Statement of Cash Flows: Background, Structure, and Analysis

1. HUANGHUAI UNIVERSITY & BANGOR UNIVERSITY Lecture 9 Statement of Cash Flows DR. AZIZ JAAFAR

2. Statement of Cash Flows – Background • Required presentation since 1987 • Cash and cash equivalents • Cash on hand • Cash on deposit • Investments in short-term, highly liquid securities

3. Statement Use • Internal users • Determine dividend policy • Evaluate cash generated by operations • Review investing and financing policy • External users • Assess firm’s ability to increase dividends • Assess firm’s ability to pay debt from operations • Assess firm’s relationship of cash from operations to total cash

4. Statement Structure Cash flows from operations + Cash flows from investing activities + Cash flows from financing activities = Change in cash + Beginning cash balance = Ending cash balance Supplemental disclosure: non-cash financing and investing activities

5. Operating Activities Cash outflows for Payments for acquisitions of inventory Payments to employees Payments for taxes Payments for interest Payments for other expenses The cash effects of transactions and other events that enter into the determination of net income: Cash inflows from • Sale of goods or services • Returns on loans (interest) • Return on equity securities (dividends)

6. Investing Activities Cash inflows from Receipts for loans collected Sales of debt or equity securities Sales of plant, property, and equipment Cash outflows for Loans to other entities Investment in debt or equity securities Purchase of plant, property, and equipment Lending money and collecting on those loans and acquiring and selling investments and productive long-term assets:

7. Financing Activities Cash inflows from Sale of equity securities Sale of bonds, mortgages, notes, and other short- and long-term borrowings Cash outflows for Payment of dividends Reacquisition of capital stock Payment of amounts borrowed Borrowing and repaying long-term loans; issuing equity securities; payment of dividends to shareholders:

8. Cash Flows From Operations • Alternative presentations: • Direct method • Presents the income statement on a cash basis • Encouraged by FASB 95 • Supplemental information required: reconciliation of net income to cash provided by operations • Indirect method • Adjusts net income for items that affected net income but did not affect cash • Supplemental information required: cash paid for income taxes and for interest

9. Cash Flows From Operations:Direct Method Presents the income statement on a cash basis

10. Cash Flows From Operations:Indirect Method Adjusts net income for items that affected net income but did not affect cash

11. Cash Flows From Operations Direct Indirect

12. Cash Flows From Investing Activities

13. Cash Flows From Financing Activities

14. Statement of Cash Flows – Direct Method(supplemental disclosures not illustrated)

15. Statement of Cash Flows – Indirect Method(supplemental disclosures not illustrated)

16. Alternative Cash Flow Analysis

17. Financial Ratios and the Statement of Cash Flows • Statement of cash flows is relatively new • Required presentation began in 1987 • Cash flow financial ratios were slowly developed • Traditional ratios relate balance sheet to income statement

18. Operating Cash Flow/Current Maturities of Long-Term Debt and Current Notes Payable • Indicates a firm’s abilities to meet its current maturities of debt • Higher ratio indicates better liquidity

19. Operating Cash Flow to Total Debt • Indicates a firm’s ability to cover total debt with the yearly operating cash flow • Conservative approach is to include all possible balance sheet debt

20. Operating Cash Flow per Share • A better indication of a firm’s ability to make capital expenditure decisions and pay dividends than is earnings per share • Does not reflect firm’s profitability • Firms are prohibited from reporting this statistic in financial statements or in the notes thereto

21. Operating Cash Flow to Cash Dividends • Indicates a firm’s ability to cover cash dividends with the yearly operating cash flow

22. Alternative Cash Flow • No standard definition of cash flow • Alternative definition • Net income plus depreciation expense • Less useful than the net cash flow from operating activities

23. Procedures to Develop the Statement of Cash Flows Analyze all balance sheet accounts other than cash and cash equivalents.

24. Procedures to Develop the Statement of Cash Flows (cont’d) • Determine change in cash and cash equivalents • Compute the change in all other balance sheet accounts • Classify as operating, investing, and financing

25. Procedures to DevelopDirect Operating Cash Flows • Operating section describes income statement accounts as receipts or payments • Cash receipts • From customers • From other operating sources • Cash payments • For merchandise • To employees • For other operating expenses

26. Procedures to DevelopIndirect Operating Cash Flows • Begin with net income • Eliminate gains and losses that relate to investing and financing activities • Add back or deduct adjustments to change accrual-based net income to cash basis • Current noncash assets • Current liabilities