Chapter 5 - Statement of Cash Flows

Learning Objectives (LO) After studying this chapter, you should be able to

Statement of Cash Flows

© 2010 Pearson Education Inc. Publishing as Prentice Hall

CHAPTER

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

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Introduction to Financial Accounting, 10/e

Learning Objectives (LO)

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


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LO 1 - Purpose of Cash Flow Statement Statement

After studying this chapter, you should be able to



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• Cash Flow Statement – reports reports the the cash receipts and cash payments during a period and classifies them as financing, investing, and operating cash flows. • What What is “cash “cash”” – Money in the bank bank and at hand – Cash equivalents equivalents (maturity (maturity less than 90 days and easily and quickly convertible into cash –Money market funds Very low probability of change in value – Treasury Treasury bills © 2010 Pearson Education Inc. Publishing as Prentice Hall


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



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LO 3 - Cash Flows from Financing Financing Activities

LO 2 - Cash Flow Flow Activit Activities ies

• Cash flows flows to and from from providers providers of capital: capital: – Invest Investors ors – Debt Debtors ors

• Two Two gener general al rule rules: s: – Increases in cash stem from from increases in liabilities or paid-in capital – Decreases in cash stem from from decreases in liabilities or paid in capital



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LO 4 - Cash Flows from Investing Activities



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LO 5 - Operating Operating Cash Cash Flows Flows

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

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

• Two gener general al rul rules: es: – increases in cash cash stem from decreases decreases in long-lived long-lived assets, collection of loans made to others, and sale of investments – decreases decreases in cash stem from increases increases in long-lived long-lived assets, granting of loans to others, and purchases of investments © 2010 Pearson Education Inc. Publishing as Prentice Hall


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LO 5 - Operating Operating Cash Cash Flows Flows – Direct method method • Operating Operating cash inflows inflows less operating operating cash outflows = operating cash flows • Preferred Preferred method method by investors, investors, FASB and IASB, because it is easily understood • If use this method, method, must also show indirect method – Indirect method method • Adjusts the the previously calculated accrual net net income to reflect only cash receipts and cash disbursements • Most commonly used method method • Do not have have to show show the direct method Introduction to Financial Accounting, 10/e


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LO 5 - Operating Operating Cash Cash Flows Flows - Direct

• Operat Operating ing Cash Cash Flows Flows – Two metho methods ds



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



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LO 6 - Operating Operating Cash Cash Flows Flows - Indirect Indirect

LO 6 - Operating Operating Cash Cash Flows Flows - Indirect Indirect

• The indirect indirect method method of computing cash flows flows from operating activities reconciles net income to the net cash provided by operating activities

•

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

– Depreciation Depreciation is added back to net income because because it is a noncash item. – Add decreases decreases in noncash current assets. assets. – Add increases increases in current liabilities. – Deduct increases increases in noncash current current assets. – Deduct decreases decreases in current current liabilities.



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LO 7 – Adjustment Adjustments s to Net Income Income

End



LO 7 – Adjustmen Adjustments ts to Net Income Income

• Deprec Depreciat iation ion Expens Expense e

• Account Accounts s Receiva Receivable ble

– Was deducted deducted in net income income – Is not a cash item and applies to investing investing activities – To remove it from net income, add add it back Net Income

$57,900

Add back Depreciation Depreciation Expense

– By assuming net income income is all in cash, all revenue ($160,000) is assumed to be in cash – Accounts Receivables Receivables increased from $0 to $155,000 $155,000 this year, meaning $155,000 of this year’s revenue ($160,000) was not collected in cash by year-end

100 Net Income

$57,900

Add back Depreciation Depreciation Expense Increase in Receivables © 2010 Pearson Education Inc. Publishing as Prentice Hall


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100 (155,000)


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LO 7 – Adjustmen Adjustments ts to Net Income Income

• Inve Invent ntor ory y

• Accou Account nts s Payab Payable le

– Be B eginning + Bought – Sold = Ending 0 ? 100,000 59,200 – Bought $159,200 $159,200 – Net income includes includes only $100,000 deduction deduction – Deduct an additional $59,200

Net Income Add back Depreciation Expense Increase in Receivables Increase in Inventory © 2010 Pearson Education Inc. Publishing as Prentice Hall

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– Beginning + Charged – Paid of off = Ending 0 159,200 ? 25,200 – Paid off $134,0 $134,000 00 – Net income includes $100,000 $100,000 + adjustment $59,200 $59,200 – Add back back $25,200 $25,200

$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 © 2010 Pearson Education Inc. Publishing as Prentice Hall

$57,900 100 (155,000) (59,200) 25,200


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LO 7 – Adjustmen Adjustments ts to Net Income Income • Prep Prepai aid d Ren Rentt

• Accounts Accounts Payable Payable – conti continue nued d – Deducted in net net income for for cost of goods sold) – Subtracted Subtracted from net income income due to inventory increase – Added back to net net income because because accounts payable increased Cash paid for inventory


– Be B eginning + Bought – Used = Ending 0 ? 2,000 4,000 – Bought $6,000 $6,000 (no payable payable so all in cash) – Net income includes includes only $2,000 deduction deduction – Deduct an additiona additionall $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

(100,000) (59,200) 25,200 $134,000


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LO 9 – Free Free Cas Cash h Flow Flow • The main main focus of the the statement statement of cash cash flows is the the net cash flow from operating activities. Cash flow is used a measure of a firm’s performance in maintaining a strong cash position. • Free cash flow is defined as the cash flows from operations less capital expenditures. expenditures. This is the cash flow left over after undertaking operations and making the investments necessary to ensure continued operations. • Judging Judging a firm on the basis basis of net income misses important 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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Chapter 5 - Statement of Cash Flows

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