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Understanding Cash Flow Statements: Reporting and Analysis

Learn the essentials of the Statement of Cash Flows, its sections, and key concepts. Walk through operating, investing, and financing activities, and analyze cash flows using T-accounts.

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Understanding Cash Flow Statements: Reporting and Analysis

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  1. CHAPTER 14 Statement ofCash Flows

  2. Operating Activities Investing Activities Financing Activities Reporting Format for the Statement of Cash Flows The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95:

  3. Inflows • Receipts from sales. • Commissions and fees. • Interest and dividends received. Outflows • Payments for inventory. • Salaries and wages. • Operating expenses • Interest on liabilities. • Taxes. Cash Flows fromOperating Activities Cash Flows from Operating Activities

  4. Inflows Selling property, plant, and equipment. Selling investment securities. Collecting loans. Outflows • Purchasing property, plant, and equipment. • Purchasing investment securities. • Lending to others. Cash Flows fromInvesting Activities Cash Flows from Investing Activities

  5. Inflows Borrowing. Issuing stock. Outflows • Repaying debt (excluding interest). • Purchasing treasury stock. • Paying dividends. Cash Flows fromFinancing Activities Cash Flows from Financing Activities

  6. Noncash Investing and Financing Transactions • Significant noncash investing and financing transactions must be reported separately. • Example: Issuing common stock in exchange for land.

  7. Cash Flows fromOperating Activities Cash flows from operating activities can be prepared using either the direct method or the indirect method. Let’s look at the direct methodfirst.

  8. Accrual basis revenue includes sales that did not result in cash inflows. Cash received from customers can be computed as follows: Converting from Accrual to Cash-Basis Accounting Decrease in receivables + = Cash received from customers Net sales Increase in receivables – =

  9. Converting from Accrual to Cash-Basis Accounting We will use T-accounts toanalyze changes in accounts. Let’s look at an example. The Accounts Receivable balance was $1,200 on 12/31/04 and $1,000 on 12/31/05. If accrual Sales Revenue for 2005 was $20,600, what were cash receipts from sales?

  10. $1,200 + $20,600 - $1,000 Converting from Accrual to Cash-Basis Accounting Accounts Receivable 12/31/04 Balance Cash receipts = Accrual Sales Revenue $20,800 12/31/05 Balance The Accounts Receivable balance was $1,200 on 12/31/04 and $1,000 on 12/31/05. If accrual Sales Revenue for 2005 was $20,600, what were cash receipts from sales?

  11. Converting from Accrual to Cash-Basis Accounting Now let’s use T-account analysis for a liability account with anaccrued expense. The Salaries Payable balance was $900 on 12/31/04 and $1,000 on 12/31/05. If accrued Salaries Expense for 2005 was $2,700, what amount of cash was paid for salaries?

  12. $900 + $2,700 - $1,000 Converting from Accrual to Cash-Basis Accounting Salaries Payable 12/31/04 Balance Accrued Salaries Expense Cash payments = $2,600 12/31/05 Balance The Salaries Payable balance was $900 on 12/31/04 and $1,000 on 12/31/05. If accrued Salaries Expense for 2005 was $2,700, what amount of cash was paid for salaries?

  13. Direct Method Now that we have seen the T-account method of analysis, let’s use it to prepare a Direct MethodStatement of Cash Flows for New South Corporation. We will begin with by analyzing changes in balance sheet accounts.

  14. Direct Method Additional Information • The corporation sold equipment for $300 cash during the year. The equipment had an original cost of $1,500 and accumulated depreciation of $1,100 at the time of sale. • The corporation issued a $2,500 mortgage note in exchange for land during the year. • There was a $1,500 cash dividend paid during the year. Let’s get started analyzing the accounts. First, we willreview the T-account analysis that we completed earlier.Then we will analyze the remaining balance sheet accounts starting with the current accounts.

  15. Salaries Payable 12/31/04 Balance Accrued salaries expense Cash Payments = $2,600 12/31/05 Balance Accounts Receivable 12/31/04 Balance Cash receipts = $20,800 Accrual sales revenue 12/31/05 Balance

  16. Accounts Payable 12/31/04 Balance Purchases Cash Payments = 12/31/05 Balance Inventory 12/31/04 Balance Cost of Goods Sold Purchases = $11,200 12/31/05 Balance $11,500

  17. Interest Payable 12/31/04 Balance Interest Expense Cash payment = 12/31/05 Balance Interest Receivable 12/31/04 Balance Cash receipts = $600 Interest Revenue 12/31/05 Balance $600

  18. Unearned Rent 12/31/04 Balance Rent Revenue Cash receipt = 12/31/05 Balance Prepaid Insurance 12/31/04 Balance Cash payment = $300 Insurance Expense 12/31/05 Balance $1,400

  19. Other Operating Expenses Payable 12/31/04 Balance Cash payment = $1,200 Other Operating Expenses 12/31/05 Balance Now that we have analyzed the current accounts and found the cash receipts and cash payments related to operations, we are ready to prepare the Cash Flow from Operating Activities portion of the Statement of Cash Flows.

  20. Cash Flow fromOperating Activities

  21. Direct Method Now, let’s continue to use the T-account analysis for the remaining noncurrent balance sheet accounts.

  22. Land 12/31/04 Balance Mortgage issued for land = 12/31/05 Balance Marketable Securities 12/31/04 Balance Cash paid = $1,600 12/31/05 Balance $2,500

  23. Equipment Equipment sale 12/31/04 Balance Cash paid for equipment = $2,300 12/31/05 Balance After completing the analysis of noncurrentassets, we are ready to prepare the CashFlow from Investing Activities portionof the Statement of Cash Flows.

  24. Cash Flow fromInvesting Activities Next, we will analyze noncurrent liabilities and equity so that we can prepare the Cash Flow from Financing Activities portion of the Statement of Cash Flows.

  25. Bonds Payable 12/31/04 Balance Cash paid to retire bonds = 12/31/05 Balance Mortgage Payable 12/31/04 Balance Mortgage issued for Land = $2,500 12/31/05 Balance $3,000

  26. Common Stock 12/31/04 Balance Cash received from stocksale = $2,000 12/31/05 Balance After completing the analysis of noncurrentliabilities and equity, we are ready to prepare the Cash Flow from Financing Activitiesportion of the Statement of Cash Flows.

  27. Third item of additional information. Cash Flow fromFinancing Activities Next, we will put the three sections together to completethe Statement of Cash Flows.

  28. Notice that the Ending Cash Balance on the Statement of Cash Flows agrees with the 12/31/05 Cash balance on the Balance Sheet.

  29. Indirect Method Now let’s look at theIndirect Methodthat is used by over 95% of all companies.

  30. 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.

  31. Indirect Method Changes in current assets and current liabilities as shown on the following table. Cash Flows from Operating Activities Net Income + Losses and - Gains + Noncash expenses such as depreciation and amortization.

  32. Indirect Method Use this table when adjusting Net Incometo Cash Flow from Operations.

  33. Indirect Method We will use the Indirect Methodto prepare the Cash Flows from Operating Activities for the New South Corporation. First, we will review the Balance Sheet and Income Statement for New South Corporation.

  34. The Indirect Method begins with Net Income, which is then adjusted for the non-cash items included in net income. For New South Corporation, the only non-cash items are depreciation and a loss.

  35. To complete the Cash Flow 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.)

  36. Statement of Cash Flows Indirect Method Example

  37. Remember that when we prepared the operating section using the Direct Method, we also arrived at Net Cash Flow from Operating Activities of $6,600.

  38. Indirect Method Because the investingand financing sectionsare identical with eithermethod of preparation, we will not repeatthose sections of thestatement.

  39. The Financial Analyst A rapidly growingcompany might be short ofcash in spite of largereported net income. Because accruals anddeferrals affect operating income,cash flow from operating activitiesmay be stable thanoperating income.

  40. Ability to generate cashfrom its operations. Management of currentassets and current liabilities. Expenditures forlong-term assets. Amount received fromexternal financing. The Financial Analyst The statement focusesattention on:

  41. End of Chapter 14

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