Chapter 10

1. Chapter 10 The Statement of Cash Flows – A Closer Look

2. Learning Objective 1 Explain the purpose of the statement of cash flows.

3. Introduction to theStatement of Cash Flows The main purpose of the statement of cash flows is to provide information about a company’s cash receipts and cash payments during a specific period. Cash flows Receipts Payments

4. a company’s ability to generate positive cash flows. a company’s need for external financing and its ability to pay debts and dividends. differences between net income and changes in cash. Introduction to theStatement of Cash Flows Cash flows Helps assess... Reconciles...

5. Learning Objective 2 Describe the three types of activities that can either generate or use cash in any business.

6. Investing activities Financing activities Basic Organization of the Statement of Cash Flows Operating activities

7. Operating Activities Operating activities are those centered on the actual day-to-day business transactions of a company.

8. Direct Method versusIndirect Method The direct method involves a series of calculations to determine the amount of cash inflow and cash outflow from each individual facet of operating activities.

9. is closely tied to accrual accounting does not attempt to provide details about individual cash inflows and outflows Direct Method versusIndirect Method The indirect method

10. Direct Method versusIndirect Method 1.2% of companies use the direct method. 98.8% of companies use the indirect method.

11. Investing Activities Investing activities are those associated with buying and selling the investments used to support the operation of the business.

12. Selling shares Borrowing Profitable operations Financing Activities External financing Internal financing Financing activities deal only with external financing.

13. Cash Inflows Cash Outflows From customers as a result of sales or rent received From interest earned From dividends received To suppliers To employees To governments To creditors To others for operating expenses Summary of the Three Business Activities Reported: Operating

14. Cash Inflows Cash Outflows Fromsale of property, plant, and equipment Fromsale of investments Fromcollecting on loans made to other companies To purchase property, plant, and equipment Topurchase debt and equity investments in other companies Making loans to others Summary of the Three Business Activities Reported: Investing

15. Cash Inflows Cash Outflows Fromselling shares of the company’s own stock Frombank loans or the sale of corporate bonds Topay dividends to stockholders To reacquire shares of the company’s own stock Torepay loans or redeem corporate bonds Summary of the Three Business Activities Reported: Financing

16. Learning Objective 3 Prepare a statement of cash flows using the indirect method for the operating activities section.

17. For the Year Ended December 31, 2004 (in thousands) Sales $15,158 Cost of goods sold 11,151 Gross margin $ 4,007 Operating expenses: Depreciation expense $ 231 Selling and administration 3,047 Total operating expenses 3,278 Operating income $ 729 Gain on sale of long-term investments 31 Less: Interest expense –160 Income before income taxes $ 600 Income tax expense 180 Net income $ 420 Tsujimoto’s Income Statement

18. December 31, 2004 and December 31, 2003 (in thousands) Assets: Current assets: Cash $ 981 $ 419 Accounts receivable 1,925 2,112 Merchandise inventory 1,022 858 Prepaid expenses 192 132 Total current assets $4,120 $3,521 Long-term investments 21 73 Plant and equipment: Equipment $1,155 $1,045 Less: Accumulated depreciation – 851 – 620 Equipment, net 304 425 Total assets $4,445 $4,019 Tsujimoto’s Comparative Balance Sheets

19. Tsujimoto’s Comparative Balance Sheets December 31, 2004 and December 31, 2003 (in thousands) Liabilities: Current liabilities: Accounts payable $ 820 $ 710 Accrued expenses 17 28 Income tax payable 25 10 Total current liabilities $ 862 $ 710 Notes payable 425 700 Bonds payable 1,100 900 Total long-term liabilities $1,525$1,600 Total liabilities $2,387 $2,348 Stockholders’ equity: Common stock, no par value $1,332 $1,228 Retained earnings 726 443 Total stockholders’ equity $2,058$1,671 Total liabilities and stockholders’ equity $4,445 $4,019

20. Additional Information During 2004, Tsujimoto’s sold some of its long-term investments for $83,000 but did not purchase any. During 2004, Tsujimoto’s purchased equipment for cash of $110,000. During 2004, Tsujimoto’s paid $137,000 cash dividends to its stockholders.

21. For the Year Ended December 31, 2004 Cash flows from operating activities: Net income $420 Adjustments to reconcile net income to net cash provided by operating activities: Net cash provided (used) by operating activities ? Cash flows from investing activities Net cash provided (used) by investing activities ? Cash flows from financing activities: Net cash provided (used) by financing activities ? Net increase (decrease) in cash during 2004 $562 Beginning cash balance January 1, 2004 419 Ending cash balance December 31, 2004 $981 Basic Format of the Statement of Cash Flows for Tsujimoto’s

22. 1 Add back depreciation expense. Add back losses and subtract gains associated with the sale of investment or property, plant, and equipment. 2 Adjust for changes in current assets and current liabilities associated with operations. 3 Cash Flow from Operating Activities for Tsujimoto’s Three basic adjustments $231,000 Gain $31,000

23. Partial Balance Sheets December 31, 2004 and December 31, 2003 (in thousands) Assets: 20042003Inc./(Dec.) Current assets: Cash $ 981 $ 419 $562 Accounts receivable 1,925 2,112 (187) Merchandise inventory 1,022 858 164 Prepaid expenses 192 132 60 Total current assets $4,120 $3,521 Current liabilities: Accounts payable $ 820 $ 710 $110 Accrued expenses 17 28 (11) Income tax payable 25 10 15 Total current liabilities $ 862 $ 748 Tsujimoto’s Current Assetsand Liabilities Sections

24. Partial Statement of Cash Flows For the Year Ended December 31, 2004 (in thousands) Cash flows from operating activities: Net income $420 Adjustments to reconcile net income to cash provided by operating activities: Depreciation expense $231 Gain on sale of long-term investments (31) Decrease in accounts receivable 187 Increase in merchandise inventory (164) Increase in prepaid expense (60) Increase in accounts payable 110 Decrease in accrued expenses (11) Increase in income taxes payable 15 277 Net cash provided by operating activities $697 Tsujimoto’s Partial Statement of Cash Flows: Operating Activities

25. Partial Balance Sheets December 31, 2004 and December 31, 2003 (in thousands) 20042003Inc./(Dec.) Long-term investments $ 21 $ 73 $ (52) Plant and equipment: Equipment 1,155 1,045 110 Less: Acc. depreciation – 851 – 620 231 Equipment, net 304 425 Total non-current assets $4,445 $4,019 Tsujimoto’s Non-Current Asset Section of Balance Sheets

26. Partial Statement of Cash Flows For the Year Ended December 31, 2004 (in thousands) Cash flows from operating activities: Net income $420 Adjustments to reconcile net income to net cash provided by operating activities $277 Net cash provided by operating activities $697 Cash flows from investing activities: Sale of long-term investment 83 Purchase of equipment (110) Net cash used by investing activities (27) Tsujimoto’s Partial Statement of Cash Flows: Investing Activities

27. Partial Balance Sheets December 31, 2004 and December 31, 2003 (in thousands) 20042003 Inc./ Long-term liabilities: (Dec.) Notes payable $ 425 $ 700 $(275) Bonds payable 1,100 900 200 Total long-term liabilities $1,525 $1,600 Stockholders’ equity: Common stock, no par value $1,332 $1,228 $ 104 Retained earnings 726 443 283 Total stockholders’ equity $2,058 $1,671 Long-Term Liabilities and Equity Sections of Balance Sheet

28. Partial Statement of Cash Flows For the Year Ended December 31, 2004 (in thousands) Net cash provided by operating activities $697 Net cash used by investing activities – 27 Cash flows from financing activities: Payment of long-term notes payable – 275 Proceeds from sale of bonds 200 Proceeds from sale of common stock 104 Payment of cash dividends – 137 Net cash used by financing activities –108 Net increase in cash during 2004 $562 Cash balance at January 1, 2004 419 Cash balance at December 31, 2004 $981 Tsujimoto’s Partial Statement of Cash Flows: Financing Activities

29. Learning Objective 4 Evaluate and use the information the statement of cash flows provides.

30. Uses of cash It shows a company’s investment during the period and how that investment was financed. How to Use theStatement of Cash Flows Cash flows Sources of cash

31. How to Use theStatement of Cash Flows Tsujimoto’s Cash Flows Year Ended December 31, 2004 Net cash provided by operating activities $ 697,000 Net cash used by investing activities $ (27,000)* Net cash used by financing activities $(108,000) *Sale of long-term investments $83 Purchase of equipment $(110)

32. 2003 2002 2001 2000 1999 1998 Net cash provided by operating activities: $150 $300 $700 $ 800 $1,200 $1,000 How to Use theStatement of Cash Flows The Downward Spiral of the Weiser Company Net cash used by investing activities: $(125) $(450) $(450) $(900) $ (900) $ (900) Net cash provided by financing activities: $ (25) $ 60 $(275) $ 150 $ (250) $ (300)

33. Operating Cash Flowto Current Debt Ratio This ratio measures the sufficiency of cash flows from operating activities to meet current obligations. Operating cash flow to current debt ratio = Cash provided by operating activities ÷ Average current liabilities Tsujimoto’s ratio for 2004: $697,000 ÷ $805,000 = 0.87 to 1

34. Operating Cash FlowCoverage Ratio This ratio indicates a company’s capacity to repay its liabilities from the net cash generated by its operating activities. Operating cash flow coverage ratio = Cash provided by operating activities ÷ Average total liabilities Tsujimoto’s ratio for 2004: $697,000 ÷ $2,367,500 = 0.29 to 1

35. Learning Objective 5 Prepare a statement of cash flows using the direct method for the operating activities section.

36. Tsujimoto’s Partial Statement of Cash Flows For the Year Ended December 31, 2004 (in thousands) Cash flows from operating activities: Cash received from customers $? Cash paid for: Merchandise inventory ? Operating expenses ? Interest ? Income taxes ? Net cash provided (used) by operating activities $? Cash Flows from Operating Activities – Direct Method

37. Cash Received from Customers Beginning accounts receivable balance $ 2,112 + Sales during 2004 15,158 = Amount that could have been collected from customers in 2004 $17,270 – Ending accounts receivable balance – 1,925 = Total cash received from customers $15,345

38. Step 1 Cost of goods sold in 2004 $11,151 – Beginning merchandise inventory – 858 = Amount of cost of goods sold purchased in 2004 $10,295 + Ending merchandise inventory balance 1,022 = Merchandise inventory purchased in 2004 $11,315 Cash Paid forMerchandise Inventory

39. Cash Paid forMerchandise Inventory Step 2 Beginning accounts payable balance $ 710 + Merchandise inventory purchased in 2004 11,315 = Amount that could have been paid to suppliers in 2004 $12,205 – Ending accounts payable balance – 820 = Total cash paid for merchandise inventory in 2004 $11,205

40. Cash Paid forOperating Expenses Operating expenses other than depreciation $3,047 – Beginning prepaid expenses balance – 132 + Ending prepaid expenses balance 192 + Beginning accrued expenses balance 28 – Ending accrued expenses balance – 17 = Total cash paid for operating expenses in 2004 $3,118

41. Cash Paid for Income Taxes Income tax expenses (from the 2004 income statement) $180 + Beginning taxes payable 10 – Ending taxes payable – 25 = Cash paid for income taxes in 2004 $165

42. Tsujimoto’s Partial Statement Of Cash Flows For the Year Ended December 31, 2004 (in thousands) Cash flows from operating activities: Cash received from customers $15,345 Cash paid for: Merchandise inventory –11,205 Operating expenses – 3,118 Interest – 160 Income taxes – 165 Net cash provided (used) by operating activities $697 Cash Flows from Operating Activities – Direct Method

43. End of Chapter 10