Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Statement of Cash Flows...

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Statement of Cash Flows

Chapter 13

13-2

Understanding the Business

Positive cash flows permit a company to . . .

Expand its operations.Expand its operations.

Replace needed assets.

Replace needed assets.

Take advantage of market

opportunities.

Take advantage of market

opportunities.

Pay dividends to

owners.

Pay dividends to

owners.

Wall Street analysts consider cash flow an important indicator of a company’s financial

health.

Wall Street analysts consider cash flow an important indicator of a company’s financial

health.

13-3

Learning Objectives

Classify cash flow statement items as part of net cash flows from operating, investing, and

financing activities.

Classify cash flow statement items as part of net cash flows from operating, investing, and

financing activities.

13-4

CashCashCurrency

Cash Equivalents

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

interest rate changes (i.e., less than 3 months to maturity).

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

interest rate changes (i.e., less than 3 months to maturity).

Classifications of the Statement of Cash Flows

13-5

Classifications of the Statement of Cash Flows

Operating Activities

Cash inflows and outflows directly related to earnings

from normal operations.

Investing Activities

Cash inflows and outflows related to the acquisition or sale of productive

facilities and investments in the securities of other companies.

Financing Activities

Cash inflows and outflows related to external sources of financing (owners and creditors) for the

enterprise.

13-6

Investing ActivitiesOperating Activities Financing ActivitiesSale of operational assets

Sale of investments

Collections of loans

Cash received from revenues

Issuance of stock

Issuance of bonds and notes

CASH INFLOWS

Business

CASH OUTFLOWS

Purchase of operational assets

Purchase of investmentsLoans to others

Cash paid for expenses

Payment of dividends

Repurchase of stock

Repayment of debt

13-7

Cash Flows from Operating Activities

Cash Flows from


Cash Flows from


Inflows Cash received from: Customers Dividends and interest on

investments

Inflows Cash received from: Customers Dividends and interest on

investments

+

Outflows Cash paid for: Purchase of goods for resale

and services (electricity, etc.) Salaries and wages Income taxes Interest on liabilities

Outflows Cash paid for: Purchase of goods for resale

and services (electricity, etc.) Salaries and wages Income taxes Interest on liabilities

_

13-8

Direct Method vs. Indirect Method

Two Formats for Reporting Operating Activities

Reports the cash effects of each

operating activity

Direct Method

Starts with accrual net income and

converts to cash basis

Indirect Method

Note that no matter which format is used, the same amount of net cash flows from operating activities is generated.

13-9

Cash Flows from


Cash Flows from


+

Cash Flows from Investing Activities

Inflows Cash received from: Sale or disposal of property,

plant and equipment Sale or maturity of investments

in securities

Inflows Cash received from: Sale or disposal of property,

plant and equipment Sale or maturity of investments

in securities

_

Outflows Cash paid for: Purchase of property, plant and

equipment Purchase of investments in

securities

Outflows Cash paid for: Purchase of property, plant and

equipment Purchase of investments in

securities

13-10

Cash Flows from


Cash Flows from


+

_

Cash Flows from Financing Activities

Inflows Cash received from: Borrowings on notes,

mortgages, bonds, etc. from creditors

Issuing stock to owners

Inflows Cash received from: Borrowings on notes,

mortgages, bonds, etc. from creditors

Issuing stock to owners

Outflows Cash paid for: Repayment of principal to

creditors (excluding interest, which is an operating activity)

Repurchasing stock from owners

Dividends to owners

Outflows Cash paid for: Repayment of principal to

creditors (excluding interest, which is an operating activity)

Repurchasing stock from owners

Dividends to owners

13-11

(in thousands) Three months ended(unaudited) March 27, 2004Cash flows from operating activities: Net income 1,271$ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,543 Changes in assets and liabilities: Accounts receivable 861

Inventory (577)Prepaid expense (322)Accounts payable (52)Accrued expenses (954)

Net cash provided by operating activities 2,770Cash flows for investing activities: Purchases of property, plant and equipment (2,373) Purchase of short-term investments (4,627) Net cash provided by investing activities (7,000) Cash flows from financing activities: Purchase of treasury stock (4,409) Proceeds from issuance of stock 5,593 Net cash used in financing activities 1,184 Net increase (decrease) in cash & cash equivalents (3,046) Cash & cash equivalents at beginning of period 27,792 Cash & cash equivalents at end of period 24,746$

CONSOLIDATED STATEMENT OF CASH FLOWSTHE BOSTON BEER COMPANY, INC.

Boston Beer uses the indirect

method.

Boston Beer uses the indirect

method.

The indirect method is used by 98.3% of

companies.

The indirect method is used by 98.3% of

companies.

This ending cash balance should agree with the balance sheet.

This ending cash balance should agree with the balance sheet.

13-12

Relationships to the Balance Sheet and the Income Statement

Information needed to prepare a statement of cash flows:

Comparative Balance Sheets. Income Statement. Additional details concerning selected

accounts.

Information needed to prepare a statement of cash flows:

Comparative Balance Sheets. Income Statement. Additional details concerning selected

accounts.

13-13


Cash = Liabilities Stockholders’ Equity Noncash Assets

Cash = Liabilities Stockholders’ Equity Noncash Assets

Derives from . . .

Assets = Liabilities Stockholders’ Equity

Assets = Liabilities Stockholders’ Equity

13-14


Category Transactions Cash Effect Other Account AffectedOperating Collect accounts receivable +Cash -Accounts Receivable (A)

Pay accounts payable -Cash -Accounts Payable (L)Prepay rent -Cash +Prepaid Rent (A)Pay interest -Cash -Retained Earnings (SE)Sale for cash +Cash +Retained Earnings (SE)

Investing Purchase equipment for cash -Cash +Equipment (A)Sell investment securities for cash +Cash -Investments (A)

Financing Pay back debt to bank -Cash -Notes Payable-Bank (L)

Issue stock for cash +Cash+Common Stock and Paid-in-Capital (SE)

Selected Cash Transactions and Their Effect on Other Balance Sheet Accounts

13-15

Learning Objectives

Report and interpret cash flows from operating activities using the indirect method.

Report and interpret cash flows from operating activities using the indirect method.

13-16

Reporting Cash Flows from Operating Activities—Indirect Method

Net Income

Net Income

Cash Flows from Operating

Activities - Indirect Method

Cash Flows from Operating

Activities - Indirect Method

+/- Changes in current assets and current

liabilities.

+/- Changes in current assets and current

liabilities.

+ Losses and - Gains

+ Losses and - Gains

+ Noncash expenses such as depreciation and

amortization.

+ Noncash expenses such as depreciation and

amortization.

The indirect method adjusts net income by eliminating noncash items.

The indirect method adjusts net income by eliminating noncash items.

13-17

Use this table when adjusting Net Income Use this table when adjusting Net Income to Operating Cash Flows using the to Operating Cash Flows using the

indirect methodindirect method..


13-18


Use the following financial statements for

The Boston Beer Company and prepare the Statement of Cash Flows for the quarter ended on March 27,

2004.

Use the following financial statements for

The Boston Beer Company and prepare the Statement of Cash Flows for the quarter ended on March 27,

2004.

13-19

(Unaudited) March 27, Dec. 27,

In Thousands 2004 2003 Changes

ASSETSCurrent assets:

Cash & cash equivalents 24,746$ 27,792$ (3,046) Short-term investments 19,725 15,098 4,627 Accounts Receivable 9,571 10,432 (861) Inventories 10,467 9,890 577 Prepaid expenses 1,448 1,126 322

Total current assets 65,957 64,338 Equipment, net 16,889 17,059 (170) Total assets 82,846$ 81,397$

LIABILITIES & STOCKHOLDERS' EQUITYCurrent liabilities:

Accounts payable 6,343$ 6,395$ (52)Accrued expenses 14,550 15,504 (954)

Total current liabilities 20,893 21,899 Stockholders' Equity:

Contributed capital 24,107 22,923 1,184Retained earnings 37,846 36,575 1,271

Total stockholders' equity 61,953 59,498Total liabs & stockholders' equity 82,846$ 81,397$

THE BOSTON BEER COMPANY, INC.CONSOLIDATED BALANCE SHEET

13-20

The Statement of Cash Flows will begin with Boston Beer’s Net income from the

Income Statement.

The Statement of Cash Flows will begin with Boston Beer’s Net income from the

Income Statement.

13-21

Step 1Adjust net income for

depreciation and amortization expense.

Step 1Adjust net income for

depreciation and amortization expense.

13-22

(Remember, we showed the comparative balance sheets a few slides earlier.)

Step 2Adjust net income for changes in current assets and current

liabilities.

Step 2Adjust net income for changes in current assets and current

liabilities.

13-24

Learning Objectives

Report and interpret cash flows from operating activities using the direct method.

Report and interpret cash flows from operating activities using the direct method.

13-25

Reporting Cash Flows from Operating Activities—Direct Method

Sales revenue + Decrease in accounts receivable

- Increase in accounts receivable= Cash collected from customers

Interest/Dividend revenue+ Decrease in interest/dividends

receivable- Increase in interest/dividends

receivable= Collections of interest/dividends

on investments

Cost of goods sold+ Increase in inventory- Decrease in inventory- Increase in accounts payable+ Decrease in accounts payable= Cash payments to suppliers

Other expenses+ Increase in prepaid expenses- Decrease in prepaid expenses- Increase in accrued expenses+ Decrease in accrued expenses= Cash paid for expenses

Income tax expense+ Increase in prepaid income taxes- Decrease in prepaid income taxes- Increase in income taxes payable+ Decrease in income taxes payable= Payments of income taxes

13-26

Reporting Cash Flows from Operating Activities—Direct Method44,655$ Sales revenue

861 Decrease in accounts receivable

n/a Increase in accounts receivable $ 45,516 Cash collected from customers

192$ Interest/Dividend revenuen/a Decrease in interest/dividends

receivablen/a Increase in interest/dividends

receivable $ 192 Collections of interest/dividends

on investments

$ 18,073 Cost of goods sold577 Increase in inventory

n/a Decrease in inventoryn/a Increase in accounts payable

52 Decrease in accounts payable $ 18,702 Cash payments to suppliers

$ 22,188 Other expenses322 Increase in prepaid expenses

n/a Decrease in prepaid expensesn/a Increase in accrued expenses

954 Decrease in accrued expenses23,464$ Cash paid for expenses

$ 772 Income tax expensen/a Increase in prepaid income taxesn/a Decrease in prepaid income taxesn/a Increase in income taxes payablen/a Decrease in income taxes payable772$ Payments of income taxes

13-27

Remember that when we prepared the operating section using the indirect method, we also arrived at net cash inflow of $2,770.

13-28

Interpreting Cash Flows from Operating Activities

Accounts Receivable Changes

Managers sometimes attempt to boost declining sales by extending credit terms or by lowering credit

standards. The resulting increase in accounts receivable can cause net income to outpace cash flows from

operations.

Inventory Changes

Inventory growth can be a sign that planned sales growth did not

materialize. A decline in inventory can be a sign that the company is

anticipating lower sales in the next quarter.

13-29

Learning Objectives

Analyze and interpret the quality of income ratio.

Analyze and interpret the quality of income ratio.

13-30

Quality of Income Ratio

In general, this ratio measures the portion of income that was generated in cash. All other things equal, a higher quality of

income ratio indicates greater ability to finance operating and other cash needs from

operating cash inflows.

Cash Flow from Operating Activities Net Income

Quality of Income Ratio

=

13-31

Learning Objectives

Report and interpret cash flows from investing activities.

Report and interpret cash flows from investing activities.

13-32











THE BOSTON BEER COMPANY, INC.CONSOLIDATED BALANCE SHEET Here is

the balance

sheet we

looked at

earlier.

Let’s focus on

the investing accounts.

13-33





The balance sheet indicates that

Equipment decreased by $170 during the quarter.

If you had access to additional company

information, you would discover that

the company purchased $2,373 of

new equipment. This is offset by

$2,543 in depreciation

expense (see the Cash Flows from

Operating Activities).

The balance sheet indicates that

Equipment decreased by $170 during the quarter.

If you had access to additional company

information, you would discover that

the company purchased $2,373 of

new equipment. This is offset by

$2,543 in depreciation

expense (see the Cash Flows from

Operating Activities).

13-34

Short-term investments increased by $4,627 during the quarter.

Although short-term

investments is a current asset, it is reported in the investing

section on the statement of cash flows.

Short-term investments increased by $4,627 during the quarter.

Although short-term

investments is a current asset, it is reported in the investing

section on the statement of cash flows.





13-35

Learning Objectives

Analyze and interpret the capital acquisition ratio.

Analyze and interpret the capital acquisition ratio.

13-36

In general, this ratio reflects the portion of purchases of property, plant and equipment financed from operating

activities. A high ratio indicates less need for outside financing for current

and future expansions.

Capital Acquisition Ratio

Cash Flow from Operating Activities Cash Paid for Property, Plant,

and Equipment

Capital Acquisition

Ratio=

13-37

In general, this measures a firm’s ability to pursue long-term investment

opportunities.

Free Cash Flow

Cash Flow from Operating Activities – Dividends – Cash Flow from Operating Activities – Dividends – Capital ExpendituresCapital Expenditures

13-38

Learning Objectives

Report and interpret cash flows from financing activities.

Report and interpret cash flows from financing activities.

13-39











THE BOSTON BEER COMPANY, INC.CONSOLIDATED BALANCE SHEET Here is

the balance

sheet we

looked at

earlier.

Let’s focus on

the financing account.

13-40





The net increase in Contributed Capital

of $1,184 was caused by two transactions.

First, Boston Beer repurchased $4,409

of outstanding stock, which is a cash outflow.

Second, the company issued common stock to

employees for $5,593, which is a

cash inflow.

The net increase in Contributed Capital

of $1,184 was caused by two transactions.

First, Boston Beer repurchased $4,409

of outstanding stock, which is a cash outflow.

Second, the company issued common stock to

employees for $5,593, which is a

cash inflow.

13-41

Interpreting Cash Flows from Financing Activities

The long-term growth of a company is normally financed from three sources:

internally generated funds, the issuance of stock, and money borrowed on a long-

term basis.

The statement of cash flows shows how management has elected to fund its growth.

This information is used by analysts who wish to evaluate the capital structure and growth

potential of a business.

13-42

Learning Objectives

Explain the impact of additional cash flow disclosures.

Explain the impact of additional cash flow disclosures.

13-43

Required Supplemental Information

1. Reconciliation of net income to cash flow from operations.

2. Cash paid for income taxes and interest.

3. Significant noncash investing and financing activities.

Required Supplemental Information

1. Reconciliation of net income to cash flow from operations.

2. Cash paid for income taxes and interest.

3. Significant noncash investing and financing activities.

Additional Cash Flow Disclosures

Significant noncash investing and financing transactions do not involve cash.

Example: Purchase of a building with a mortgage.

13-44

Chapter Supplement A

Adjustment for Gains and Losses: Indirect Method

13-45

Adjustment for Gains and Losses

GainsGains must be subtracted from net

income to avoid double counting the gain.

Losses Losses must be added to net income to avoid double counting the loss.

Transactions that cause gains and losses should be classified on the cash flow statement as operating, investing, or financing activities, depending on their dominate characteristics. For example, if the sale of

equipment produced a gain, it would be classified as an investing activity.

13-46

Chapter Supplement B

Spreadsheet Approach—Statement of Cash Flows: Indirect Method

13-47

Spreadsheet Approach

The spreadsheet approach offers a systematic way to keep track of data. A

spreadsheet is organized as follows:

1. Four columns to record dollar amounts are established (beginning balance, debit changes, credit changes, and ending balance).

2. On the far left of the top half of the spreadsheet, each account name from the balance sheet is entered.

3. On the far left of the top half of the spreadsheet, the name of each item that will be reported on the statement of cash flows is entered.

13-48

After entering all the transactions illustrated in the textbook, this is

what the spreadsheet looks like.

Dec. 31, 2003 Debits Credits

Mar. 27, 2004

Balance SheetAssets:Cash and equivalents 27,792 (n) 3,046 24,746 Short-term investments 15,098 (k) 4,627 19,725 Accounts receivable 10,432 (d) 861 9,571 Inventories 9,890 (e) 577 10,467 Prepaid expenses 1,126 (f) 322 1,448 Equipment, net 17,059 (i) 2,373 (b) 2,543 16,889

Accounts payable 6,395 (g) 52 6,343 Accrued expenses 15,504 (h) 954 14,550 Contributed capital 22,923 (l) 4,409 (m) 5,593 24,107 Retained earnings 36,575 (a) 1,271 37,846

Statement of Cash Flows SubtotalsCash flows from operating activities: Net income (a) 1,271 Adj. to reconcile net income to net cash provided by operating activities: Depreciation and amortization (b) 2,543 Changes in assets and liabilities: Accounts receivable (d) 861 Inventory (e) 577 Prepaid expense (f) 322 Accounts payable (g) 52 Accrued expenses (h) 954 Net cash provided by operating activities 2,770 Cash flows for investing activities: Purchases of property, plant and equipment (i) 2,373 Purchase of short-term investments (k) 4,627 Net cash provided by investing activities (7,000) Cash flows from financing activities: Purchase of treasury stock (l) 4,409 Proceeds from issuance of stock (m) 5,593 Net cash used in financing activities 1,184 Net decrease in cash & cash equivalents (n) 3,046 Totals

26,628 26,628 (3,046)

BOSTON BEER COMPANYChanges

Inflows Outflows

13-49

End of Chapter 13

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Statement of Cash Flows...

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