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Prepared by Karleen Nordquist.. The College of St. Benedict... and St. Johns University...
with contributions by Dr. Jessica J. Frazier.. and Philip Li... Eastern Kentucky University.
Chapter 11
Chapter 11
Statement of Cash Flows
After studying this chapter, you should be able to:
1 Indicate the primary purpose of the statement of cash flows. 2 Distinguish among operating, investing, and financing activities. 3 Explain the impact of the product life cycle on a companys cash flows. 4 Prepare a statement of cash flows using one of two approaches: (a) the indirect method or (b) the direct method. 5 Use the statement of cash flows to evaluate a company.
Preview of Chapter 11
The Statement of Cash Flows: Purpose and Format
Purpose Classifications Significant Noncash Activities Format Corporate Life Cycle Usefulness Preparation
Preview of Chapter 11
Section 1: Indirect Method
Determining Net Increase/ Decrease in Cash Determining Net Cash Provided/ Used by Operating Activities Determining Net Cash Provided/ Used by Investing and Financing Activities Summary of Indirect Method
Preview of Chapter 11
Determining Net Increase/ Decrease in Cash Determining Net Cash Provided/ Used by Operating Activities Determining Net Cash Provided/ Used by Investing and Financing Activities
Preview of Chapter 11
Free Cash Flow Capital Expenditure Ratio Assessing Liquidity, Solvency, and Profitability
Study Objective 1
Study Objective 2
Operating Activities
Operating activities include the cash effects of
transactions that create revenues and expenses and thus enter into the determination of net income. Operating activities is the most important category because it shows the cash provided or used by company operations. Cash provided by operations is generally considered to be the best measure of whether a company can generate sufficient cash to continue as a going concern and to expand.
Investing Activities
Investing activities include purchasing and disposing of investments and productive long-lived assets using cash, and lending money and collecting the loans.
Financing Activities
Financing activities include obtaining cash from issuing debt and repaying the amounts borrowed and obtaining cash from stockholders and paying them dividends.
From sale of equity securities (company's own stock) From issuance of debt (bonds and notes)
Cash outflows:
To stockholders as dividends
To redeem long-term debt or reacquire capital stock
Illustration 11-1c
Operating Activities
Some cash flows relating to investing or
financing activities are classified as operating activities. For example, receipts of investment revenue (interest and dividends) and payments of interest to lenders are classified as operating activities because these items are reported in the income statement.
Operating Activities
As a general rule: Operating activities involve income
determination (income statement) items. Investing activities involve cash flows resulting from changes in investments and long-term asset items. Financing activities involve cash flows resulting from changes in long-term liability and stockholders' equity items.
XX
XXX
XXX
Illustration 11-2
Study Objective 3
Explain the impact of the product life cycle on a companys cash flows.
Additional information.
(Includes transaction data that helps determine how cash was provided or used.)
Study Objective 4a
Liabilities and Stockholders Equity Accounts payable $ 4,000 Common stock 50,000 Retained earnings 20,000 Total $74,000
$ -0-0-0$ -0-
Illustration 11-5
Additional information: (a)Examination of selected data indicates that a dividend of $15,000 was declared and paid during the year. (b)The equipment was purchased at the end of 1999. No depreciation was taken in 1999.
Illustration 11-6
Net Income
Incurred Expenses
Illustration 11-7
Computer Services Company Partial Statement of Cash Flows - Indirect Method For the Year Ended December 31, 1999
Cash flows from operating activities Net income $ 35,000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $(30,000) Increase in accounts payable 4,000 (26,000) Net cash provided by operating activities $ 9,000
Illustration 11-10
Step 3: Determining Net Cash Provided/Used by Investing & Financing Activities No transaction data are given for the increases in
Equipment of $10,000, and Common Stock of $50,000. When other explanations are lacking, assume any differences involve cash. The increase in equipment is assumed to be a purchase of equipment for $10,000 cash. This purchase is reported as a cash outflow in the investing activities section. The increase of common stock is assumed to result from the issuance of common stock for $50,000 cash. It is reported as an inflow of cash in the financing section.
Illustration 11-12
Liabilities and Stockholders Equity Accounts payable $ 59,000 Bonds payable 130,000 Common stock 50,000 Retained earnings 144,000 Total $383,000
Additional information: (a)In 2000 the company declared and paid a $15,000 cash dividend. (b)The company obtained land through the issuance of $130,000 of long-term bonds. (c)An office building costing $160,000 was purchased for cash; equipment costing $25,000 was also purchased for cash. (d)During 2000 the company sold equipment with a book value of $7,000 (cost $8,000 less accumulated depreciation $1,000) for $4,000 cash. Illustration 11-14
Computer Services Company Statement of Cash Flows - Indirect Method For the Year Ended December 31, 2000
Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $ 15,000 Loss on sale of equipment 3,000 Decrease in accounts receivable 10,000 Increase in prepaid expenses (4,000) Increase in accounts payable 55,000 Net cash provided by operating activities Cash flows from investing activities Purchase of building (160,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash used by investing activities Cash flows from financing activities Payment of cash dividends (15,000) Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities: Issuance of bonds payable to purchase land $139,000
79,000 218,000
(181,000)
Illustration 11-18
Study Objective 4b
Liabilities and Stockholders Equity Accounts payable $ 60,000 Accrued expenses payable 20,000 Common stock 300,000 Retained earnings 42,000 Total $422,000
$ -0-0-0-0$ -0-
Illustration 11-21
Additional information: (a)Dividends of $70,000 were declared and paid in cash. (b)The accounts payable increase resulted from the purchase of merchandise.
Illustration 11-22
Cash Payments
To suppliers
To employees
For interest
For taxes
Illustration 11-23
Balance, Dec. 31
Illustration 11-29
Illustration 11-31
Operating Expenses
Illustration 11-31
Juarez Company Partial Statement of Cash Flows - Direct Method For the Year Ended December 31, 1999
Cash flows from operating activities Cash receipts from customers $765,000 Cash payments: To suppliers $550,000 For operating expenses 158,000 For income taxes 48,000 756,000 Net cash provided by operating activities $ 9,000
Illustration 11-10
Illustration 11-35
Illustration 11-36
Change Increase/Decrease $ 32,000 increase 3,000 decrease 30,000 decrease 2,000 decrease 100,000 increase 160,000 increase 16,000 increase
Liabilities and Stockholders Equity Accounts payable $ 52,000 Accrued expenses payable 15,000 Income taxes payable 12,000 Bonds payable 90,000 Common stock 400,000 Retained earnings 94,000 Total $663,000
$ 8,000 decrease 5,000 decrease 12,000 increase 90,000 increase 100,000 increase 52,000 increase
Additional information: (a)In 2000 the company declared and paid a $32,000 cash dividend. (b)Bonds were issued at face value for $90,000 in cash. (c)Equipment costing $180,000 was purchased for cash. (d)Equipment costing $20,000 was sold for $17,000 cash when the book value of the equipment was $18,000. (e)Common stock of $100,000 was issued to acquire land. Illustration 11-37
Juarez Company Statement of Cash Flows - Direct Method For the Year Ended December 31, 2000
Cash flows from operating activities Cash receipts from customers Cash payments: To suppliers $638,000 For operating expenses 179,000 For income taxes 24,000 Net cash provided by operating activities Cash flows from investing activities Purchase of equipment (180,000) Sale of equipment 17,000 Net cash used by investing activities Cash flows from financing activities Issuance of bonds payable 90,000 Payment of cash dividends (32,000) Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities: Issuance of common stock to purchase land
$978,000
841,000 218,000
(163,000)
Illustration 11-44
Study Objective 5
Illustration 11-46
Capital Expenditures
Dividends Paid
Microsofts free cash flow is calculated as shown below. (In as much detail as is available.)
Net cash provided by operating activities Less: Expenditures on PP&E Dividends paid Free cash flow $6,880 (656) 0 $6,224
Illustration 11-47
Capital Expenditures
= =
$6,880
$656
10.49 times
Illustration 11-49
Liquidity
Liquidity is the ability of a business to meet its
immediate obligations. You may be familiar with one measure of liquidity called the current ratio. (It will also be covered in Chapter 12.) Current ratio equals current assets divided by current liabilities. A disadvantage of the current ratio is that it uses year-end balances of current assets and current liabilities, which may not be representative of a company's position during most of the year.
=
=
Microsoft
$6,880
($5,730 + $3,610)/2
1.47 times
2.77:1 1.74.1
Oracle
.73 times
Microsofts net cash provided by operations is nearly 1- times its average current liabilities. Oracles ratio of .73 times, though not a cause for concern, is substantially lower than Microsofts.
Solvency
Solvency is the ability of a firm to survive over the
long term. A measure of solvency that uses cash figures is the cash debt coverage ratio: the ratio of cash provided by operations to total debt as represented by average total liabilities. This ratio measures a company's ability to repay its liabilities from cash generated from operations.
=
=
Microsoft Oracle
$6,880
($5,730 + $3,610)/2
26% 49%
Microsoft has no long-term obligations so its cash debt coverage ratio is the same as its current cash debt coverage ratio. Oracle has long-term debt so its ratios are not as good as Microsofts. Neither company has a solvency problem, however.
Profitability
Profitability refers to a company's ability to
generate a reasonable return. Chapter 12 will introduce accrual-based ratios that measure profitability, such as gross profit rate, profit rate margin, and return on assets, if they are not already familiar to you. A cash-based measure of performance is the cash return on sales ratio.
Net Sales
Microsoft Oracle
$6,880
$14,484
48% 22%
Oracles cash return on sales ratio of 22% is substantially less than Microsofts at 48%. This indicates that Microsoft is more efficient in turning sales into cash. Yet Oracles cash return on sales ratio is quite respectable.
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Copyright 1999 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that named in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
Chapter 11
Statement of Cash Flows