Learning Objectives (LO)

After studying this chapter, you should be able to

Statement of Cash Flows

CHAPTER

1. Identify the purposes of the statement of cash flows 2. Classify activities affecting cash as operating, investing, or financing activities 3. Compute and interpret cash flows from financing activities 4. Compute and interpret cash flows from investing activities 5. Use the direct method to calculate cash flows from operations

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Learning Objectives (LO)

After studying this chapter, you should be able to
6. Use the indirect method to explain the difference between net income and net cash provided by (used for) operating activities 7. Understand why we add depreciation to net income when using the indirect method for computing cash flow from operating activities 8. Identify free cash flow, and interpret information in statements of cash flow

LO 1 - Purpose of Cash Flow Statement

Cash Flow Statement reports the cash receipts and cash payments during a period and classifies them as financing, investing, and operating cash flows. What is cash
Money in the bank and at hand Cash equivalents (maturity less than 90 days and easily and quickly convertible into cash Money market funds Very low probability of Treasury bills change in value
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LO 1 - Purpose of Cash Flow Statement

Past cash flows help to predict future cash flows Evaluates how management generates and uses cash Determines a companys ability to pay interest, dividends, and debts when they are due Identifies specific increases and decreases in a firms productive assets Helps to understand the relationship of net income to changes in cash balances. Cash balances can decline despite positive net income and vice versa.

LO 1 - Purpose of Cash Flow Statement

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LO 2 - Cash Flow Activities

LO 3 - Cash Flows from Financing Activities

Cash flows to and from providers of capital:
Investors Debtors

Two general rules:

Increases in cash stem from increases in liabilities or paid-in capital Decreases in cash stem from decreases in liabilities or paid in capital

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LO 4 - Cash Flows from Investing Activities

Cash flows from the purchase or sale of plant, property, equipment, or securities (excluding cash equivalents) and other long-lived assets. Purchase and disposal of resources that serve the company over a one year period fall under investing activities.

LO 5 - Operating Cash Flows

Operating cash flows
Transactions that affect the income statement All cash flows other than investing and financing Cash flows with the normal operations of the business

Two general rules:

increases in cash stem from decreases in long-lived assets, collection of loans made to others, and sale of investments decreases in cash stem from increases in long-lived assets, granting of loans to others, and purchases of investments
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LO 5 - Operating Cash Flows

Operating Cash Flows Two methods
Direct method Operating cash inflows less operating cash outflows = operating cash flows Preferred method by investors, FASB and IASB, because it is easily understood If use this method, must also show indirect method Indirect method Adjusts the previously calculated accrual net income to reflect only cash receipts and cash disbursements Most commonly used method Do not have to show the direct method
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LO 5 - Operating Cash Flows - Direct

A listing of all cash receipts (inflows) and cash disbursements (outflows). The Cash column of the balance sheet equation should be examined. Cash flows from operating activities
Collections from sales to customers are almost always the major operating activity that increases cash. Disbursements for purchases of goods to be sold and operating expenses are almost always the major operating cash outflows. The excess of collection over disbursements is net cash provided by operating activities.

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LO 6 - Operating Cash Flows - Indirect

LO 6 - Operating Cash Flows - Indirect

Indirect method of preparing the operating section of the statement of cash flows
Start

The indirect method of computing cash flows from operating activities reconciles net income to the net cash provided by operating activities Depreciation is added back to net income because it is a noncash item. Add decreases in noncash current assets. Add increases in current liabilities. Deduct increases in noncash current assets. Deduct decreases in current liabilities.

End

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LO 7 Adjustments to Net Income

Depreciation Expense
Was deducted in net income Is not a cash item and applies to investing activities To remove it from net income, add it back Net Income Add back Depreciation Expense $57,900 100

LO 7 Adjustments to Net Income

Accounts Receivable
By assuming net income is all in cash, all revenue ($160,000) is assumed to be in cash Accounts Receivables increased from $0 to $155,000 this year, meaning $155,000 of this years revenue ($160,000) was not collected in cash by year-end Net Income Add back Depreciation Expense Increase in Receivables $57,900 100 (155,000)
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LO 7 Adjustments to Net Income

Inventory
Beginning + Bought Sold = Ending 0 ? 100,000 59,200 Bought $159,200 Net income includes only $100,000 deduction Deduct an additional $59,200

LO 7 Adjustments to Net Income

Accounts Payable
Beginning + Charged Paid off = Ending 0 159,200 ? 25,200 Paid off $134,000 Net income includes $100,000 + adjustment $59,200 Add back $25,200

Net Income Add back Depreciation Expense Increase in Receivables Increase in Inventory
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$57,900 100 (155,000) (59,200)

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Net Income Add back Depreciation Expense Increase in Receivables Increase in Inventory Increase in Accounts Payable
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$57,900 100 (155,000) (59,200) 25,200

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LO 7 Adjustments to Net Income

Accounts Payable continued
Deducted in net income for cost of goods sold) Subtracted from net income due to inventory increase Added back to net income because accounts payable increased Cash paid for inventory (100,000) (59,200) 25,200 $134,000

LO 7 Adjustments to Net Income

Prepaid Rent
Ending Beginning + Bought Used = 0 ? 2,000 4,000 Bought $6,000 (no payable so all in cash) Net income includes only $2,000 deduction Deduct an additional $4,000 Net Income $57,900 Add back Depreciation Expense 100 Increase in Receivables (155,000) Increase in Inventory (59,200) Increase in Accounts Payable 25,200 Increase in Prepaid Rent (4,000) Net cash used for operations $135,000
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LO 9 Free Cash Flow

The main focus of the statement of cash flows is the net cash flow from operating activities. Cash flow is used a measure of a firms performance in maintaining a strong cash position. Free cash flow is defined as the cash flows from operations less capital expenditures. This is the cash flow left over after undertaking operations and making the investments necessary to ensure continued operations. Judging a firm on the basis of net income misses important information which is contained within the statement of cash flows. A firm that reports strong earnings or net income may still experience a negative cash flow and be forced into bankruptcy if it lacks sufficient funds to meet its obligations.

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