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11-1 ©2006 Prentice Hall, Inc.
11-1 ©2006 Prentice Hall, Inc.
11-1 ©2006 Prentice Hall, Inc.
11-1 ©2006 Prentice Hall, Inc.

11-1

©2006 Prentice Hall, Inc.

PREPARING & ANALYZING THE STMT OF CASH FLOWS (1

of 2)
of 2)
PREPARING & ANALYZING THE STMT OF CASH FLOWS (1 of 2)  Learning objectives  Categories

Learning objectives Categories of cash flows Accrual-basis accounting vs. cash- basis accounting Overview of statement of cash flows Statement of cash flowsindirect method

©2006 Prentice Hall, Inc.

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PREPARING & ANALYZING THE STMT OF CASH FLOWS (2

of 2)
of 2)
PREPARING & ANALYZING THE STMT OF CASH FLOWS (2 of 2)  Cash flows from operating

Cash flows from operating activitiesdirect method

Cash flows from investing and financing activities

Preparing the statement of cash flows Financial statement analysis Business risk, control, and ethics

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©2006 Prentice Hall, Inc.

Learning Objectives (1 of 4)
Learning Objectives
(1 of 4)

Categorize cash flows as operating, investing, or financing cash flows

Explain the difference between accrual-basis and cash-basis

accounting

Explain the difference between the two methods of preparing and presenting the statement of cash

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Learning Objectives (2 of 4)
Learning Objectives
(2 of 4)

Compute cash from operating activities using the indirect method

Compute cash from operating activities using the direct method

Compute cash from investing activities and cash from financing activities

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Learning Objectives (3 of 4)
Learning Objectives
(3 of 4)

Prepare a complete statement of cash flows and know the required supplemental disclosures

Use the statement of cash flows to help evaluate a firm’s past and

future performance

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Learning Objectives (4 of 4)
Learning Objectives
(4 of 4)

Identify the risk of investing in a given firm by using the statement of cash flows and the related controls

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Categories of Cash Flows (1 of 3)
Categories of Cash Flows
(1 of 3)

Cash flow

Inflows and outflows that result from transactions

Cash account must increase or decrease

Operating activities

Cash receipts and cash disbursements from revenues and

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expenses

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Categories of Cash Flows (2 of 3)
Categories of Cash Flows
(2 of 3)

Investing activities

Cash receipts and disbursements that result from purchasing or selling long-

term assets or investments in other

firms

Financing activities

Cash receipts and disbursements from long-term debt and equity transactions

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©2006 Prentice Hall, Inc.

Categories of Cash Flows (3 of 3)
Categories of Cash Flows
(3 of 3)

Financing activities (continued)

Debt

Issuing debt Repaying debt

Interest expense results from financing activities because it arises from debt financing. Why is it reported in the operating section?

Equity

Receiving contributions from owners Paying dividends to owners

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Accrual-basis Accounting vs. Cash-basis Accounting (1 of 2)

Accrual-basis Accounting vs. Cash-basis Accounting (1 of 2)  Must convert from accrual-basis accounting (GAAP) to
Accrual-basis Accounting vs. Cash-basis Accounting (1 of 2)  Must convert from accrual-basis accounting (GAAP) to
Accrual-basis Accounting vs. Cash-basis Accounting (1 of 2)  Must convert from accrual-basis accounting (GAAP) to

Must convert from accrual-basis accounting (GAAP) to cash-basis accounting to prepare statement of

cash flows Accrual-basis accounting

Revenues recorded when earned and expenses recorded when incurred

Timing of cash receipt is irrelevant

©2006 Prentice Hall, Inc.

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Accrual-basis Accounting vs. Cash-basis Accounting (2 of 2)

Accrual-basis Accounting vs. Cash-basis Accounting (2 of 2)  Cash-basis accounting  Revenues recorded when cash
Accrual-basis Accounting vs. Cash-basis Accounting (2 of 2)  Cash-basis accounting  Revenues recorded when cash
Accrual-basis Accounting vs. Cash-basis Accounting (2 of 2)  Cash-basis accounting  Revenues recorded when cash

Cash-basis accounting

Revenues recorded when cash received and expenses recorded cash paid

Timing of revenue and expense recognition is irrelevant

Convert from accrual basis to cash basis

Accounts payable (assume for inventory)

Beg bal $1,200; End bal $400; purch $36,300

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Compute cash paid

©2006 Prentice Hall, Inc.

Overview of the Statement of Cash Flows (1 of 3)

Overview of the Statement of Cash Flows (1 of 3)  Operating activities  Direct method
Overview of the Statement of Cash Flows (1 of 3)  Operating activities  Direct method

Operating activities

Direct method

Cash inflows and outflows explicitly identified Analyzes every item on income statement

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Overview of the Statement of Cash Flows (2 of 3)

Overview of the Statement of Cash Flows (2 of 3)  Operating activities (continued)  Indirect
Overview of the Statement of Cash Flows (2 of 3)  Operating activities (continued)  Indirect

Operating activities (continued)

Indirect method

Reconciles net income and cash flow Starts with net income Makes adjustments for income statement items that do not affect cash Adjust for changes in current assets and current liabilities Ends with net cash flow

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©2006 Prentice Hall, Inc.

Overview of the Statement of Cash Flows (3 of 3)

Overview of the Statement of Cash Flows (3 of 3)  Investing and financing activities 
Overview of the Statement of Cash Flows (3 of 3)  Investing and financing activities 

Investing and financing activities

Same presentation for both direct and indirect methods

Cash flows for each activity directly identified

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Statement of Cash FlowsIndirect Method

Statement of Cash Flows — Indirect Method  Used by 90% of companies. Why?  Financial
Statement of Cash Flows — Indirect Method  Used by 90% of companies. Why?  Financial

Used by 90% of companies. Why? Financial statements needed

Current year income statement Beginning and ending balance sheet

Steps to calculate operating cash flows

Cash flow indirect method example

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©2006 Prentice Hall, Inc.

Steps to Calculate Operating Cash Flows (1 of 2)

Steps to Calculate Operating Cash Flows (1 of 2) 1. Start with net income 2. Add
  • 1. Start with net income

  • 2. Add back non-cash expenses such as depreciation

    • Undo the effect of non-cash expenses

  • 3. Adjust for changes in current assets

    • Increase (decrease) in account should be subtracted from (added to) net income to arrive at cash balance.

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Why?

©2006 Prentice Hall, Inc.

Steps to Calculate Operating Cash Flows (2 of 2)

Steps to Calculate Operating Cash Flows (2 of 2) 4. Adjust for changes in current liabilities
  • 4. Adjust for changes in current

liabilities

  • Increase (decrease) in account should

be added to (subtracted from) net

income to arrive at cash balance. Why?

©2006 Prentice Hall, Inc.

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Cash Flow Indirect Method Example (1 of 4)

Cash Flow Indirect Method Example (1 of 4) Cost of Goods Sold Sales Revenues Depreciation Expense

Cost of Goods Sold

Sales Revenues

Depreciation Expense

Interest Expense

Salary Expense

Gross M argin

N et Income

$ 50,000

105,000

5,000

$ 500,000

284,000

216,000 160,000 56,000 $

216,000

160,000

56,000

$

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Cash Flow Indirect Method Example (2 of 4)

Cash Flow Indirect Method Example (2 of 4) Beginning Ending Cash $ 37,500 $ 75,000 Accounts
 

Beginning

 

Ending

Cash

$

37,500

$

75,000

Accounts Receivable, net

17,000

13,000

Inventory

27,000

20,000

Prepaid Insurance

-

12,000

Prepaid Rent

28,000

4,000

Total Current Assets

109,500

124,000

Equip, net of $75K & $125K Accum Depr

175,000

193,000

Total Assets

$ 284,500

$

317,000

 

©2006 Prentice Hall, Inc.

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Cash Flow Indirect Method Example (3 of 4)

Cash Flow Indirect Method Example (3 of 4) Unearned Revenue Accounts Payable Interest Payable Total Liabilities

Unearned Revenue

Accounts Payable

Interest Payable

Total Liabilities and Equity

Long-term N otes Payable

Total Current Liabilities

Retained Earnings

Common Stock

Beginning Ending 4,000 4,250 9,000 4,375 3,125 1,500 $ $
Beginning
Ending
4,000
4,250
9,000
4,375
3,125
1,500
$
$
$ 317,000 $ 284,500 245,625 189,625 40,000 40,000 45,000 15,000 14,875 11,375

$ 317,000

$ 284,500

245,625

189,625

40,000

40,000

45,000

15,000

14,875

11,375

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Cash Flow Indirect Method Example (4 of 4)

Cash Flow Indirect Method Example (4 of 4) + / - N et income Depreciation expense

+ / -

 

N et income

Depreciation expense

Decrease in accounts receivable

Decrease in inventory

Increase in prepaid insurance

Decrease in prepaid rent

Decrease in accounts payable

Decrease in unearned revenue

Increase in interest payable

N et cash from operating activities

 

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©2006 Prentice Hall, Inc.

Cash Flows from Operating ActivitiesDirect Method (1 of 6)

Cash Flows from Operating Activities — Direct Method (1 of 6)  Changing revenues from accrual
Cash Flows from Operating Activities — Direct Method (1 of 6)  Changing revenues from accrual

Changing revenues from accrual basis to cash basis

Accounts receivable

Beginning balance (balance sheet)

+ Sales (income statement)

  • - Cash collected from customers

(compute)

Ending balance (balance sheet)

©2006 Prentice Hall, Inc.

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Cash Flows from Operating ActivitiesDirect Method (2 of 6)

Cash Flows from Operating Activities — Direct Method (2 of 6)  Changing expenses from accrual
Cash Flows from Operating Activities — Direct Method (2 of 6)  Changing expenses from accrual

Changing expenses from accrual basis to cash basis

Cost of goods sold

Inventory account Beginning inventory (balance sheet) + Purchases (compute)

  • - Cost of goods sold (income statement)

Ending balance (balance sheet)

©2006 Prentice Hall, Inc.

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Cash Flows from Operating ActivitiesDirect Method (3 of 6)

Cash Flows from Operating Activities — Direct Method (3 of 6)  Cost of goods sold
Cash Flows from Operating Activities — Direct Method (3 of 6)  Cost of goods sold

Cost of goods sold (continued)

Accounts payable Beginning balance (balance sheet)

+ Purchases (from inventory computation)

  • - Cash paid to vendors (compute)

Ending balance (balance sheet)

©2006 Prentice Hall, Inc.

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Cash Flows from Operating ActivitiesDirect Method (4 of 6)

Cash Flows from Operating Activities — Direct Method (4 of 6)  Changing expenses from accrual
Cash Flows from Operating Activities — Direct Method (4 of 6)  Changing expenses from accrual

Changing expenses from accrual basis to cash basis (continued)

Rent expense

Prepaid rent Beginning balance (balance sheet) + Cash paid for rent (compute)

  • - Rent expense (income statement) Ending balance (balance sheet)

©2006 Prentice Hall, Inc.

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Cash Flows from Operating ActivitiesDirect Method (5 of 6)

Cash Flows from Operating Activities — Direct Method (5 of 6)  Changing expenses from accrual
Cash Flows from Operating Activities — Direct Method (5 of 6)  Changing expenses from accrual

Changing expenses from accrual basis to cash basis (continued)

Interest expense

Interest payable Beginning balance (balance sheet) + Interest expense (income statement)

  • - Cash paid for interest (compute)

Ending balance (balance sheet)

©2006 Prentice Hall, Inc.

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Cash Flows from Operating ActivitiesDirect Method (6 of 6)

Cash Flows from Operating Activities — Direct Method (6 of 6) Use the information provided earlier
Cash Flows from Operating Activities — Direct Method (6 of 6) Use the information provided earlier

Use the information provided earlier

Cash collected from customers

Cash paid to employees

Cash paid for insurance

Cash paid to vendors

Cash paid for interest

Cash paid for rent

N et cash from operating activities

Use the information provided earlier Cash collected from customers Cash paid to employees Cash paid for

©2006 Prentice Hall, Inc.

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Cash Flows from Investing and Financing Activities (1 of 3)

Cash Flows from Investing and Financing Activities (1 of 3)  Investing cash flows  Equipment
Cash Flows from Investing and Financing Activities (1 of 3)  Investing cash flows  Equipment
Cash Flows from Investing and Financing Activities (1 of 3)  Investing cash flows  Equipment

Investing cash flows

Equipment purchases/disposals require the following accounts

Asset account (beg & end) Accumulated depreciation (beg & end) Depreciation expense (current)

©2006 Prentice Hall, Inc.

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Cash Flows from Investing and Financing Activities (2 of 3)

Cash Flows from Investing and Financing Activities (2 of 3)  Financing cash flows  Debt
Cash Flows from Investing and Financing Activities (2 of 3)  Financing cash flows  Debt
Cash Flows from Investing and Financing Activities (2 of 3)  Financing cash flows  Debt

Financing cash flows

Debt financing

Need to analyze changes in long-term liability accounts

Equity financing

Additional capital contributions

Common and preferred stock accounts

Dividends

Retained earnings and current net income

©2006 Prentice Hall, Inc.

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Cash Flows from Investing and Financing Activities (3 of 3)

Cash Flows from Investing and Financing Activities (3 of 3) Use the information provided earlier Financing
Cash Flows from Investing and Financing Activities (3 of 3) Use the information provided earlier Financing
Cash Flows from Investing and Financing Activities (3 of 3) Use the information provided earlier Financing

Use the information provided earlier

Use the information provided earlier
Use the information provided earlier
Use the information provided earlier
Financing Activities N et cash used by financing activities Proceeds from issue of new stock Repayment

Financing Activities

N et cash used by financing activities

Proceeds from issue of new stock

Repayment of note payable

Financing Activities N et cash used by financing activities Proceeds from issue of new stock Repayment
Financing Activities N et cash used by financing activities Proceeds from issue of new stock Repayment

N et cash used by investing activities

Purchase of equipment

Investing Activities

Financing Activities N et cash used by financing activities Proceeds from issue of new stock Repayment
Financing Activities N et cash used by financing activities Proceeds from issue of new stock Repayment
Financing Activities N et cash used by financing activities Proceeds from issue of new stock Repayment
Use the information provided earlier Financing Activities N et cash used by financing activities Proceeds from

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©2006 Prentice Hall, Inc.

Preparing the Statement of Cash Flows (1 of 3)

Preparing the Statement of Cash Flows (1 of 3)  Prepare operating, investing, and financing sections
Preparing the Statement of Cash Flows (1 of 3)  Prepare operating, investing, and financing sections
Preparing the Statement of Cash Flows (1 of 3)  Prepare operating, investing, and financing sections

Prepare operating, investing, and financing sections

Supplementary disclosures

Noncash financing and investing activities Cash paid for interest expense and income taxes

Broken out in supplementary disclosures because usually part of subtotals

©2006 Prentice Hall, Inc.

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Preparing the Statement of Cash Flows (2 of 3)

Preparing the Statement of Cash Flows (2 of 3)  Add beginning cash to sum of
Preparing the Statement of Cash Flows (2 of 3)  Add beginning cash to sum of
Preparing the Statement of Cash Flows (2 of 3)  Add beginning cash to sum of

Add beginning cash to sum of operating, investing, and financing activities to get ending cash balance

Reconciles cash account on balance sheet

Which financial statement is easier to manipulate, the statement of cash flows or the income statement? Why?

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©2006 Prentice Hall, Inc.

Preparing the Statement of Cash Flows (3 of 3)

Preparing the Statement of Cash Flows (3 of 3) Cash at end of year Cash at
Preparing the Statement of Cash Flows (3 of 3) Cash at end of year Cash at
Preparing the Statement of Cash Flows (3 of 3) Cash at end of year Cash at
Cash at end of year Cash at beginning of year N et cash used by financing
Cash at end of year
Cash at beginning of year
N et cash used by financing activities
N et cash used by investing activities
N et cash provided by operations
Use the information provided earlier
Cash at end of year Cash at beginning of year N et cash used by financing

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Financial Statement Analysis

Financial Statement Analysis  Using cash flows to evaluate performance  Free cash flow  Cash

Using cash flows to evaluate performance

Free cash flow Cash flow adequacy ratio Cash needed to pay current liabilities

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Free Cash Flow

Free Cash Flow Net cash from operating activities - Cash dividends - Capital expenditures Free cash

Net cash from operating activities

  • - Cash dividends

  • - Capital expenditures Free cash flow

_

Why does a company need positive free-cash flow?

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Cash Flow Adequacy Ratio

Cash Flow Adequacy Ratio  Measures the firm’s ability to generate enough cash from operating activities

Measures the firm’s ability to generate enough cash from operating activities to pay for its capital expenditures

Net cash from operating activities _ Cash required for investing activities

Cash required for investing activities

Cash paid for capital expenditures and acquisitions minus cash proceeds from disposal

of capital assets

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Cash Needed to Pay Current Liabilities (1 of 2)

Cash Needed to Pay Current Liabilities (1 of 2)  Current cash debt coverage ratio 

Current cash debt coverage ratio

Measures a firm’s ability to generate the cash it needs in the short-run

A liquidity measure

Net Cash Provided by Operations Average Current Liabilities

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Cash Needed to Pay Current Liabilities (2 of 2)

Cash Needed to Pay Current Liabilities (2 of 2)  How does current cash debt coverage

How does current cash debt coverage ratio differ from other liquidity measures previously discussed?

Current ratio Quick ratio Working capital

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Business Risk, Control, and

Ethics
Ethics
Business Risk, Control, and Ethics  Investors’ risks associated with statement of cash flows  Investors

Investors’ risks associated with statement of cash flows

Investors look for positive cash flows from operations

How could a company manipulate operating cash flows?

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Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth
Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at

University of Northern Colorado’s

Kenneth W. Monfort College of Business

richard.newmark@PhDuh.com

©2006 Prentice Hall, Inc.

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