14 Statementofcashflows 090801051035 Phpapp02

Chapter 14
Statement of Cash Flows
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
The Statement of Cash Flows

shows how a companys operating, investing, and financing activities affected cash during an accounting period
Explains the net increase (or decrease) in cash during the accounting period
Copyright Houghton Mifflin Company. All rights reserved.
142
Cash and Cash Equivalents

Cash includes cash and cash equivalents
Cash
Money on hand Deposits in company checking accounts
Cash equivalents
Short-term, highly liquid investments including
Money market accounts Commercial paper U.S. Treasury bills
Combined with the Cash account on the cash flows
statement of
143
Purposes of the Statement of Cash Flows

is to provide information about a companys cash receipts and cash payments during an accounting period Other financial statements may also provide some of this information
144
Internal Uses of the Statement of Cash Flows

Management uses the statement of cash flows to
Assess liquidity
Determine if short-term financing is necessary
Determine dividend policy

Decide whether to raise or lower dividends
Evaluate the effects of investment and financing decisions

Plan for investing and financing needs
Copyright Houghton Mifflin Company. All rights reserved. 145
External Uses of the Statement of Cash Flows

Investors and creditors use the statement of cash flows to assess a companys ability to
Manage cash flows Generate positive future cash flows Pay its liabilities Pay dividends and interest Anticipate its need for additional financing
Classification of Cash Flows

The statement of cash flows classifies cash receipts and cash payments into categories
1. Operating activities 2. Investing activities 3. Financing activities
147
Operating Activities
include the cash effects of transactions and other events that affect the income statement In effect, items on the income statement are changed from an accrual to a cash basis
148
Operating Activities
Cash inflows
Cash receipts from customers for goods and services Interest and dividends received on loans and investments Sales of trading securities
Cash outflows
Cash payments for
Wages Goods and services Expenses Interest Taxes Purchases of trading securities
Investing Activities
include the cash effects of transactions that affect long-term assets Acquiring and selling long-term assets
Acquiring and selling marketable securities other than trading securities or cash equivalents
Making and collecting loans
Investing Activities
Cash inflows
Cash receipts from selling long-term assets and marketable securities
Collecting loans
Cash outflows
Cash expended for purchases of long-term assets and marketable securities Cash loaned to borrowers
Financing Activities
include the cash effects of transactions that affect long-term liabilities and stockholders equity
Obtaining resources from stockholders Returning resources to stockholders and providing them with a return on their investment Obtaining resources from creditors Repaying amounts borrowed from creditors or otherwise settling obligations
Repayments of accounts payable or accrued liabilities are classified under operating activities
Financing Activities
Cash inflows
Proceeds from issues of stock
Proceeds from short-term and long-term borrowing
Cash outflows
Repayment of loans
Payments to owners (cash dividends)

Treasury stock transactions
Classification of Cash Inflows and Cash Outflows
Noncash Investing and Financing Transactions

Involve only long-term assets long-term liabilities stockholders equity in significant investing and financing activities
Not reflected on the statement of cash flows because they do not involve either cash inflows or cash outflows Disclosed in a separate schedule as part of the statement of cash flows
Format of the Statement of Cash Flows

Divided into three sections
Cash flows from operating activities
Cash flows from investing activities Cash flows from financing activities
A reconciliation of beginning and ending Cash balances appears near the bottom of the statement Schedule of noncash investing and financing transactions
Cash-Generating Efficiency (CGE)

shows the companys ability to generate cash from its current or continuing operations
There are three measures of CGE 1. Cash Flow Yield
Cash Flow Yield Net Cash Flows from Operating Activities Net Income
Shows how much of net income actually results in operating cash inflows
1417
$850 1.8 times $479

Cash-Generating Efficiency (CGE)

(contd)
2. Cash Flows to Sales

Net Cash Flows from Operating Activities Cash Flows to Sales Net Sales
$850 8.5% $10,017
Shows how much of net sales actually results in cash inflows
3. Cash Flows to Assets

Cash Flows to Assets
Shows how much cash is being generated by operations for each dollar of assets
Net Cash Flows from Operating Activities Average Total Assets
$850 10.9% ($8,239 $7,324) 2

1418
Free Cash Flow (FCF)

is the amount of cash that remains after paying for continuing operations at the current level, interest, income taxes, dividends, and net capital expenditures Shows how much cash a company has available to reduce debt or expand
Free Cash Flow = + Net Cash Flows from Operating Activities Dividends Purchases of Plant Assets Sales of Plant Assets
1419
Free Cash Flow (contd)

If free cash flow is positive, the company
Has met all of its planned cash commitments
Has cash available to reduce debt or expand
If free cash flow is negative, the company will have to

Sell investments Borrow money
Issue stock in the short term
to continue at its planned level of operation

Determining Cash Flows from Operating Activities

There are two methods of converting the income statement from an accrual basis to a cash basis
1. The direct method
Adjusts each item in the income statement to its cash equivalent More easily understood by the average reader Lists only necessary adjustments to convert net income to net cash flows Superior from an analysts perspective Used by most companies
2. The indirect method

Both methods produce the same net figure

Indirect Method of Determining Net Cash Flows from Operating Activities
1422
Depreciation
Depreciation, amortization, and depletion expense are allocations of expense and do not involve cash flows An adjustment is needed to increase net income by the amount recorded
1423
Adjustments to Depreciation
Depreciation expense $37,000
Depreciation Expense 37,000
Income Taxes Payable 37,000
Cash
Effect on income statement:
-$37,000
Effect on cash flows:
zero
Cash flow out is $37,000 less, because depreciation expense has no cash effect Add $37,000 to net income
1424
Adjustments to Depreciation
Depreciation expense $37,000
Depreciation Expense 37,000
Accumulated Depreciation 37,000
Cash
Cash Flows from Operating Activities Net income Depreciation expense
$16,000 $37,000
1425
Gains and Losses

Gains and losses do not affect cash flows from operating activities and need to be removed from this section The cash receipts that resulted in the gains or losses are shown with investing activities
1426
Adjustments to Gains and Losses

Gain on sale of investments Investments sold for $102,000 (original cost $90,000) $12,000
Gain on Sale - Investments 12,000
Investments 90,000 90,000
Cash 102,000
-0-
+$102,000 Effect on cash flows: (Shown under investing activities) Gains do not affect cash flows from operating activities and need to be removed from this section Effect on income statement: Deduct $12,000 from net income
1427
+$12,000

Gain on sale of investments Investments sold for $102,000 (original cost $90,000) $12,000
Gain on Sale - Investments 12,000
Investments 90,000 90,000
Cash 102,000
-0-
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments
$16,000 $37,000 (12,000)
1428

Loss on sale of plant assets Plant assets (original cost $10,000) sold for $5,000
Loss on Sale of Plant Assets 3,000 Accum. Dep. Plant Assets 2,000 2,000 -0-
$3,000
Plant Assets 10,000 10,000 -0-
Cash
5,000
+$5,000 Effect on cash flows: (Shown under investing activities) Losses do not affect cash flows from operating activities and need to be removed from this section Effect on income statement: Add $3,000 to net income
-$3,000
1429

Loss on sale of plant assets Plant assets (original cost $10,000) sold for $5,000
Loss on Sale of Plant Assets 3,000 -0Accum. Dep. Plant Assets 2,000 2,000 -0-
$3,000
Plant Assets 10,000 10,000
Cash 5,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets
$16,000 $37,000 (12,000) 3,000
1430
Changes in Current Assets

Decreases are added to net income
Increases are deducted from net income
1431
Adjustments to Changes in Current Assets

Example Accounts Receivable balance decreased by $8,000 ($47,000 - $55,000) Add $8,000 to net income because cash received from sales was $8,000 more than sales ($706,000 - $698,000)
Accounts Receivable Beg. Bal. 55,000 698,000 End. Bal. 47,000 706,000 Cash Receipts from Customers
Sales to Customers
1432

Beginning Accounts Receivable Ending Accounts Receivable Sales $ 55,000 47,000 698,000
Sales
698,000
Accounts Receivable 55,000 698,000 706,000 47,000
Cash
706,000
+$698,000
+$706,000
Cash flow in is $8,000 more than Sales because Accounts Receivable decreased $8,000 Add $8,000 to net income
1433

Beginning Accounts Receivable Ending Accounts Receivable Sales
Sales Accounts Receivable
$ 55,000 47,000 698,000

Cash
698,000
55,000 698,000
706,000
47,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable
706,000
$16,000 $37,000 (12,000) 3,000 8,000
1434

Beginning Inventory Ending Inventory
Inventory 110,000 34,000 Cash 34,000
$110,000 144,000
144,000
None
-$34,000
Cash flow out is $34,000 more because the Inventory account increased Deduct 34,000 from net income
1435

Beginning Inventory Ending Inventory
Inventory 110,000 34,000 Cash 34,000
$110,000 144,000
144,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable Increase in inventory
$16,000 $37,000 (12,000) 3,000 8,000 (34,000)
1436

Beginning Prepaid Expenses Ending Prepaid Expenses Insurance expense
Insurance Expense Prepaid Expenses 5,000 6,000
$5,000 1,000 6,000

Cash
6,000 2,000
1,000
2,000
-$6,000
-$2,000
Cash flow out is $4,000 less than expenses because Prepaid Expenses decreased $4,000 Add $4,000 to net income
1437

Beginning Prepaid Expenses Ending Prepaid Expenses Insurance expense
Insurance Expense Prepaid Expenses 5,000 6,000
$5,000 1,000 6,000

Cash
6,000 2,000
1,000
2,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable Increase in inventory Decrease in prepaid expenses
$16,000 $37,000 (12,000) 3,000 8,000 (34,000) 4,000
1438
Changes in Current Liabilities

Increases are added to net income
Decreases are deducted from net income
1439
Adjustments to Changes in Current Liabilities

Example Accounts Payable balance increased by $7,000 ($50,000 - $43,000) Add $7,000 to net income because cash paid for purchases was $7,000 less than what appears on the income statement ($554,000 - $547,000)
Cash Paid to Suppliers Accounts Payable 547,000 Beg. Bal. 43,000 554,000 End. Bal. 50,000 Purchases
1440

Beginning Accounts Payable Ending Accounts Payable Cost of Goods Sold
Cost of Goods Sold 520,000 Accounts Payable 43,000 520,000
$43,000 50,000 520,000

Cash
513,000
50,000
513,000
-$520,000
-$513,000
Cash flow out is $7,000 less because Accounts Payable decreased Add $7,000 to net income
1441

Beginning Accounts Payable Ending Accounts Payable Cost of Goods Sold
Cost of Goods Sold 520,000 Accounts Payable 43,000 520,000
$43,000 50,000 520,000

Cash
513,000
50,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable Increase in inventory Decrease in prepaid expenses Increase in accounts payable
513,000
$16,000 $37,000 (12,000) 3,000 8,000 (34,000) 4,000 7,000

1442
Relationship of Inventory and Accounts Payable Accounts

Beginning Inventory Ending Inventory Cost of goods sold
Cost of Goods Sold 520,000
$110,000 Beginning Accounts Payable 144,000 Ending Accounts Payable 520,000 Purchases
Inventory Accounts Payable
$43,000 50,000 554,000

Cash
110,000
520,000
43,000
554,000 547,000
554,000
144,000
547,000
50,000
-$520,000
-$547,000
Cash flow out is $27,000 more than expenses (-$34,000 + $7,000) $34,000 deducted from net income for increase in Inventory($144,000 - $110,000) $7,000 added to net income for increase in Accounts Payable ($50,000 - $43,000)
1443
Relationship of Inventory and Accounts Payable Accounts

Beginning Inventory Ending Inventory Cost of goods sold
Cost of Goods Sold 520,000 554,000 647,000 144,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable Increase in inventory Decrease in prepaid expenses Increase in accounts payable
$110,000 Beginning Accounts Payable 144,000 Ending Accounts Payable 520,000 Purchases
Inventory Accounts Payable 43,000 520,000 554,000
$43,000 50,000 554,000

Cash
110,000
647,000 50,000
$16,000 $37,000 (12,000) 3,000 8,000 (34,000) 4,000 7,000
1444

Beginning Accrued Liabilities Ending Accrued Liabilities
Accrued Expenses 3,000
$ 9,000 12,000
Accrued Liabilities 9,000 3,000 12,000
-$3,000
None
Cash flow out is $3,000 less than expenses Add $3,000 to net income
1445

Beginning Accrued Liabilities Ending Accrued Liabilities
Accrued Expenses 3,000
$ 9,000 12,000
Accrued Liabilities 9,000 3,000 12,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable Increase in inventory Decrease in prepaid expenses Increase in accounts payable Increase in accrued liabilities
$16,000 $37,000 (12,000) 3,000 8,000 (34,000) 4,000 7,000 3,000

1446
Current Liabilities
Beginning Income Taxes Payable Ending Income Taxes Payable
Income Taxes Payable 5,000 2,000 3,000 2,000 Cash
$5,000 3,000
None
-$2,000
Cash flow out is $2,000 more because Income Taxes Payable decreased Deduct $2,000 from Net Income
1447

Beginning Income Taxes Payable Ending Income Taxes Payable
Income Taxes Payable 5,000 2,000 3,000
Cash Flows from Operating Activities Net income Depreciation expense Gain on sale of investments Loss on sale of plant assets Decrease in accounts receivable Increase in inventory Decrease in prepaid expenses Increase in accounts payable Increase in accrued liabilities Decrease in income taxes payable
$5,000 3,000
Cash 2,000
$16,000 $37,000 (12,000) 3,000 8,000 (34,000) 4,000 7,000 3,000 (2,000)
1448
Schedule of Cash Flows from Operating Activities: Indirect Method
Effects of Items on the Income Statement That Do Not Affect Cash Flows
Add to or Deduct from Net Income Add Add Add Add Deduct
Depreciation expense Amortization expense Depletion expense Losses Gains
1450
Adjustments for Increases and Decreases in Current Assets

Add to Net Income Current assets Accounts receivable (net) Inventory Prepaid expenses Current liabilities Accounts payable Accrued liabilities Income taxes payable Decrease Decrease Decrease Increase Increase Increase Deduct from Net Income Increase Increase Increase Decrease Decrease Decrease
1451
Preparing the Statement of Cash Flows: Investing Activities

Objective 4
Determine cash flows from investing activities
1452
Cash Flows from Investing Activities

Analyze increases and decreases in the Investments account to determine effects on Cash account Objective
Explain the change in each account balance from one year to the next
Focus
Long-term assets (balance sheet) Short-term investments (current asset section of the balance sheet) Investment gains and losses (income statement)
Accounting for Investments

Beginning Investments Ending Investments Purchase of investments Sale of investments (which cost $90,000)
Gain on Sale - Investments Investments 127,000 78,000 90,000 115,000
$127,000 115,000 78,000 102,000

Cash 78,000 102,000
12,000
Effects on cash flows:
Purchase of investment Sale of investment
$78,000 +$102,000
($78,000) 102,000
Cash Flows from Investing Activities Purchase of investments Sale of investments
1454
Plant Assets
Explain changes in both the asset and related accumulated depreciation accounts
Purchases increase plant assets Sales decrease plant assets
Accumulated depreciation is
Increased by the amount of depreciation expense Decreased by the removal of accumulated depreciation associated with plant assets that are sold
1455
Accounting for Plant Assets

Beginning Plant Assets Ending Plant Assets Purchase of plant assets Sale of plant assets
Loss on Sale Plant Assets
8,000 Plant Assets 505,000 120,000 10,000 715,000 Accum. Dep. Plant Assets 68,000 2,000 37,000 103,000
$505,000 715,000 120,000 5,000

Cash 120,000 5,000
Purchase of plant assets Sale of plant assets
$120,000 +$5,000
($78,000) 102,000 (120,000) 5,000
1456
Cash Flows from Investing Activities Purchase of investments Sale of investments Purchase of plant assets Sale of plant assets
Accounting for Plant Assets

Beginning Plant Assets Ending Plant Assets Purchase of plant assets Sale of plant assets
Loss on Sale Plant Assets Plant Assets 505,000 120,000 8,000 Accum. Dep. Plant Assets 68,000 2,000 37,000 103,000
$505,000 715,000 120,000 5,000

Cash 120,000
??? 715,000
10,000
5,000
All items affecting the Plant Assets account have not been accounted for
1457
Accounting for Noncash Investing and Financing Transactions

Issue of bonds in exchange for plant assets $100,000
Plant Assets 505,000 120,000 10,000 ??? 100,000 715,000
Bonds Payable
Cash
100,000
None
Schedule of Noncash Investing and Financing Activities Issue of Bonds Payable for Plant Assets $100,000
1458
Accounting for Cash Flows from Investing Activities
Cash Flows from Investing Activities Purchase of investments Sale of investments Purchase of Plant Assets Sale of Plant Assets Net cash flows from investing activities
($78,000) 102,000 (120,000) 5,000 (91,000)
1459
Accounting for Noncash Investing and Financing Transactions
Schedule of Noncash Investing and Financing Activities Issue of bonds payable for plant assets
$100,000
1460
Cash Flows from Financing Activities

Analysis similar to investing activities, including treatment of related gains or losses Focus
Short-term borrowings
Long-term liabilities
Stockholders equity accounts
Cash dividends from the statement of stockholders equity must also be considered
1461
Accounting for Cash Flows from Financing Activities

Beginning Bonds Payable Ending Bonds Payable Issue of bonds payable for plant assets Repayment of bonds at face value maturity
Income Taxes Payable 245,000 100,000 Cash
$245,000 295,000 100,000 50,000
50,000 295,000
50,000
Repayment of bonds
-$50,000
Cash Flows from Financing Activities Repayment of bonds
($50,000)
1462

Beginning Common Stock Ending Common Stock Beginning Paid-in Capital in Excess of Par, Common Ending Paid-in Capital in Excess of Par, Common Issue of common stock
Common Stock 245,000 76,000 295,000
$200,000 276,000 115,000 189,000 175,000

Cash
Paid-in Capital - Common

115,000
99,000
189,000
175,000
Issue of common stock
+$175,000
Cash Flows from Financing Activities Repayment of bonds Issue of common stock
($50,000) 175,000
1463

Beginning Retained Earnings Ending Retained Earnings Dividends paid Net income
Income Summary Retained Earnings 132,000 8,000 16,000 16,000 140,000 8,000
$132,000 140,000 8,000 16,000

Cash
Paid dividends
-$8,000
Cash Flows from Financing Activities Repayment of bonds Issue of common stock Dividends paid
($50,000) 175,000 (8,000)

1464

Purchase of treasury stock 25,000
Treasury Stock 25,000
Cash 25,000
Purchase of treasury stock
-$25,000
Cash Flows from Financing Activities Repayment of bonds Issue of common stock Dividends paid Purchase of treasury stock
($50,000) 175,000 (8,000) (25,000)

1465
Cash Flows from Financing Activities Repayment of bonds Issue of common stock Payment of dividends Purchase of treasury stock Net cash flows from financing activities
($50,000) 175,000 (8,000) (25,000) $92,000
1466
Statement of Cash Flows: Indirect Method
Discussion
Q. Using the indirect method to prepare the statement of cash flows, tell whether each of the following items would appear
a) b) c) d) As cash flows from operating activities As cash flows from investing activities As cash flows from financing activities In the schedule of noncash investing and financing transactions e) Not at all
1468
Discussion (contd)
a) b) c) d) As cash flows from operating activities As cash flows from investing activities As cash flows from financing activities In the schedule of noncash investing and financing transactions e) Not at all
1. 2. 3. 4. 5. 6. 7. 8.
Dividends paid Cash receipts from sales Decrease in accounts receivable Sale of plant assets Gain on sale of investment Issue of stock for plant assets Issue of common stock Net income
1. 2. 3. 4. 5. 6. 7. 8.
c e a b a d c a
1469

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Chapter 14

Statement of Cash Flows

The Statement of Cash Flows

Copyright Houghton Mifflin Company. All rights reserved.

Cash and Cash Equivalents

Combined with the Cash account on the cash flows

Copyright Houghton Mifflin Company. All rights reserved.

Purposes of the Statement of Cash Flows

Copyright Houghton Mifflin Company. All rights reserved.

Internal Uses of the Statement of Cash Flows

Determine dividend policy

Evaluate the effects of investment and financing decisions

External Uses of the Statement of Cash Flows

Classification of Cash Flows

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

Payments to owners (cash dividends)

Classification of Cash Inflows and Cash Outflows

Noncash Investing and Financing Transactions

Format of the Statement of Cash Flows

Cash-Generating Efficiency (CGE)

$850 1.8 times $479

Cash-Generating Efficiency (CGE)

2. Cash Flows to Sales

3. Cash Flows to Assets

Net Cash Flows from Operating Activities Average Total Assets

$850 10.9% ($8,239 $7,324) 2

Copyright Houghton Mifflin Company. All rights reserved.

Free Cash Flow (FCF)

Copyright Houghton Mifflin Company. All rights reserved.

Free Cash Flow (contd)

If free cash flow is negative, the company will have to

Issue stock in the short term

to continue at its planned level of operation

Determining Cash Flows from Operating Activities

2. The indirect method

Both methods produce the same net figure

Indirect Method of Determining Net Cash Flows from Operating Activities

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

Depreciation Expense 37,000

Income Taxes Payable 37,000

Effect on income statement:

Effect on cash flows:

Copyright Houghton Mifflin Company. All rights reserved.

Depreciation Expense 37,000

Accumulated Depreciation 37,000

Cash Flows from Operating Activities Net income Depreciation expense

Copyright Houghton Mifflin Company. All rights reserved.

Gains and Losses

Copyright Houghton Mifflin Company. All rights reserved.

Adjustments to Gains and Losses

Gain on Sale - Investments 12,000

Investments 90,000 90,000

Copyright Houghton Mifflin Company. All rights reserved.

Adjustments to Gains and Losses

Gain on Sale - Investments 12,000

Investments 90,000 90,000

$16,000 $37,000 (12,000)

Copyright Houghton Mifflin Company. All rights reserved.

Adjustments to Gains and Losses

Plant Assets 10,000 10,000 -0-

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