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How Well Am I Doing?

Statement of Cash Flows


Chapter 15

McGrawHill/Irwin

Copyright2010byTheMcGrawHillCompanies,Inc.Allrightsreserved.

Purpose of the Statement of Cash Flows


Are
Arecash
cashflows
flows
sufficient
sufficientto
to
support
supportongoing
ongoing
operations?
operations?

Will
Will the
thecompany
company
have
haveto
toborrow
borrow
money
moneyto
tomake
make
needed
needed
investments?
investments?

Can
Canwe
wemeet
meet
our
ourobligations
obligations
to
tocreditors?
creditors?

Why
Whyis
isthere
thereaa
difference
difference
between
betweennet
net
income
incomeand
andnet
net
cash
cashflow?
flow?

Can
Can we
wepay
pay
dividends?
dividends?

15-2

Cash
The term cash on the statement of cash flows refers
broadly to both currency and cash equivalents.
Currency and
Bank Accounts

Treasury
Bills

Cash
Money Market
Funds

Commercial
Paper
15-3

Constructing the Statement of Cash Flows Using Changes


in Noncash Balance Sheet Accounts

15-4

Constructing the Statement of Cash Flows Using Changes


in Noncash Balance Sheet Accounts

Increases in noncash asset


accounts imply uses of cash.
Example: Inventory is
purchased on credit from
a supplier.
It is implied that cash
was used to acquire the
inventory.
15-5

Constructing the Statement of Cash Flows Using Changes


in Noncash Balance Sheet Accounts

Increases in liability accounts imply


sources of cash.
Example: Inventory is
purchased on credit from
a supplier.
It is implied that an increase
in a payable has the effect
of increasing cash available
for other uses.
15-6

Constructing the Statement of Cash Flows Using Changes


in Noncash Balance Sheet Accounts

Decreases in noncash assets


accounts imply sources of cash.
Example: Accounts receivable
decreases when a customer
pays their bill.
When the customer pays the
bill, the companys cash
increases.
15-7

Constructing the Statement of Cash Flows Using Changes


in Noncash Balance Sheet Accounts

Decreases in liability accounts


imply uses of cash.
Example:
Example: A
A company
company
pays
pays aa note
note payable
payable held
held
by
by aa creditor.
creditor.
When the payment is made,
cash decreases.

15-8

The Full-Fledged Statement of Cash Flows:


Operating Activities
Operating activities are
those activities that enter
into the determination of
net income.
1. Transactions
affecting current
assets

2. Transactions
affecting current
liabilities

3. Changes in
noncurrent
balance sheet
accounts that
directly affect net
income

15-9

The Full-Fledged Statement of Cash Flows:


Investing Activities
Investing activities relate to
transactions involving the
acquiring or disposing of
noncurrent assets.
1. Acquiring or
selling property,
plant and
equipment

2. Acquiring or
selling securities

3. Lending money
to another entity
and subsequently
collecting on the
loan

15-10

The Full-Fledged Statement of Cash Flows:


Financing Activities
Financing activities relate to
transactions involving borrowing
from creditors or repaying
creditors and engaging in
transactions with the
companys owners.
1. Issuing stock
and purchasing
treasury stock

2. Issuing longterm debt and


repayment of debt.

3. Payment of
dividends (note
that interest on
debt is classified
as an operating
activity)

15-11

The Full-Fledged Statement of Cash Flows:


An Overview
Operating Activities:
Net income
Changes in current assets
Changes in noncurrent assets that affect net income (e.g., depreciation)
Changes in current liabilities (except for debts to lenders and dividends
payable)
Changes in noncurrent liabilities that affect net income
Investing Activities:
Changes in noncurrent assets that are not included in net income
Financing Activities:
Changes in the current liabilities that are debts to lenders rather than
obligations to suppliers, employees, or the government
Changes in noncurrent liabilities that are not included in net income
Changes in capital stock accounts
Dividends
15-12

The Full-Fledged Statement of Cash Flows: An


Overview

Operating Activities
Investing Activities
Financing Activities

Reconciliation of the
beginning cash balance
with the ending cash
balance

Noncash Investing
and Financing
Activities
15-13

Operating Activities

Sources of cash are added to net


income and uses of cash are
deducted from net income.

15-14

Other Issues: Direct Method or Indirect Method?


Two Formats for Reporting Operating Activities
Direct Method

Indirect Method

Reports the
cash effects of
each operating
activity

Starts with
accrual net
income and
converts to
cash basis
No matter which format is used, the same amount of net
cash provided by operating activities is generated.
15-15

A Full-Fledged Statement of Cash Flows:


An Example

Lets revisit the


comparative
balance sheet
account balances
for Eds Pizza Hut.

15-16

A Full-Fledged Statement of Cash Flows:


An Example
Lets also refresh our memory regarding the
following additional information.
There
There was
was aa net
net loss
loss for
for the
the year
year of
of $27,000.
$27,000.
Depreciation
Depreciation charges
charges for
for the
the year
year were
were $6,000.
$6,000.
During
During the
the year,
year,Ed
Ed sold
sold land
land originally
originally costing
costing
$32,000
$32,000 for
for $32,000.
$32,000.
During
During the
the year,
year,Ed
Ed purchased
purchased equipment
equipment for
for
$28,000.
$28,000.
During
During the
the year,
year,Ed
Ed paid
paid dividends
dividends of
of $3,000
$3,000 to
to
the
the stockholders.
stockholders.
Ed
Ed issued
issued $50,000
$50,000 of
of common
common stock
stock to
to settle
settle the
the
note
note due
due to
to Joe
Joe Doe.
Doe.
15-17

Example Indirect Method


In addition, on the
face of the
statement or in a
supplemental
schedule, disclose
the issuance of
$50,000 of stock
to a creditor, a
noncash financing
activity.

15-18

Free Cash Flows


Free cash flow measures a companys ability to
fund its capital expenditures and dividends from
its net cash provided by operating activities.

15-19

Computing Net Cash Provided by Operating


Activities
The direct method computes
net cash provided by operating
activities by reconstructing the
income statement on a cash
basis from top to bottom.

Net cash provided by operating


activities under the direct method will
always agree with the amount
computed using the indirect method.
15-20

Similarities and Differences in Handling Data


Revenue or Expense Item
Sales revenue (as reported)
Adjustments to a cash basis:
Increases in accounts receivable
Decreases in accounts receivable
Cost of goods sold (as reported)
Adjustments to a cash basis:
Increase in merchandise inventory
Decrease in merchandise inventory
Increase in accounts payable
Decrease in accounts payable
Operating expenses (as reported)
Adjustments to a cash basis:
Increase in prepaid expenses
Decrease in prepaid expenses
Increase in accrued liabilities
Decrease in accrued liabilities
Period's depreciation, depletion and
amortization charges
Income tax expense (as reported)
Adjustments to a cash basis:
Increase in accrued taxes payable
Decrease in accrued taxes payable
Increase in deferred income taxes
Decrease in deferred income taxes

Add (+) or
Deduct (-) to
Adjust to a
Cash Basis

+
+

+
+
-

+
+

Adjustments for accounts


that affect revenue are the
same in the direct and
indirect methods.
Adjustments for accounts
that affect expenses are
handled in opposite ways
for the direct and indirect
methods.

15-21

The Direct Method: An Example

Notice that the


net cash
provided by
operating
activities agrees
with that
computed using
the indirect
method.
15-22

End of Chapter 15

15-23