1. Categories of Cash Flows
Inflows and outflows that result from transactions
Cash account must increase or decrease
Operating activities
Cash receipts and cash disbursements from revenues and expenses
Involve current assets and current liabilities
Investing activities
Cash receipts and disbursements that result from purchasing or selling long-term assets or investments in other firms
Financing activities
Cash receipts and disbursements from long-term debt and equity transactions

2. Categories of Cash Flows
Financing activities
Debt
Issuing debt
Repaying debt
Interest expense results from financing activities because it arises from debt financing. Why is it reported in the operating section?
Equity
Receiving contributions from owners
Paying dividends to owners

3. Accrual-basis vs. Cash-basis
Must convert from accrual-basis accounting (GAAP) to cash-basis accounting to prepare statement of cash flows
Accrual-basis accounting
Revenues recorded when earned and expenses recorded when incurred
Timing of cash receipt is irrelevant
Cash-basis accounting
Revenues recorded when cash received and expenses recorded cash paid
Timing of revenue and expense recognition is irrelevant
Convert from accrual basis to cash basis
Accounts payable (assume for inventory)
Beg bal $1,200; End bal $400; purch $36,300
Compute cash paid

4. Operating activities Direct method Indirect method
Cash inflows and outflows explicitly identified
Analyzes every item on income statement
Indirect method
Reconciles net income and cash flow
Starts with net income
Makes adjustments for income statement items that do not affect cash
Adjust for changes in current assets and current liabilities
Ends with net cash flow

5. Investing and financing activities
Same presentation for both direct and indirect methods
Cash flows for each activity directly identified
Used by 90% of companies.
Financial statements needed
Current year income statement
Beginning and ending balance sheet

6. Steps to Calculate Operating Cash Flows
Start with net income
Add back non-cash expenses such as depreciation
Undo the effect of non-cash expenses
Adjust for changes in current assets
Increase (decrease) in account should be subtracted from (added to) net income to arrive at cash balance.
Adjust for changes in current liabilities
Increase (decrease) in account should be added to (subtracted from) net income to arrive at cash balance.

7. Cash Flow Indirect Method

8. Cash Flow Indirect Method

9. Cash Flow Indirect Method

10. Cash Flow Indirect Method

11. Operating Activities—Direct Method
Changing revenues from accrual basis to cash basis
Accounts receivable
Beginning balance (balance sheet)
+ Sales (income statement)
- Cash collected from customers (compute)
Ending balance (balance sheet)

12. Changing expenses from accrual basis to cash basis
Cost of goods sold
Inventory account
Beginning inventory (balance sheet)
+ Purchases (compute)
- Cost of goods sold (income statement)
Ending balance (balance sheet)
Accounts payable
Beginning balance (balance sheet)
+ Purchases (from inventory computation)
- Cash paid to vendors (compute)

13. Changing expenses from accrual basis to cash basis
Rent expense
Prepaid rent
Beginning balance (balance sheet)
+ Cash paid for rent (compute)
- Rent expense (income statement)
Ending balance (balance sheet)
Interest expense
Interest payable
+ Interest expense (income statement)
- Cash paid for interest (compute)

15. Investing and Financing Activities
Investing cash flows
Equipment purchases/disposals require the following accounts
Asset account (beg & end)
Accumulated depreciation (beg & end)
Depreciation expense (current)
Financing cash flows
Debt financing
Need to analyze changes in long-term liability accounts
Equity financing
Additional capital contributions
Common and preferred stock accounts
Dividends
Retained earnings and current net income

17. Preparing the Statement of Cash Flows
Prepare operating, investing, and financing sections
Supplementary disclosures
Noncash financing and investing activities
Cash paid for interest expense and income taxes
Broken out in supplementary disclosures because usually part of subtotals

18. Preparing the Statement of Cash Flows

19. Free Cash Flow Net cash from operating activities - Cash dividends
- Capital expenditures _
Free cash flow

20. Cash Flow Adequacy Ratio
Measures the firm’s ability to generate enough cash from operating activities to pay for its capital expenditures
Net cash from operating activities _
Cash required for investing activities
Cash paid for capital expenditures and acquisitions minus cash proceeds from disposal of capital assets

21. Cash Needed to Pay Current Liabilities
Current cash debt coverage ratio
Measures a firm’s ability to generate the cash it needs in the short-run
A liquidity measure
Net Cash Provided by Operations
Average Current Liabilities

22. Business Risk, Control, and Ethics
Investors’ risks associated with statement of cash flows
Investors look for positive cash flows from operations
How could a company manipulate operating cash flows?

23. Assign #7: pg , E1A, E5A;
Assign #8: P11-1A, P11-9A