Accounting

Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm

Prepared by:
Carole Bowman, Sheridan College
 CHAPTER

18

CASH FLOW STATEMENT

 PURPOSE OF THE
CASH FLOW STATEMENT
• The primary purpose of the cash flow
statement is to provide information about
the cash receipts and cash payments of an
entity during a period.
• A secondary objective is to provide
information about its
– Operating activities
– Investing activities
– Financing activities
 MEANING OF CASH FLOWS
• The cash flow statement is usually prepared
using cash and cash equivalents as its basis.
• Cash equivalents are short-term, highly
liquid investments that are both
1. readily convertible to known amounts of
cash, and
2. so near to their maturity that their
market value is relatively insensitive
to changes in interest rates.
 CLASSIFICATION OF CASH
FLOWS

• Operating activities
• Investing activities
• Financing activities
 OPERATING ACTIVITIES

• Include
– Cash effects of transactions that create
revenues and expenses and
– Enter into determination of net income (loss)

Balance Sheet: Noncash Current

Assets and Current Liabilities;
Income Statement Items
 INVESTING ACTIVITIES

• Include
– Purchasing and disposing of investments
and productive long-lived assets using
cash and
– Lending money and collecting the loans

Balance Sheet: Investment and

Long-Term Asset Items
 FINANCING ACTIVITIES

• Include
– Obtaining cash from issuing debt and
repaying the amounts borrowed and
– Obtaining cash from owners/shareholders
and paying them drawings/dividends

Balance Sheet: Long-Term

Liability and Equity Items
 SIGNIFICANT NONCASH
ACTIVITIES
• If it does not affect cash, do NOT report in
body of cash flow statement
• Report in separate note to the financial
statements
 ILLUSTRATION 18-2
FORMAT OF CASH FLOW STATEMENT
COMPANY NAME
Operating, investing,
Cash Flow Statement
and financing plus
Period Covered
the significant Cash flows from operating activities
noncash investing and (List of individual items) XX
financing activities Net cash provided (used) by operating activities XXX
Cash flows from investing activities
constitute the general (List of individual items) XX
format of the cash Net cash provided (used) by investing activities XXX
flow statement, an Cash flows from financing activities
example of which is (List of individual items) XX
Net cash provided (used) by financing activities XXX
shown on the right. Net increase (decrease) in cash XXX
Cash at beginning of period XXX
Cash at end of period XXX
Note x:
Noncash investing and financing activities
(List of significant noncash transactions) XXX
 PREPARING
THE CASH FLOW STATEMENT
The cash flow statement is prepared differently from
the three other basic financial statements.
1. It is not prepared from the adjusted trial balance.
2. The cash flow statement deals with cash receipts
and payments, so the accrual concept is not used in
the preparation of this statement.
The information to prepare this statement usually
comes from three sources:
1. Comparative balance sheet
2. Current income statement
3. Additional information
 ILLUSTRATION 18-3
THREE MAJOR STEPS IN PREPARING
THE CASH FLOW STATEMENT
Step 1: Determine the net increase (decrease) in cash.
The difference between the
beginning and ending cash
balances can be easily calculated + or -
from comparative balance sheets.
Step 2: Determine net cash provided (used) by operating activities.
This step involves analysing not only the current XYZ
Goods
year’s income statement but also comparative
balance sheets and selected additional data.

Step 3: Determine net cash provided (used) by investing and

financing activities.
This step involves analysing
For
comparative balance sheet data Sale Investing Financing
and selected additional information
for their effects on cash.
STEP 1: DETERMINE NET INCOME
(DECREASE) IN CASH
 STEP 2: DETERMINE NET CASH
PROVIDED (USED) BY OPERATING
ACTIVITIES
• Net income must be converted from an
accrual basis to a cash basis in the
operating activities section
• Conversion may be done by two methods:
– Indirect (used extensively in practice)
– Direct
 INDIRECT AND DIRECT METHODS

• Both methods arrive at the same total

amount of cash provided (used) by
operating activities
• Methods differ in disclosing the items
that make up the total amount
• Choice of methods affects only the
operating activities section; the investing
and financing activities sections are the
same
OPERATING ACTIVITIES –
INDIRECT METHOD

Section 1
 ILLUSTRATION 18-6
NET INCOME VS. NET CASH PROVIDED
BY OPERATING ACTIVITIES
The indirect method starts with net income and converts it to net
cash provided by operating activities. In other words, it adjusts net
income for items that affect reported net income but do not affect
cash, as shown below.
Accrual Basis of Accounting Cash Basis of Accounting

Earned Eliminate noncash revenues

Revenues

Net Cash Provided

Net Income (Used) by Operating
Activities

Incurred
Expenses
Eliminate noncash expenses
 NET INCOME TO NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
(B/S: Noncash Current Assets and Current Liabilities)

Adjustments to Convert Net Income

to Net Cash Provided (Used) by
Operating Activities
Add* Deduct*

Change in Current Asset Account Balance

Accounts receivable Decrease Increase
Inventory Decrease Increase
Prepaid expenses Decrease Increase
Other current assets Decrease Increase

Change in Current Liability Account Balance

Accounts payable Increase Decrease
Accrued expenses payable Increase Decrease
Other current liabilities Increase Decrease

* Add (deduct) change in account balance to net income

 NET INCOME TO NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
(I/S: Noncash Items)
Adjustments to Convert Net
Income to Net Cash Provided
(Used) by Operating Activities

Noncash Items on Income Statement

Amortization (of capital assets) expense Add

Amortization of bond discount to interest expense Add
Amortization of bond premium to interest expense Deduct
Loss on sale of asset Add
Gain on sale of asset Deduct
Income from long-term equity investment Deduct
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES

Indirect Method –
Sample Format

Computer Services Corporation

Cash Flow Statement - Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income 35,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable (30,000)
Increase in inventory (25,000)
Increase in accounts payable 15,000
Increase in accrued expenses payable 4,000 (36,000)
Net cash used by operating activities (1,000)
OPERATING ACTIVITIES
– DIRECT METHOD

Section 2
CASH RECEIPTS AND CASH PAYMENTS
(Direct Method)
 CASH RECEIPTS FROM
CUSTOMERS

• The relationships among cash receipts from

customers, revenues from sales, and
changes in accounts receivable is:

Cash + Decrease in accounts receivable

receipts from
customers
=
Revenues
{
from sales or
– Increase in accounts receivable
 CASH PAYMENTS TO SUPPLIERS

• The relationship among cash payments to

suppliers, cost of goods sold, changes in
inventory, and changes in accounts payable
is:
Cash
payments
to suppliers

=
+ Increase in inventory + Decrease in accounts payable
Cost of
goods sold { or
– Decrease in inventory{ or
– Increase in accounts payable
 CASH PAYMENTS FOR OPERATING
EXPENSES
• The relationship among cash payments for
operating expenses, changes in prepaid
expenses, and changes in accrued expenses
payable is:
Cash
payments
for services

=
+ Increase in prepaid + Decrease in accrued expenses
Operating
dxpenses
{ expenses
or {
– Decrease in prepaid
expenses
payable
or
– Increase in accrued expenses
payable
 CASH PAYMENTS FOR INCOME
TAX

• The relationships among cash payments for

income tax, income tax expense, and
changes in income tax payable is:

Cash
payments for
income tax
=
Income
tax
expense
{
+ Decrease in income tax payable
or
– Increase in income tax payable
 NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES

Direct Method –
Sample Format

COMPUTER SERVICES CORPORATION

Cash Flow Statement – Direct Method
For the Year Ended December 31, 2002
Cash flows from operating activities

Cash receipts from customers $120,000

Cash payments:
To suppliers ($75,000)
For operating expenses (36,000)
For income tax (10,000) (121,000)
Net cash used by operating activities (1,000)
 STEP 3: DETERMINE NET CASH
PROVIDED (USED) BY INVESTING AND
FINANCING ACTIVITIES
 NET CASH PROVIDED (USED) BY
INVESTING ACTIVITIES

• Study the balance sheet to determine changes

in investments and long-term assets
• Changes in each short-term investment
(unless incorporated as part of cash
definition) and long-term account are
analysed using selected transaction data to
determine the effect, if any, the changes had
on cash
 NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES

• Study the balance sheet to determine

changes in noncurrent liabilities and
owner’s/shareholders’ equity
• Changes in each noncurrent account are
analysed using selected transaction data
to determine the effect, if any, the
changes had on cash
 ILLUSTRATION 18-8
CASH FLOW STATEMENT
INDIRECT METHOD
COMPUTER SERVICES COMPANY
Cash Flow Statement — Indirect Method Operating
For the Year Ended December 31, 2002
Cash flows from operating activities activities used
Net income $ 35,000 $1,000 cash and
Adjustments to reconcile net income to net cash
provided by operating activities: investing
Increase in accounts receivable $ (30,000) activities used
Increase in inventory (25,000)
Increase in accounts payable 15,000 $10,000 cash,
Increase in accrued expenses payable 4,000 (36,000) while financing
Net cash used by operating activities (1,000)
Cash flows from investing activities activities
Purchase of equipment $ (10,000) provided
Net cash used by investing activities (10,000)
Cash flows from financing activities $45,000 cash.
Issue of common shares $ 60,000
Payment of cash dividend (15,000)
Net cash provided by financing activities 45,000
Net increase in cash 34,000
Cash, January 1 -
Cash, December 31 $ 34,000
 ILLUSTRATION 18-23
CASH FLOW STATEMENT
DIRECT METHOD
COMPUTER SERVICES CORPORATION
Cash Flow Statement
For the Year Ended December 31, 2002
Cash flows from operating activities
Cash receipts from customers The cash flow $120,000
Cash payments: statement
To suppliers shows that $(75,000)
For operating expenses operating (36,000)
For income tax activities used (10,000) (121,000)
Net cash provided by operating activities$1,000 cash (1,000)
Cash flows from investing activities and investing
Purchase of equipment activities used $(10,000)
Net cash used by investing activities $10,000 cash, (10,000)
Cash flows from financing activities while
Issue of common shares $ 60,000
financing
Payment of cash dividends (15,000)
activities
Net cash provided by financing activities 45,000
provided
Net increase in cash 34,000
Cash, January 1 $45,000 cash. 0
Cash, December 31 $ 34,000
 USING CASH FLOWS TO
EVALUATE COMPANY
• Liquidity
– Cash current debt coverage ratio
• Profitability
– Cash return on sales ratio
– Cash flow per share
• Solvency
– Cash total debt coverage

These ratios are cash-based instead of

accrual-based
CASH CURRENT DEBT COVERAGE
• Cash current debt coverage indicates the amount
of cash to pay off current debt that is generated
from operating activities.
• The ratio provides a better picture of liquidity
than using the current ratio because it uses cash
provided by operating activities rather than the
year-end asset balance.

Cash
Provided Average Cash
by
Operating
 Current Current
Debt
Liabilities
Activities Coverage
 CASH RETURN ON SALES
• Cash return on sales indicates how quickly
sales are turned into cash.
• The company is efficient at turning sales
into cash when its cash return on sales is
greater than its accrual-based counterpart,
the profit margin.

Cash
Provided Cash
by
Operating  Net Sales Return
on Sales
Activities
 CASH FLOW PER SHARE

• Cash flow per share indicates the cash flow

generated for each common share.

Cash Flow
from
Number of

Operating, Cash Flow per
Investing, and Common
Share
Financing Shares
Activities
 CASH TOTAL DEBT COVERAGE
• Cash total debt coverage indicates the
amount of cash to pay off total debt that is
generated from operating activities.
• The ratio is the cash based counterpart to
the debt to total assets ratio.

Cash
Provided Average

Cash Total
by Total Debt
Operating Liabilities Coverage
Activities
 COPYRIGHT

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