Chapter 12Statement of Cash Flows

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Chapter 12: Key Concepts Identify and explain the purposes and content in the

Statement of Cash Flows.

Discuss the usefulness of the Statement of Cash Flows.

Prepare a Statement of Cash Flows.

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Information in Statement of Cash Flows

Three-fold:1. Where does the cash come from?

2. What does the cash get spent on?

3. What explains the change in cash between periods?

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Usefulness of Statement of Cash Flows

Helps predict future cash flows. Investments today should generate operating cash flows

tomorrow. Financing should help spur investment.

Useful tool for evaluating managers’ decisions. Are those investments from the past few years paying

off?

Helps to determine whether interest and dividends payments can be made.

Provides insight about profitability and cash generation. Are the sales turning into cash?

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Summary of Statement of Cash Flows

Classifies cash inflows and outflows as follows: Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities

Reported for a period of time What other financial statements are reported over a

period of time?

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Statement of Cash Flows Categories

Operating Transactions resulting from day-to-day activities.

Production & Selling Examples:

Investing Transactions for purchases or sales of long-term assets.

Also includes investments in securities & non-trade receivables Examples:

Financing Debt & equity transactions that affect “cash”.

Includes non-trade short-term debt, all long-term debt, and stockholders’ equity.

Examples:

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Statement of Cash Flows:Other Disclosures

Disclosures Relating to Noncash Investing & Financing If transactions that relate to investing or

financing are material, have to disclose even if no cash is involved! Buying long-term assets with a long-term note Retiring debt by issuing equity securities Converting preferred stock to common stock

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Cash Flows: Relationship to the Balance Sheet

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Current assets Current liabilities

Long-term assets

Long-term liabilities

Owners’ equity

Operating cash flows

Operating cash flows

Financing cash flowsInvesting

cash flows

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Statement of Cash Flows:FAQs

Interest payments Included as an __________ activity, even though the proceeds

from selling the related instruments are included as a ____________ activity.

Dividend payments Included in ______________ activity, consistent with the placement

of proceeds from selling stock.

Interest and dividends received Both included as an ____________ activity, even though the related

outflows may have been included as an __________ activity.

Tax payments/refunds Included as an __________ activity, regardless of whether

underlying taxable income relates to operations or not (e.g. if a firm has a taxable capital gain on the sale of equipment).

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Statement of Cash Flows:Preparation

What information do you need to prepare the SoCF? Comparative (BOY & EOY) Balance Sheet Current Year Income Statement Other Information (Transaction Details)

Preparing the SoCF involves 4 general steps1. Calculate the cash flows from operating activities

Direct or Indirect Method

2. Calculate the cash flows from investing activities

3. Calculate the cash flows from financing activities

4. Calculate net cash flows (use items 1-3 above). This should tie to the change in cash on the Balance Sheet.

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Statement of Cash Flows:Preparation

Two Ways to approach preparation of the SoCF By Analyzing the Cash Account By Analyzing Noncash Accounts

Analyzing the Cash Accounts: Look at cash account & categorize each transaction as

operating, investing, or financing. Then classify into sub-categories like “cash receipts

from customers”, “cash from issuing stock”, etc. Big drawback of this approach is how time consuming

it is and small errors could add up.

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Statement of Cash Flows:Preparation

Two Ways to approach preparation of the SoCF By Analyzing the Cash Account By Analyzing Noncash Accounts

Analyzing the Non-Cash Accounts: Based on how double-entry accounting works

Debits = Credits Any transaction that affects the cash account ALSO

affects a non-cash account.

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Cash +Noncash

Assets = Liabilities + Equity

Cash = Noncash Accounts

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Cash Flows from Operating Activities

Cash Flows from Operating Activities can be calculated using either the Direct Method or the Indirect Method.

Direct Method Reconcile based on major income statement categories. “Cash Received From…” / “Cash Paid To…”. Recommended by FASB / Required by IASB.

Indirect Method Start with Net Income and reconcile based on the type of

account affected. Used more often due to simplicity.

Either way, net cash flows from operating activities will be the same.

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Cash Flows from Operating Activities: Indirect Method

What you need from the Income Statement:

What you need from the comparative Balance Sheets:

And “other” information, such as:

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Indirect Method: Types of Adjustments

Income Statement Adjustments __________ Gains on sales of PP&E. __________ Losses on sales of PP&E

Why make these adjustments?

Expenses without cash outflows are added to Net Income Examples?

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Indirect Method: Types of Adjustments

Changes in current assets (NOT CASH!!) Accounts Receivable, Prepaid Accounts Decreases are added to Net Income

If A/R decreases, you’ve collected more cash than the amount reflected in sales.

Changes in current liabilities (for operations) Accounts Payable, Interest Payable Decreases are subtracted from Net Income

If A/P decreases, you’ve paid more cash out to suppliers than you actually purchased.

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Operating Activities It can be challenging to keep straight

whether a balance should be added or subtracted from Net Income.

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Change in Account Balance During the Year

Increase Decrease

Current Assets

Current Liabilities

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Indirect Method Format

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Net Income

+

-

+

+

-

+

-

=

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Step 2: Cash Flows From Investing Activities

Transactions you will encounter most often:

Balance Sheet Account(s)

Investing Activity Cash Flow Effect

Plant Assets, Intangibles

Purchase of Plant Assets or Intangibles for cash

Sale of Plant Assets or Intangibles for cash

Short- or Long-term Investments (stocks & bonds from other companies)

Purchase of Investment Securities for cash

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Sales of Assets: Calculating Cash Received

Based on:

Use t-account to determine Cost and/or Accumulated Depreciation at the time of the sale.

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Cash

- (Cost

- A/D) = Gain/<Loss>

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Step 3: Cash Flows From Financing Activities

Transactions you will encounter most often:

Balance Sheet Account(s)

Financing Activity Cash Flow Effect

Short-Term Debt (Notes Payable)

Borrowing Cash from bank

Repayment of Loan Principal

Long-Term Debt Issuance of Bonds for Cash

Repayment of Bond Principal

Common Stock & Contributed Capital

Issuance of Stock for Cash

Repurchase (Retirement) of Stock with Cash

Retained Earnings Payment of Cash Dividends

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Calculating Cash Flows from Financing Activities: Examples

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Long-Term Debt

Beginning balancePayments of debt

Issuance of new debt

Ending balance

Retained Earnings

Beginning balanceDividends declared

Net income

Ending balance

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Step 4: Proving the Cash Balance

Finally!Cash flows from Operating Activities

+ Cash flows from Investing Activities

+ Cash flows from Financing ActivitiesNet Increase in Cash

+ Cash Balance, Beginning of YearCash Balance, End of Year

This amount must tie to the amount on the Balance

Sheet

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Other Disclosures

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Remember, still need to disclose non-cash investing and financing transactions. Example: Acquisition of building by issuing common stock Acquisition of land by issuing note payable Payment of long-term debt by issuing stock Bonds converted into common stock Stock dividends distributed

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Chapter 12: Key Concepts

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Identify and explain the usefulness and content in the Statement of Cash Flows.

Know how to classify items as Operating, Investing, Financing, or Non-cash investing and financing.

Be able to prepare a Statement of Cash Flows.

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Statement of Cash FlowsNon-Cash Accounts: Proof

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Statement of Cash Flows: Noncash Accounts (cont.)

Assets

= Liabilities

+ Equity

Cash +Noncas

hAssets

= Liabilities + Equit

y

Cash +Noncash

Assets = Liabilities +Equity

Cash = Liabilities + Equity - Noncas

h Assets

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Statement of Cash Flows: Noncash Accounts (cont.)

Assets

= Liabilities

+ Equity

Cash +Noncas

hAssets

= Liabilities + Equit

y

Cash +Noncash

Assets = Liabilities +Equity

Cash = Noncash Accounts