“How Well Am I Doing?” Statement of Cash Flows

1. “How Well Am I Doing?” Statement of Cash Flows

2. Statement of Cash Flows Are cash flows sufficient to support ongoing operations? Can we meet our obligations to creditors? Why is there a difference between net income and net cash flow? Will the company have to borrow money to make needed investments? Can we pay dividends?

3. Learning Objective LO1 To classify changes in noncash balance sheet accounts as sources or uses of cash.

4. Definition of Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Currency and Bank Accounts T-bills Cash Commercial Paper Money Market Funds

5. Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Changes in Capital Stock Changes in Liabilities Dividends Paid to Stockholders Changes in Noncash Assets Net Income Net Cash Flows for a Period

6. Constructing the Statement of Cash Flows

7. Constructing the Statement of Cash Flows Increases in noncash asset accounts imply uses of cash. Example: Inventory is purchased on credit from a supplier. It is implied that cash was used to acquire the inventory.

8. Constructing the Statement of Cash Flows Increases in liability accounts imply sourcesof cash. Example: Inventory is purchased on credit from a supplier. It is implied that an increase in a payable has the effect of increasing cash available for other uses.

9. Constructing the Statement of Cash Flows Decreases in noncash assets accounts imply sourcesof cash. Example: Accounts receivable decreases when a customer pays their bill. When the customer pays the bill, the company’s cash increases.

10. Constructing the Statement of Cash Flows Decreases inliabilityaccounts implyusesof cash. Example: A company pays a note payable held by a creditor. When the payment is made, cash decreases.

11. A Simplified Statement of Cash Flows: An Example

12. A Simplified Statement of Cash Flows: An Example • Additional Information: • There was a net loss for the year of $27,000. • Depreciation charges for the year were $6,000. • During the year, Ed sold land originally costing $32,000 for $32,000. • During the year, Ed paid dividends of $3,000 to the stockholders. • Ed issued $50,000 of common stock to settle the note due to Joe Doe.

13. A Simplified Statement of Cash Flows: An Example Here is a summary of the sources of cash for Ed’s Pizza Hut.

14. A Simplified Statement of Cash Flows: An Example Here is a summary of the uses of cash for Ed’s Pizza Hut. The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.

15. A Simplified Statement of Cash Flows This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only.

16. Learning Objective LO2 To classify transactions as operating activities, investing activities, or financing activities.

17. The Full-Fledged Statement of Cash Flows: Operating Activities Operating activities are those activities that enter into the determination of net income. Transactions affecting current assets Changes in noncurrent balance sheet accounts that directly affect net income Transactions affecting current liabilities

18. The Full-Fledged Statement of Cash Flows: Investing Activities Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. Acquiring or selling property, plant and equipment Lending money to another entity and subsequently collecting on the loan Acquiring or selling investment securities

19. The Full-Fledged Statement of Cash Flows: Financing Activities The Full-Fledged Statement of Cash Flows: Financing Activities Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. Interest on debt is classified as an operating activity

20. Organization of the Full-Fledged Statement of Cash Flows Cash flows are divided into three categories.

21. Organization of the Full-Fledged Statement of Cash Flows Operating Activities Investing Activities Reconciliation of the Net Increase or Decrease in Cash with the Change in the Balance of the Cash Account Financing Activities Noncash Investing and Financing Activities

22. Operating Activities Includes those activities that enter into the determination of net income.

23. Operating Activities Sources of cash are added to net income and uses of cash are subtracted from net income.

24. Operating Activities

25. Operating Activities

26. Operating Activities Depreciation and Amortization charges are added back to net income because they are decreases in noncash assets.

27. Operating Activities Gains are subtracted from net income. Losses are added back to net income.

28. Investing Activities Includes transactions that involve the acquisition or disposal of noncurrent assets.

29. Financing Activities Includes transactions involving receipts from or payments to creditors and owners.

30. Other Issues: Gross or Net? For investing and financing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts. Example: Assume Macy’s purchases $50 million in property during the year and sells other property for $30 million. Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.

31. Operating Activities: Direct or Indirect Method? Direct Method Indirect Method Reports the cash effects of each operating activity Starts with accrual net income and converts to cash basis Two Formats for Reporting Operating Activities Note that no matter which format is used, the same amount of net cash flows from operating activities is generated.

32. Learning Objective LO3 To prepare a statement of cash flows using the indirect method to determine the net cash provided by operating activities.

33. A Full-Fledged Statement of Cash Flows: An Example Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut.

34. A Full-Fledged Statement of Cash Flows: An Example Let’s also refresh our memory regarding the following additional information. • Additional Information: • There was a net loss for the year of $27,000. • Depreciation charges for the year were $6,000. • During the year, Ed sold land originally costing $32,000 for $32,000. • During the year, Ed paid dividends of $3,000 to the stockholders. • Ed issued $50,000 of common stock to settle the note due to Joe Doe.

35. Preparing the Statement of Cash Flows: Step 1 List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings.

36. Preparing the Statement of Cash Flows: Step 2 Compute the change from the beginning balance to the ending balance for each account.

37. Preparing the Statement of Cash Flows: Step 3 { Recall that the transaction involving the Notes Payable and Common Stock was noncash. Code each entry on the worksheet as a source or use of cash.

38. Preparing the Statement of Cash Flows: Step 4 Code sources of cash as positive numbers and uses of cash as negative numbers.

39. Preparing the Statement of Cash Flows: Step 5 { We need to make an adjustment for the noncash transaction relating to Notes Payable and Common Stock. Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero.

40. Preparing the Statement of Cash Flows: Step 6 Classify each entry as operating, investing or financing activity.

41. Preparing the Statement of Cash Flows: Step 7 Copy the data from the worksheet into the Statement of Cash Flows section by section.

42. Preparing the Statement of Cash Flows: Step 8 Prepare a cash reconciliation at the bottom of the statement.

43. Preparing the Statement of Cash Flows In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity.

44. Interpretation of the Statement of Cash Flows Examine the operating activities section carefully. Ed’s Pizza Hut generated a negative cash flow from operations of $48,000. This is usually a sign of fundamental difficulties. Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.

45. Learning Objective LO4 To use the direct method to determine the net cash provided by operating activities. (Appendix 13A)

46. Appendix 13A The Direct Method of Determining the Net Cash Provided by Operating Activities

47. Computing Net Cash Provided by Operating Activities The direct method computes net cash provided by operating activities by reconstructing the income statement on a cash basis from top to bottom. Cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method.

48. Similarities and Differences in Handling Data Adjustments for accounts that affect revenue are the same in the direct method and indirect methods. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods.

49. Direct Method: Gains and Losses Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method.

50. The Direct Method: An Example Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut.