Post on 18-Dec-2015
Chapter 5
Statement of Cash Flows
Overview of Statement
of Cash Flows
The statement of cash flows provides a thorough
explanation of the changes that occurred in a
firms cash balance during the entire accounting period.
The statement of cash flows reports cash receipts
and payments of a company during a given period
for operating, financing, and investing activities.
Cash includes cash and cash equivalents.
Purposes of Cash Flow
Statement
It shows the relationship of net income to changes
in cash balances.
It reports past cash flows as an aid to: Predicting future cash flows
Evaluating the way management generates and uses cash
Determining a companys ability to pay interest and dividends and to pay debts when they are due
Purposes of Cash Flow
Statement
The relationship among the balance sheet, income
statement, and statement of cash flows:
Balance Sheet
December 31,
20X3
Balance Sheet
December 31,
20X2
Income Statement
Statement of Cash Flows
Typical Activities Affecting
Cash
Cash is affected by two primary areas of a
firm.
Operating management - largely concerned
with the major day-to-day activities that
generate revenues and expenses
Financial management - largely concerned
with where to get cash and how to use cash
for the benefit of the entity
Typical Activities Affecting
Cash
1. Operating activities - transactions that affect the
income statement
2. Financing activities - activities that include
obtaining resources as a borrower or issuer of
securities and repaying creditors and owners
3. Investing activities - activities that involve
(1) providing and collecting cash as a lender or as an
owner of securities and
(2) acquiring and disposing of plant, property,
equipment, and other long-term productive assets
Typical Activities Affecting
Cash
Cash inflows Collections from
customers
Interest and dividends collected
Other operating receipts
Cash outflows Cash payments to suppliers
Cash payments to employees
Interest and tax payments
Other operating cash payments
Typical operating activities
Typical Activities Affecting
Cash
Cash inflows Borrowing cash from
creditors
Issuing equity securities
Issuing debt securities
Cash outflows Repayment of amounts
borrowed
Repurchase of equity shares
Payment of dividends
Typical financing activities
Typical Activities Affecting
Cash
Cash inflows Sale of property, plant, and
equipment
Sale of securities that are not cash equivalents
Receipt of loan repayments
Cash outflows
Purchase of property, plant,
and equipment
Purchase of securities that
are not cash equivalents
Making loans
Typical investing activities
How to treat Interest payments
and Dividends payments?
Preparing a Statement of Cash
Flows
Financing Activities
2 general rules for financing activities:
a. Increases in cash (cash inflows) stem from
increase in liabilities or paid In capital
b. Decreases in cash (cash outflows ) stem
from decreases in liabilities or paid in capital
Preparing a Statement of Cash
Flows
Investing activities
2 general rules for investing activities
a. Increases in Cash stem from decreases in
long lived assets, loans and investments
b. Decreases in cash stem from increases in
long lived assets, loans and investments
Approaches to Calculating the
Cash Flow from Operating Activities
2 approaches may be used to compute cash
flow from operating activities.
1. Direct method - the method that calculates net cash
provided by operating activities as collections minus
operating distributions
2. Indirect method - the method that adjusts the accrual
net income to reflect only cash receipts and outlays
Under either method, the final cash flow from operating
activities will be the same.
Transactions Affecting Cash
Flows from All Sources
Effects of operating transactions on cash:
Sales of goods and services for cash +
Sales of goods and services on credit 0
Receive dividends or interest +
Collection of accounts receivable +
Recognize cost of goods sold 0
Purchase inventory for cash -
Purchase inventory on credit 0
Pay trade accounts payable -
0 denotes that the transaction has no effect on cash.
Transactions Affecting Cash
Flows from All Sources
Effects of operating transactions on cash: Accrue operating expenses 0
Pay operating expenses -
Accrue taxes 0
Pay taxes -
Accrue interest 0
Pay interest -
Prepay expenses for cash -
Write off prepaid expenses 0
Charge depreciation or amortization 0
0 denotes that the transaction has no effect on cash.
Transactions Affecting Cash
Flows from All Sources
Effects of investing activities on cash:
Purchase fixed assets for cash -
Purchase fixed assets by issuing debt 0
Sell fixed assets +
Purchase securities that are not cash equivalents -
Make a loan -
0 denotes that the transaction has no effect on cash.
Transactions Affecting Cash
Flows from All Sources
Effects of financing transactions on cash:
Increase long-term or short-term debt +
Reduce long-term or short-term debt -
Sell common or preferred shares +
Repurchase or retire common or preferred shares -
Pay dividends -
Convert debt to common stock 0
0 denotes that the transaction has no effect on cash.
Schedule of non cash investing
and financing activities
Common stock issued to acquire store
equipment
Loan taken to acquire furniture
Changes in the
Balance Sheet Equation
The balance sheet equation can be rearranged as follows:
Cash = Liabilities + Equity - Noncash Assets
or
DCash = DL + DSE - DNCA
Any change (D) in a noncash item (liability, equity, or
asset) must be accompanied by a change in cash to
keep the equation balanced.
Changes in the
Balance Sheet Equation
The statement of cash flows focuses on the change
in the noncash accounts as a way of explaining how
and why the amount of cash changes during a given
period.
Change in cash = Change in all noncash accounts
or
What happened to cash = Why it happened
Preparing a Statement of Cash
Flows - The Indirect Method
In calculating cash flows from operating
activities, the alternative to the direct method
is the indirect method.
The indirect method is generally more
convenient.
The indirect method reconciles
accrual net income to cash flows
from operating activities.
Reconciliation of Net Income to Net Cash
Provided by Operations
Items included in the reconciliation:
Depreciation is added back to net income because it
was deducted in arriving at net income, but it does not represent a use of cash.
Increases in noncash current assets result in less cash flow from operations, so such increases are deducted from net income.
Decreases in noncash current assets result in more cash flow from operations, so such decreases are added back to net income.
Reconciliation of Net Income to Net
Cash Provided by Operations
Items included in the reconciliation (continued):
Increases in current liabilities result in more cash flow from operations, so such increases are added back to net income.
Decreases in current liabilities result in less cash flow from operations, so such decreases are deducted from net income.
The Crisis of Negative Cash
Flow
Although investors make many decisions
based on net income, earnings numbers do
not tell the whole story of what is happening
inside a company.
Sometimes companies can show
lots of net income, but that net
income comes from selling off
assets to meet its obligations.