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Chapter 12

Chapter 12. Reporting and Interpreting the Statement of Cash Flows. Learning Objective 1. Identify cash flows arising from operating, investing, and financing activities. Ability to generate cash from its operations. Management of current assets and current liabilities.

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Chapter 12

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  1. Chapter 12 Reporting andInterpreting the Statementof Cash Flows

  2. Learning Objective 1 Identify cash flows arising from operating, investing, and financing activities.

  3. Ability to generate cashfrom its operations. Management of currentassets and current liabilities. Expenditures forlong-term assets. Amount received fromexternal financing. Business Activities and Cash Flows The statement focusesattention on:

  4. Business Activities and Cash Flows The statement helps to answer these questions: • Is there enough cash to pay short-term debt? • Are accounts receivable and inventory adequately managed? • Has the company purchased sufficient equipment and other long-term assets? • Did the company generate enough cash internally to finance the purchases, or did it rely on external financing? • Is the company changing the source of its external financing?

  5. Checking and Savings Accounts Currency Cash Equivalents • Highly liquid short-term investmentswithin three months of maturity. Business Activities and Cash Flows Cash

  6. Financing Activities Operating Activities Investing Activities Classifying Cash Flows The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95:

  7. Classifying Cash Flows

  8. Operating Activities Cash inflows and outflows that directly relate to revenues and expenses reported on the income statement.

  9. Inflowsfrom: • Sales to customers. • Interest and dividends received. + Outflowsto: • Purchase of goods for resale and services. • Salaries and wages. • Income taxes. • Interest on liabilities. _ Operating Activities Cash Flows from Operating Activities

  10. Inflowsfrom: Sale or disposal of property, plant, and equipment. Sale or maturity of investments in securities. + Outflowsto: • Purchase property, plant, and equipment. • Purchase investments in securities. _ Investing Activities Cash Flows from Investing Activities

  11. Inflowsfrom: Borrowing on notes, mortgages, bonds, etc. from creditors. Issuing stock to owners. + Outflowsto: • Repay principal to creditors (excluding interest). • Repurchase stock from owners. • Dividends to owners. _ Financing Activities Cash Flows from Financing Activities

  12. Relationships Between Balance Sheet and Cash flow Categories

  13. Relationship With OtherFinancial Statements Information needed to prepare a statement of cash flows: • Comparative Balance Sheets. • Income Statement. • Additional details concerningselected accounts.

  14. From this basic balance sheet equation, wedevelop our model to solve for the change in cash:  Cash = Liabilities Stockholders’ Equity Noncash Assets Relationship With OtherFinancial Statements Recall that the basic balance sheet equation is: Assets = Liabilities Stockholders’ Equity

  15. Learning Objective 2a Report cash flows from operating activities, using the indirect method.

  16. Changes in current assets and current liabilities. + Losses and - Gains + Noncash expenses such as depreciation and amortization. Cash Flows from Operating Activities - Indirect Method The indirect method adjusts net income by eliminating noncash items. Cash Flows from Operating Activities - Indirect Method Net Income

  17. Relationships to the Balance Sheet and the Income Statement Change in accountbalances during the year Use this table when adjusting Net Income to Operating Cash Flows using theindirect method.

  18. Statement of Cash FlowsIndirect Method Example Use the following financial statements for The Nautilus Group and prepare the Statement of Cash Flows for the year ended December 31, 2005

  19. Statement of Cash FlowsIndirect Method Example

  20. Statement of Cash FlowsIndirect Method Example

  21. The Statement of Cash Flows will begin with Nautilus, Inc.’s net income from the Income Statement. Statement of Cash FlowsIndirect Method Example

  22. Next, adjust for the non-cash items includedin net income. For Nautilus, the only non-cash adjustmentis for depreciation expense $13,079.

  23. To complete the cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period. (Remember, we showed the balance sheets a few slides earlier.)

  24. Statement of Cash Flows Indirect Method Example

  25. Learning Objective 2b Report cash flows from operating activities, using the direct method.

  26. A Comparison of the Directand Indirect Methods • Net cash flow is the same for both methods. • The direct method provides more detail about cash from operating activities. • The investing and financing sections for the two methods are identical.

  27. Direct Method Operating Activities When we prepared the operating section using the indirect method, we also arrived at net cash inflow of ($38,091). Let’s see how we arrive at these cash flows.

  28. Direct Method Operating Activities With the direct method, we convert each revenue and expense on the income statement to a cash flow.

  29. Learning Objective 3 Report cash flows from investing activities.

  30. Reporting Cash Flows from Investing Activities Short-term investments decreased by $85,319 during the year. If we could examine the detailed accounting records, we would find that Nautilus sold short-term investments and received $85,319 in cash. The sale of short-term investments is a cash inflow.

  31. Reporting Cash Flows from Investing Activities The balance sheet indicates that Equipment increased by $87,406 during the year. Nautilus purchased equipment for $87,406 cash and did not sell any equipment during the year. The equipment purchase is a cash outflow.

  32. Learning Objective 4 Report cash flows from financing activities.

  33. Reporting Cash Flows from Financing Activities Long-term debt increased by $51,466 duringthe year. Nautilus borrowed $51,466 whichis a cash inflow.

  34. Reporting Cash Flows from Financing Activities Contributed capital decreased $9,219 because Nautilus purchased common stock for cash.

  35. Reporting Cash Flows from Financing Activities Nautilus Group declared and paid cash dividends of $13,351 which is a cash outflow.

  36. Reporting Cash Flows from Financing Activities Now we can reconcile the change in cash to the ending cash balance that appears on the Balance Sheet.

  37. Noncash Investing andFinancing Activities • Required Supplemental Information: • Cash paid for taxes and interest. • Significant non-cash investing and financing activities.

  38. Learning Objective 5 Interpret cash flows from operating, investing, and financing activities using ratios.

  39. Interpreting Operating Cash Flows • Operating cash flows must be positive over the long-run for a company to be successful. • An upward trend in operating cash flows over time indicates growth and efficient operations.

  40. CapitalAcquisitionsRatio = Net Cash Flow from Operating ActivitiesCash Paid for Property, Plant, and Equipment Interpreting Investing Cash Flows A measure for determining whether a company is generatingenough cash internally to purchase long-term assets. A ratio greater than 1.0 indicates that outsidefinancing was not needed to purchase long-term assets.

  41. Interpreting Investing Cash Flows Capital expenditures vary from year to year, so three-yearaverages are more appropriate for comparisons. For the three-year period, Nautilus’ cash flow from operationshas been insufficient to finance its investment in property, plant,and equipment. Nautilus’ primary competitor generated almosttwice as much cash flow from operations as needed for its investment in property, plant, and equipment.

  42. CashCoverageRatio Net Cash Flow from Operating Activities +Interest Paid + Income Taxes PaidInterest Paid = Interpreting Financing Cash Flows A measure for determining whether a company isgenerating enough cash before the costs offinancing and taxes to cover its interest payments. A ratio greater than 1.0 indicates thatoperating cash flows are sufficient.

  43. Chapter 12Supplement A Reporting Sales of Property, Plant, and Equipment (Indirect)

  44. Reporting Sales of Property, Plant, and Equipment (PPE) (Indirect) Depreciation Expense A loss on the sale of PPE is added back to net income just as depreciation expense is added back. Adding these noncash items restores net income to what it would have been had depreciation and the loss not been subtracted at all. Loss on Saleof PPE Just the opposite is true for a gain on the sale of PPE. Subtracting the gain reverses the effect of the gain having been added to net income. Gain on Saleof PPE

  45. Chapter 12Supplement B Spreadsheet Approach (Indirect Method)

  46. Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be reported. A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked. Spreadsheet Approach(Indirect Method) Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.

  47. We begin by entering the beginning and ending balances for each account on the comparative balance sheets. The cash inflows and outflows columns will be used later to explain the changes in each account balance.

  48. Changes in balance sheet accounts are analyzed in terms of debits and credits in the top half of the spreadsheet and recorded as cash inflows and outflows in the bottom half of the spreadsheet. We will begin with operating activities.

  49. Changes in balance sheet accounts are analyzed in terms of debits and credits in the top half of the spreadsheet and recorded as cash inflows and outflows in the bottom half of the spreadsheet. Now we will complete the analysis with investing andfinancing activities.

  50. Spreadsheet Approach(Indirect Method) The top of the completed spreadsheet is shown here.

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