1. Managerial Accounting Dr. Baldwin University of Arkansas – Fort Smith Fall 2010

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3. CHAPTER 12 Reporting and Analyzing Cash Flows

4. Purpose of Cash Flow Statement C1 The Income Statement is a summary of the income producing activities of a company during the period. The Balance Sheet shows what “stuff” we have at any point in time.

5. Purpose of Cash Flow Statement The Cash Flow Statement is needed to provide information about what happened to cash during the period. Sources (Increases) of Cash? Uses (Decreases) of Cash? Why did cash ↑ or ↓? What is the change in Cash? C1

6. Why is the Cash Flow Stmt. Important? Can the business pay dividends? Does it have the ability to pay its debts when they become due? Does current cash flow cover both principal and interest? Does it need additional financing? What is the primary source of cash? Management, creditors and investors are particularly interested in sources, uses and changes in cash. C1

7. What is “Cash” C1 Cash = Cash in Bank Cash Equivalents –Readily convertible to cash –Typically have a maturity date of <90 days

8. Classifications of Cash Flows C2 Operating Activities Investing Activities Financing Activities

9. Operating Activities Transactions or events that occur during the normal operation of the business and determine net income. Typically involve changes in current assets or current liabilities. What are the sources (increases)? What are the uses (decreases)?

10. Operating Activities Inflows Receipts from customers Cash dividends received Interest from borrowers Other. Outflows Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Other

11. Investing Activities Transactions or events that affect long term assets Sources: –Proceeds from sales of PP&E or LT Investments Uses: –Purchases of PP&E or LT Investments

12. Financing Activities Transactions or events that affect long-term debt or equity sections of the balance sheet. Sources: –Sales of stock or bonds –Bank loans Uses: –Purchase of treasury stock –Payment of dividends –Payment on loans

13. Three “Foolers” 1.Interest Paid on Debt is an OPERATING Activity 2.Interest or Dividend Income is an OPERATING Activity (Rationale: Once the decision to finance or invest has been made, any further cash received or required in an operating activity.) 3.Dividends paid to shareholders is a FINANCING Activity.

14. Non-Cash Transactions Significant financing and investing activities that do not affect cash are reported separately. Disclosed at the bottom of Cash Flow Stmt in Schedule of Noncash Investing & Financing Activities Examples: –Issuing stock for land –Signing a mortgage and taking title to the related property –Converting or retiring bonds to stock –Converting common stock to preferred stock C 3

15. Presentation of Cash Flows There are two formats to present Cash Flow from Operating Activities: –Direct method –Indirect method Indirect method is more prevalent (97.5% of companies) Direct method is easier to understand –Lists the sources and uses of cash from operations as individual line items: cash collected from customers cash paid for inventory cash paid for interest Each method produces the SAME amounts of Cash Flows Provided (Used) by Operating Activities C 4

16. Indirect Method for Calculating Cash Flow from Operations We will reconcile Accrual based Net Income to Cash flow from Operating Activities: Step 1: Net income Step 2: +/- changes in Current asset accounts Step 3: + non-cash expenses Step 4 :+/- non-operating items = cash from operations P2

17. Cash Flow from Operating Activities Example  East, Inc. reports $125,000 net income for the year ended December 31, 2008.  Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.  During 2008, East reported $12,500 of Depreciation Expense. What is East’s cash flow from operating activities for the period end 12/31/08?

18. Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities For the indirect method, start with net income. Indirect Method Example P2

19. Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense. Indirect Method Example P2

20. Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Indirect Method Example P2

21. Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Indirect Method Example P2

22. Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities. Indirect Method Example P2