Analyzing Cash Flows

Importance of Cash Flows

How did the business fund its operations? Does the business have sufficient cash to pay its debts as they mature?

Did the business make any dividend payments?

Did the business borrow any funds or repay any loans?

Measuring Cash Flows

Cash Equivalents

Cash

Currency

Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes.

Classifying Cash Flows

The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities

Operating Activities
Inflows

Receipts from customers. Cash receipts from royalties, fees, commissions and other revenue. Other.

Outflows

Salaries and wages. Payments to suppliers. Taxes and fines. Other.

Investing Activities
Inflows

disposal of fixed assets disposal of investments Other.

Outflows

acquire fixed assets to acquire shares, warrants or debt instruments of other enterprises and interest in joint ventures

Cash Flows from Investing Activities

Financing Activities
Inflows

Issuing its own equity securities. Issuing bonds and notes. Issuing short-term and long-term liabilities. Outflows
Dividend/ Interest paid Buy back of Shares Redemption of Preference Shares Redemption of Debentures Payment of Loan.

Cash Flows from Financing Activities

Noncash Investing and Financing

Items requiring separate disclosure include: Retirement of debt by issuing equity stock. Conversion of preferred stock to common stock. Lease of assets in a capital lease transaction. Purchase of long-term asset by issuing a note or bond. Exchange of noncash assets for other noncash assets. Purchase of noncash assets by issuing equity or debt.

Exh. 12.4

Exh. 12.5

Company Name Statement of Cash Flows Covered Period Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites Cash flows from investing activities: [List of individual inflows and outflows] Net cash provided (used) by investing activites Cash flows from financing activities: [List of individual inflows and outflows] Net cash provided (used) by financing activites Net increase (decrease) in cash Cash (and equivalents) balance at beginning of period Cash (and equivalents) balance at end of period

$ #####

#####

##### $ ##### ##### $ #####

Exh. 12.5

Company Name Statement of Cash Flows Covered Period Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites $ ##### Cash flows from investing activities: There are two acceptable methods to determine Cash [List of individual inflows and outflows] Flows from Operating Activities: Net cash provided (used) by investing activites ##### Cash flows from financing activities: Direct Method [List of individual inflows and outflows] Indirect Method Net cash provided (used) by financing activites ##### Net increase (decrease) in cash $ ##### Cash (and equivalents) balance at beginning of period ##### Cash (and equivalents) balance at end of period $ #####

Analyzing Noncash Accounts

The changes in cash can be determined by analyzing the noncash accounts on the balance sheet. D Cash = D Liabilities + D Stockholders Equity - D Noncash Assets
Derives from . . .

Assets = Liabilities + Stockholders Equity

Lets look at the Direct Method for preparing the Cash Flows from Operating Activities section.

Direct Method Cash Received from Customers

Can be computed two ways:
Obtained from cash receipts journal. Obtained from accrual sales information.
Cash received = Sales from customers

Exh. 12.12

- Increase in A/R + Decrease in A/R

Direct Method Cash Paid for Merchandise

Step 1
Purchases = COGS

Exh. 12.13

+ Increase in inventory - Decrease in inventory

Step 2
Cash paid for merchandise
= Purchases

+ Decrease in A/P - Increase in A/P

Direct Method Wages and Operating Expenses

The cash paid for wages and other operating expenses is affected by (1) whether the expense was prepaid, and (2) whether the expense was accrued.
Cash paid for wages and other operating expenses Wages and other = operating expenses

Exh. 12.14

+ Increase in

prepaid expenses

- Decrease in
prepaid expenses

+ Decrease in

accrued liabilities

- Increase in
accrued liabilities

Direct Method Cash Paid for Interest and Taxes

Interest
Cash paid for interest Interest Expense

Exh. 12.15

+ Decrease in interest payable - Increase in interest payable

Taxes
Cash paid for taxes Tax = Expense

+ Decrease in taxes payable - Increase in taxes payable

Direct Method Depreciation, Amortization, and Depletion Expense

Operating cash flows are not involved. They are not disclosed in the Statement of Cash Flows using the direct method.

Direct Method Gains and Losses

Gains and losses do not appear on the Statement of Cash Flows using the Direct Method.

Lets look at the Indirect Method for preparing the Cash Flows from Operating Activities section.

Indirect Method of Reporting Operating Cash Flows

Changes in current assets and current liabilities.

Net Income
+ Losses and - Gains + Noncash expenses such as depreciation and amortization.

Cash Flows from Operating Activities

97.5% of all companies use the indirect method.

Indirect Method of Reporting Operating Cash Flows

Change in Account Balance During Year Increase Decrease Subtract from net Add to net income. income. Add to net income. Subtract from net income.

Current Assets Current Liabilities

Use this table when adjusting Net Income to Operating Cash Flows.

Indirect Method Operating Activities Example

East, Inc. reports $125,000 net income for the year ended December 31, 2002. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2002, East reported $12,500 of Depreciation Expense.
What is East, Inc.s Operating Cash Flow for 2002?

Indirect Method Operating Activities Example

Net income $ 125,000

For the indirect method, start with net income.

Indirect Method Operating Activities Example

Net income Add: Depreciation expense $ 125,000 12,500

Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

Indirect Method Operating Activities Example

Net income Add: Depreciation expense Deduct: Increase in accounts receivable
Change in Account Balance During Year Increase Decrease Subtract from net Add to net income. income. Add to net income. Subtract from net income.

125,000 12,500 (7,500)

Current Assets Current Liabilities

Indirect Method Operating Activities Example

Net income Add: Depreciation expense Deduct: Increase in accounts receivable Add: Increase in accounts payable
Change in Account Balance During Year Increase Decrease Subtract from net Add to net income. income. Add to net income. Subtract from net income.

125,000 12,500 (7,500) 10,000

Current Assets Current Liabilities

Indirect Method Operating Activities Example

Net income Add: Depreciation expense Deduct: Increase in accounts receivable Add: Increase in accounts payable Cash provided by operating activities $ 125,000 12,500 (7,500) 10,000 140,000

If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

End of Chapter 12