FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTINGA USER PERSPECTIVEA USER PERSPECTIVE

Hoskin • Fizzell • Davidson

Second Canadian Edition

Cash Flow StatementCash Flow Statement

Chapter Five

Ajax Widget Company

• Product Line– Ajax Widget company sells widgets

• Supplier Credit– Widgets cost Ajax $4 each.

– All inventory must be paid in cash when it is ordered.

Ajax Widget Company

• Sales/Customer Credit– Ajax sells the widgets for $5 each

– Ajax allows customers up to 30 days to pay

– Assume: customers pay 30 days after a sale

Ajax Widget Company

• Inventory Policy– Ajax must maintain sufficient

inventory for customer purchases

– Ajax’ inventory at the end of a period is equal to 50% of the current month’s sales

Ajax Widget Company

Sales/InventoryData (in units) January February MarchBeginninginventory 250 500 800New inventorypurchases 1,250 1,900 2,500Goods availablefor sale 1,500 2,400 3,300

Sales 1,000 1,600 2,200

Ending inventory 500 800 1,100

Ajax Widget Company

IncomeStatement January February March

Revenues $5,000 $8,000 $11,000

Cost of goods sold (4,000) (6,400) (8,800)

Net income $1,000 $1,600 $2,200

Ajax Widget Company

• Net income is growing

• Increased level of sales is shown in:– Accounts receivable

– Inventory

Ajax Widget Company

PartialBalanceSheet Dec.31 Jan.31 Feb.28 Mar.31

Cash $8,000 $5,500 $2,900 $ 900Accountsreceivable 2,500 5,000 8,000 11,000

Inventory 1,000 2,000 3,200 4,400

Ajax Widget Company

Cash-to-Cash Cycle

Cash

Inventory Purchase (cash outflow)

Sale of Widget

Collection (cash inflow)

Cash-to-Cash Cycle

• Lead/lag relationship between– cash paid out to buy inventory, and

– cash coming in from collections of accounts receivable

Income Statement

• Income Statement– measures performance at a point in

the cycle

– ignores timing differences between revenues and expenses and the related cash flows

– not useful in tracking cash flows

Income and Cash Flow Statements

• Income Statement– summarizes the profitability of the

company’s operations

• Cash Flow Statement– summarizes the cash flows

Ajax Widget Company

Cash FlowStatement January February MarchReceipts(collections) $2,500 $5,000 $ 8,000Payments(inventory costs) (5,000) (7,600) (10,000)

Net cash flow ($2,500) ($2,600) ($ 2,000)

Ajax Widget Company

• Cash flow has been negative for the first three months

• March 31 cash balance: $900.

• Will the company run out of cash?

• What will it do to continue doing business?

Ajax Widget Company

April May June

Revenues $14,000 $17,000 $20,000Cost of goods sold (11,200) (13,600) (16,000)Net income $ 2,800 $ 3,400 $ 4,000

Receipts $11,000 $14,000 $17,000Payments (12,400) (14,800) (17,200)Net cash flow ($1,400) ($ 800) ($ 200)

End cash balance ($500) ($1,300) ($1,500)

Net Income, Cash Flow, and Cash Balance Forecast

Ajax Widget Company

• Net cash flow will be negative for the next three months

• The trend is improving

• What will happen in July?

• Should the company take out a loan, or establish a line of credit, with the bank?

Cash Flow Solutions

• Capitalization– the amount of cash the company starts

with

• Start-up companies tend to be under-capitalized

• How should start-up companies manage their cash flows?

Cash Flow Solutions

• Growth– Slow down the rate of growth of

sales• May be detrimental in the long run

• May divert customers to competitors

Cash Flow Solutions

• Capitalization– Start with a larger amount of cash

• Issue additional shares

• borrow the cash (debt)

Cash Flow Solutions

• Lead/Lag Relationships– change the relationships between

cash inflows and outflows• change the policies regarding

accounts receivable, accounts payable, or inventory

Cash Flow Statement

• Cash and Cash Equivalents– short-term, highly liquid

investments that are readily convertible into known amounts of cash

Cash Flow Statement

• Financing Activities

• Investing Activities

• Operating Activities

Cash Flow Statement

• Financing activities– obtaining and repaying resources

from shareholders and lenders

– Examples: shares, bonds, mortgages, notes, dividends

Cash Flow Statement

• Investing Activities– investment, sale or disposal of

long-term assets

– Examples: property, plant, equipment, long-term marketable securities

Cash Flow Statement

• Operating Activities– sale of goods and services to

customers

– changes to current assets and current liabilities

Cash Flow Statement

• Approaches–Direct approach

• theoretically informative• rarely used

–Indirect approach• normally used in published statements

Cash Flow Statement

• Direct and Indirect Approaches– differ only in format and content of

the Operating Activities section

– Investing Activities and Financing Activities sections are the same

Cash Flow Statement

• Indirect approach– shows only net cash flows from

operating activities

– then shows adjustments to net income to arrive at net cash flows from operations

Cash Flow Statement

• Indirect approach– Adjustments:

• Items from the income statement that do not involve cash flows

– Amortization, deferred income taxes, loss on sale of capital assets

• Net changes in noncash working capital– current assets and current liabilities

Cash Flow Statement

Change in the Current Account

Current Asset

Current Liability

Subtract

Increase Decrease

SubtractAdd

Add

Preparation of the Cash Flow Statement (Indirect Approach)

• Using T-Accounts– need balance sheet, income

statement, and additional information

– objective is to reconstruct all transactions affecting cash

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash 19,500

6,050

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash SE-Ret Earnings 19,500 48,300(1) 12,480 12,480(1)

59,380

6,050

Operating: (1) Net income: $12,480

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-Acc. Rec. 19,500 20,000(1) 12,480 10,000(2)(2) 10,000 10,000

6,050

Operating: (2) Decrease in A/R: $10,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-Inv entory 19,500 30,000(1) 12,480 10,000 (3) (3) 10,000(2) 10,000 40,000

6,050

Operating: (3) Increase in Inventory: $10,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-Prepaid Rent 19,500 500(1) 12,480 10,000 (3) (4) 100(2) 10,000 100 (4) 600

6,050

Operating: (4) Increase in Prepaid Rent:

$100

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-Acc. Pay. 19,500 6,000(1) 12,480 10,000 (3) 5,000 (5)(2) 10,000 100 (4) 11,000(5) 5,000

6,050

Operating: (5) Increase in A/P: $5,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-Acc. Salaries 19,500 300(1) 12,480 10,000 (3) 100 (6)(2) 10,000 100 (4) 400(5) 5,000(6) 100

6,050

Operating: (6) Increase in Acc.Sal.:

$100

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash XA-Accum Amort. 19,500 50,000(1) 12,480 10,000 (3) 20,000 (7)(2) 10,000 100 (4) 69,200(5) 5,000(6) 100(7) 20,000

6,050

Operating: (7) Amortization: $20,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-PP &E 19,500 100,000

300 (8) 1,000 (8)(8) 500 159,000

6,050 XA-Accum Amort.50,000

(8) 800 20,00069,200

Operating: (8) Gain on sale of equip.: $300 Financing: (8) Sale of equipment: $500

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash A-PP &E 19,500 100,000(1) 12,480 10,000 (3) (9) 60,000 1,000 (8)(2) 10,000 100 (4) 159,000(5) 5,000(6) 100(7) 20,000

(8) 500 60,000 (9) 6,050

Investing:(9) Purchase of PP&E: $60,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash L-Note Pay. 19,500 100(1) 12,480 10,000 (3) 100 (10)(2) 10,000 100 (4) 200(5) 5,000(6) 100(7) 20,000(10) 100

(8) 500 60,000 (9) 6,050

Financing:(10) Proceeds from note: $100

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash L-Bonds Pay. 19,500 40,000(1) 12,480 10,000 (3) 8,000 (11)(2) 10,000 100 (4) 46,000(5) 5,000(6) 100(7) 20,000(10) 100(11) 8,000

(8) 500 60,000 (9) 6,050

Financing:(11) Proceeds from bond: $8,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash L-Bonds Pay. 19,500 40,000(1) 12,480 10,000 (3) (12) 2,000 8,000(11)(2) 10,000 100 (4) 46,000(5) 5,000(6) 100(7) 20,000(10) 100 2,000 (12)(11) 8,000

(8) 500 60,000 (9) 6,050

Financing:(12) Repayment of bond: $2,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash SE-Com Shares 19,500 25,000(1) 12,480 10,000 (3) 4,000(13)(2) 10,000 100 (4) 29,000(5) 5,000(6) 100(7) 20,000(10) 100 2,000 (12)(11) 8,000(13) 4,000(8) 500 60,000 (9) 6,050

Financing:(13) Issue of shares: $4,000

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash SE-Ret. Earn. 19,500 48,300

1,230 (15) (14) 1,400 12,480 (1)59,380

6,050 L-Div. Pay. 300

(15) 1,230 1,400 (14) 470

Financing: (14) Pmt. of dividends: $1,230 Declaration of dividends: $1,400

Preparation of the Cash Flow Statement (Indirect Approach)

A- Cash 19,500(1) 12,480 10,000 (3)(2) 10,000 100 (4)(5) 5,000 300 (8)(6) 100(7) 20,000(10) 100 2,000 (12)(11) 8,000 1,230 (15)(13) 4,000(8) 500 60,000 (9) 6,050

Huskies Industries Ltd.Cash Flow Statement

For the Year Ended December 31, 2001

Operating activities:

Net income $12,480

Add back items not representing cash flows:

Amortization 20,000

Gain on disposal (300)

(Continued)

Huskies Industries Ltd.Cash Flow Statement

For the Year Ended December 31, 2001Operating activities:

Adjustments for working capital items:

Decrease in Accounts Receivable 10,000

Increase in Inventory (10,000)

Increase in Prepaid Rent (100)

Increase in Accounts Payable 5,000

Increase in Salaries Payable 100

Cash from operating activities 37,180

Huskies Industries Ltd.Cash Flow Statement

For the Year Ended December 31, 2001Financing activities:

Issue of Notes Payable 100

Issue of Common Shares 4,000

Issue of Bonds Payable 8,000

Payment of Bonds Payable (2,000)

Payment of Dividends (1,230)

Cash from operating activities 8,870

Huskies Industries Ltd.Cash Flow Statement

For the Year Ended December 31, 2001

Investing activities:

Purchase of Property, Plant and

Equipment (60,000)

Sale of Property, Plant and

Equipment 500

Cash used for operating activities (59,500)

Huskies Industries Ltd.Cash Flow Statement

For the Year Ended December 31, 2001

Decrease in Cash (13,450)

Cash - beginning of the year 19,500

Cash - end of the year $ 6,050