Understanding Financial Statements Seventh EDITION
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Transcript of Understanding Financial Statements Seventh EDITION
Understanding Understanding Financial Statements Financial Statements Seventh Seventh EDITIONEDITION
Lyn M. Fraser Lyn M. Fraser
Aileen OrmistonAileen Ormiston Insert BOOK COVER
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
4-4-22
Statement of Cash FlowsStatement of Cash Flows
Chapter 4
“Joan and Joe: A Tale of Woe”Joe added up profits and went to see Joan,Assured of obtaining a much-needed loan.
When Joe arrived, he announced with good cheer:“My firm has had an outstanding year,
And now I need a loan from your bank.”Eyeing the statements, Joan’s heart sank.
“Your profits are fine,” Joan said to Joe.But where, oh where, is your company’s cash flow?
I’m sorry to say: the answer is ‘no’.” --L. Fraser
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The Statement of Cash The Statement of Cash FlowsFlows
Provides information about cash Provides information about cash inflows and outflows during an inflows and outflows during an accounting period accounting period
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The Statement of Cash Flows The Statement of Cash Flows Con’t.Con’t.
Required by SFAS #95 Required by SFAS #95 Replaced the Statement of Changes Replaced the Statement of Changes
in Financial Position in 1988in Financial Position in 1988 Can be developed from Balance Can be developed from Balance
Sheet and Income Statement dataSheet and Income Statement data
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The Statement of Cash Flows The Statement of Cash Flows Con’t.Con’t.
“ “A positive net income on the income A positive net income on the income statement is ultimately statement is ultimately insignificant unless a company insignificant unless a company can translate its earnings into can translate its earnings into cash, and the only source in cash, and the only source in financial statement data for financial statement data for learning about the generation of learning about the generation of cash from operations is the cash from operations is the statement of cash flows”statement of cash flows”
Why is it important???
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Objectives of the ChapterObjectives of the Chapter
To explain how the statement of To explain how the statement of cash flows is preparedcash flows is prepared
To interpret the information To interpret the information presented in the statement presented in the statement
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Preparing a Preparing a Statement of Cash FlowsStatement of Cash Flows
Begins with a return to the Begins with a return to the balance sheetbalance sheet
Is prepared by calculating Is prepared by calculating changes in all of the balance changes in all of the balance sheet accounts sheet accounts
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
1.1. CashCash
2.2. Operating activitiesOperating activities
3.3. Investing activitiesInvesting activities
4.4. Financing activitiesFinancing activities
Four parts of a statement of cash flows:
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Cash & Cash equivalents:Cash & Cash equivalents:
Cash include
T-BillsT-Bills NotesNotes
CertificatesCertificatesBondsBondsCDsCDs
Commercial paperCommercial paper
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Short-term investments:Short-term investments:
Classified as investing activities
Cash include
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Delivering or producing goods Delivering or producing goods for sale and providing servicesfor sale and providing services
The cash effects of transactions The cash effects of transactions and other events that enter and other events that enter into the determination of into the determination of incomeincome
Operating Activities includeOperating Activities include
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Cash flows resulting from sales Cash flows resulting from sales of goods of goods
Purchase of inventories,Purchase of inventories, Payment of operating expensesPayment of operating expenses
Operating Activities ExamplesOperating Activities Examples
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Acquiring/disposing of securities Acquiring/disposing of securities that are not cash equivalentsthat are not cash equivalents
Acquiring/disposing of Acquiring/disposing of productive assetsproductive assets
Lending money/collecting on Lending money/collecting on loans loans
Investing Activities include
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Borrowing from Borrowing from creditors/repaying the principalcreditors/repaying the principal
Obtaining resources from Obtaining resources from ownersowners
Providing owners with a return Providing owners with a return on investment on investment
Financing Activities include
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
How Cash Flows During an Accounting Period
Total Inflows less Total Outflows = Change in cash for the accounting period
Operating Activities
Investing Activities
Financing Activities
Inflows
Outflows
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Look at changes in balance sheet Look at changes in balance sheet accounts from beginning to end accounts from beginning to end of accounting periodof accounting period
First First Step::
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
Transfer the account changes to the Transfer the account changes to the appropriate area of a statement appropriate area of a statement of cash flows of cash flows
Next Step: Step:
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Preparing a Preparing a Statement of Cash Flows Statement of Cash Flows ContinuedContinued
InflowInflow OutflowOutflow
- Asset account- Asset account + Asset account+ Asset account
+ Liability + Liability accountaccount
- Liability account- Liability account
+ Equity account+ Equity account - Equity account- Equity account
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Calculating Cash Flow Calculating Cash Flow from Operating Activitiesfrom Operating Activities
Direct MethodDirect MethodIndirect Method Indirect Method
Firms may use one of two methods prescribed by the FASB:
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
4-4-2020
Calculating Cash Flow Calculating Cash Flow from Operating Activitiesfrom Operating Activities ContinuedContinued
Shows cash collections from Shows cash collections from customers, interest and dividends customers, interest and dividends collected, other operating cash collected, other operating cash receipts, cash paid to suppliers receipts, cash paid to suppliers and employees, interest paid, and employees, interest paid, taxes paid and other operating taxes paid and other operating cash paymentscash payments
The Direct Method
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Calculating Cash Flow Calculating Cash Flow from Operating Activitiesfrom Operating Activities ContinuedContinued
Starts with net income and adjusts Starts with net income and adjusts for deferrals; accruals; noncash for deferrals; accruals; noncash items, such as depreciation and items, such as depreciation and amortization; and nonoperating amortization; and nonoperating items, such as gains and losses items, such as gains and losses on asset sales on asset sales
The Indirect Method
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Analyzing the Analyzing the Statement of Cash FlowsStatement of Cash Flows
Is an important analytical tool for Is an important analytical tool for creditors, investors and other creditors, investors and other users of financial statement users of financial statement data data
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Analyzing the Analyzing the Statement of Cash FlowsStatement of Cash Flows Con’t.Con’t.
Firm’s ability to generate cash Firm’s ability to generate cash flows in the futureflows in the future
Firm’s capacity to meet cash Firm’s capacity to meet cash obligationsobligations
Firm’s future external financing Firm’s future external financing needsneeds
Indicates
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Analyzing the Analyzing the Statement of Cash FlowsStatement of Cash Flows Con’t.Con’t.
Firm’s success in productively Firm’s success in productively managing investing activitiesmanaging investing activities
Firm’s effectiveness in Firm’s effectiveness in implementing financing and implementing financing and investing strategiesinvesting strategies
Indicates
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Cash Flow from Cash Flow from OperationsOperations
Pay dividends or invest in new Pay dividends or invest in new equipmentequipment
Service debt Service debt
It is possible for a firm to be It is possible for a firm to be highly profitable and not be able to:highly profitable and not be able to:
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Cash Flow from OperationsCash Flow from Operations ContinuedContinued
It is also possible for a firm to be It is also possible for a firm to be highly profitable and go bankrupt highly profitable and go bankrupt
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Cash Flow from Operations Cash Flow from Operations ContinuedContinued
How?How?
The problem is cash The problem is cash
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Cash Flow from Operations Cash Flow from Operations ContinuedContinued
The ongoing operation of any The ongoing operation of any business depends upon its business depends upon its success in generating cash success in generating cash from operations from operations
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Statement of Cash FlowsStatement of Cash Flows
Cash flow from operating Cash flow from operating activitiesactivities
Cash inflowsCash inflows Cash outflowsCash outflows
Should, at a minimum cover analysis ofShould, at a minimum cover analysis of
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Statement of Cash FlowsStatement of Cash Flows ContinuedContinued
The success or failure of the firm The success or failure of the firm in generating cash from in generating cash from operationsoperations
The underlying causes of the The underlying causes of the positive or negative operating positive or negative operating cash flow cash flow
Analyst Concerns:Analyst Concerns:
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Statement of Cash FlowsStatement of Cash Flows ContinuedContinued
The magnitude of positive or The magnitude of positive or negative operating cash flownegative operating cash flow
Fluctuations in cash flow from Fluctuations in cash flow from operations over timeoperations over time
Analyst Concerns:Analyst Concerns:
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Summary Analysis of the Summary Analysis of the Statement of Cash FlowsStatement of Cash Flows
Provides an approach to analyzing Provides an approach to analyzing a statement of cash flows that a statement of cash flows that can be used for any firm that can be used for any firm that provides comparative cash flow provides comparative cash flow datadata
The Summary TableThe Summary Table
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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Summary Analysis of the Summary Analysis of the Statement of Cash FlowsStatement of Cash Flows Con’t.Con’t.
The information underlines the The information underlines the importance of internal cash importance of internal cash generation—from operations—generation—from operations—and the implications for and the implications for investing and financing investing and financing activities when this does and activities when this does and does not occur does not occur
The Summary TableThe Summary Table
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Analysis of Cash InflowsAnalysis of Cash Inflows
Capital expenditures and expansionCapital expenditures and expansionRepayments of debtRepayments of debt
Payments of dividends Payments of dividends
Generating cash from operations is Generating cash from operations is the preferred method for obtaining the preferred method for obtaining excess cash to finance:excess cash to finance:
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Analysis of Cash InflowsAnalysis of Cash Inflows Con’t.Con’t.
When analyzing the cash outflows, When analyzing the cash outflows, the analyst should consider the the analyst should consider the necessity of the outflow and necessity of the outflow and how the outflow was financedhow the outflow was financed
(C) 2004 Prentice Hall, Inc.(C) 2004 Prentice Hall, Inc.
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The Journey The Journey Through the Maze Through the Maze ContinuesContinues
Ch. 5:Ch. 5: The Analysis of Financial The Analysis of Financial StatementsStatements