indirect method.

16. 12-16 Cash Flows from Operating Activities - Indirect Method Net Income Cash Flows from Operating Activities - Indirect Method Changes in current assets and current liabilities. + Losses and - Gains + Noncash expenses such as depreciation and amortization. The indirect method adjusts net income by eliminating noncash items.

17. 12-17 Use this table when adjusting Net Income to Operating Cash Flows using the indirect method. Relationships to the Balance Sheet and the Income Statement Change in account balances during the year

18. 12-18 Use the following financial statements for The Nautilus Group and prepare the Statement of Cash Flows for the year ended December 31, 2005 Statement of Cash Flows Indirect Method Example

19. 12-19 Statement of Cash Flows Indirect Method Example

20. 12-20 Statement of Cash Flows Indirect Method Example

21. 12-21 The Statement of Cash Flows will begin with Nautilus, Inc.’s net income from the Income Statement. Statement of Cash Flows Indirect Method Example

22. 12-22 Next, adjust for the non-cash items included in net income. For Nautilus, the only non-cash adjustment is for depreciation expense $13,079. Next, adjust for the non-cash items included in net income. For Nautilus, the only non-cash adjustment is for depreciation expense $13,079.

23. 12-23 (Remember, we showed the balance sheets a few slides earlier.) To complete the cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period.

24. 12-24 Statement of Cash Flows Indirect Method Example

25. 12-25 Learning Objective 2b Report cash flows from operating activities, using the direct method.

26. 12-26 A Comparison of the Direct and Indirect Methods Net cash flow is the same for both methods. The direct method provides more detail about cash from operating activities. The investing and financing sections for the two methods are identical. Net cash flow is the same for both methods. The direct method provides more detail about cash from operating activities. The investing and financing sections for the two methods are identical.

27. 12-27 When we prepared the operating section using the indirect method, we also arrived at net cash inflow of ($38,091). Let’s see how we arrive at these cash flows. Direct Method Operating Activities

28. 12-28 With the direct method, we convert each revenue and expense on the income statement to a cash flow. Direct Method Operating Activities

29. 12-29 Learning Objective 3 Report cash flows from investing activities.

30. 12-30 Short-term investments decreased by $85,319 during the year. If we could examine the detailed accounting records, we would find that Nautilus sold short- term investments and received $85,319 in cash. The sale of short-term investments is a cash inflow. Short-term investments decreased by $85,319 during the year. If we could examine the detailed accounting records, we would find that Nautilus sold short- term investments and received $85,319 in cash. The sale of short-term investments is a cash inflow. Reporting Cash Flows from Investing Activities

31. 12-31 The balance sheet indicates that Equipment increased by $87,406 during the year. Nautilus purchased equipment for $87,406 cash and did not sell any equipment during the year. The equipment purchase is a cash outflow. The balance sheet indicates that Equipment increased by $87,406 during the year. Nautilus purchased equipment for $87,406 cash and did not sell any equipment during the year. The equipment purchase is a cash outflow. Reporting Cash Flows from Investing Activities

32. 12-32 Learning Objective 4 Report cash flows from financing activities.

33. 12-33 Long-term debt increased by $51,466 during the year. Nautilus borrowed $51,466 which is a cash inflow. Reporting Cash Flows from Financing Activities

34. 12-34 Reporting Cash Flows from Financing Activities Contributed capital decreased $9,219 because Nautilus purchased common stock for cash.

35. 12-35 Nautilus Group declared and paid cash dividends of $13,351 which is a cash outflow. Reporting Cash Flows from Financing Activities

36. 12-36 Now we can reconcile the change in cash to the ending cash balance that appears on the Balance Sheet. Reporting Cash Flows from Financing Activities

37. 12-37 Required Supplemental Information: 1.Cash paid for taxes and interest. 2.Significant non-cash investing and financing activities. Required Supplemental Information: 1.Cash paid for taxes and interest. 2.Significant non-cash investing and financing activities. Noncash Investing and Financing Activities

38. 12-38 Learning Objective 5 Interpret cash flows from operating, investing, and financing activities using ratios.

39. 12-39 Operating cash flows must be positive over the long-run for a company to be successful. An upward trend in operating cash flows over time indicates growth and efficient operations. Operating cash flows must be positive over the long-run for a company to be successful. An upward trend in operating cash flows over time indicates growth and efficient operations. Interpreting Operating Cash Flows

40. 12-40 Interpreting Investing Cash Flows Capital Acquisitions Ratio Net Cash Flow from Operating Activities Cash Paid for Property, Plant, and Equipment = A measure for determining whether a company is generating enough cash internally to purchase long-term assets. A ratio greater than 1.0 indicates that outside financing was not needed to purchase long-term assets.

41. 12-41 Interpreting Investing Cash Flows Capital expenditures vary from year to year, so three-year averages are more appropriate for comparisons. For the three-year period, Nautilus’ cash flow from operations has been insufficient to finance its investment in property, plant, and equipment. Nautilus’ primary competitor generated almost twice as much cash flow from operations as needed for its investment in property, plant, and equipment.

42. 12-42 Cash Coverage Ratio Net Cash Flow from Operating Activities + Interest Paid + Income Taxes Paid Interest Paid = A measure for determining whether a company is generating enough cash before the costs of financing and taxes to cover its interest payments. Interpreting Financing Cash Flows A ratio greater than 1.0 indicates that operating cash flows are sufficient.

43. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 12 Supplement A Reporting Sales of Property, Plant, and Equipment (Indirect)

44. 12-44 Depreciation Expense Loss on Sale of PPE A loss on the sale of PPE is added back to net income just as depreciation expense is added back. Adding these noncash items restores net income to what it would have been had depreciation and the loss not been subtracted at all. Just the opposite is true for a gain on the sale of PPE. Subtracting the gain reverses the effect of the gain having been added to net income. Gain on Sale of PPE Reporting Sales of Property, Plant, and Equipment (PPE) (Indirect)

45. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 12 Supplement B Spreadsheet Approach (Indirect Method)

46. 12-46 A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked. Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be reported. Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides. Spreadsheet Approach (Indirect Method)

47. 12-47 We begin by entering the beginning and ending balances for each account on the comparative balance sheets. The cash inflows and outflows columns will be used later to explain the changes in each account balance.

48. 12-48 Changes in balance sheet accounts are analyzed in terms of debits and credits in the top half of the spreadsheet and recorded as cash inflows and outflows in the bottom half of the spreadsheet. We will begin with operating activities.

49. 12-49 Changes in balance sheet accounts are analyzed in terms of debits and credits in the top half of the spreadsheet and recorded as cash inflows and outflows in the bottom half of the spreadsheet. Now we will complete the analysis with investing and financing activities.

50. 12-50 The top of the completed spreadsheet is shown here. Spreadsheet Approach (Indirect Method)

51. 12-51 Spreadsheet Approach (Indirect Method) The bottom of the completed spreadsheet is shown here.

52. 12-52 End of Chapter 12