AGibson 12e Ch10

Chapter 10
Statement
of Cash Flows
COPYRIGHT ©2011 South-Western, a part of Cengage Learning.

Statement of Cash Flows – Background
• Required presentation since 1987
• Cash and cash equivalents

– Cash on hand
– Cash on deposit
– Investments in short-term, highly liquid securities
Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 10, Slide #2
Statement Use
• Internal (management) users

– Determine dividend policy
– Evaluate cash generated by operations
– Review investing and financing policy
• External users
– Assess firm’s ability to increase dividends
– Assess firm’s ability to pay debt from operations
– Assess firm’s relationship of cash from operations
to in relation to the cash from financing
Statement Structure
Cash flows from operations

+ Cash flows from investing activities
+ Cash flows from financing activities
= Change in cash
+ Beginning cash balance
= Ending cash balance
Supplemental disclosure: non-cash financing and

investing activities
Operating Activities
The cash effects of transactions and other

events that enter into the determination of net
income:
Cash inflows from Cash outflows for
• Sale of goods or • Payments for
services acquisitions of inventory
• Payments to employees
• Returns on loans
• Payments for taxes
(interest)
• Payments for interest
• Return on equity
• Payments for other
securities (dividends)
expenses
Investing Activities
Lending money and collecting on those loans

and acquiring and selling investments and
productive long-term assets:
• Receipts for loans • Loans to other entities
collected • Investment in debt or
• Sales of debt or equity equity securities
securities • Purchase of plant,
• Sales of plant, property, property, and
and equipment equipment
Financing Activities
Borrowing and repaying long-term loans;

issuing equity securities; payment of
dividends to shareholders:
• Sale of equity securities • Payment of dividends
• Sale of bonds, • Reacquisition of capital
mortgages, notes, and stock
other short- and long- • Payment of amounts
term borrowings borrowed
Cash Flows From Operations
• Alternative presentations:
• Direct method
– Converts the income statement from accrual basis to a cash basis
– Encouraged by FASB 95
– Supplemental information required: reconciliation of net income to
cash provided by operations
• Indirect method
– Adjusts net income for items that affected net income but did not
affect cash
– Supplemental information required: cash paid for income taxes and
for interest
Cash Flows From Operations:
Direct Method
Cash flows from operations:
Cash received from customers $ 370,000
Cash paid to suppliers and employees (310,000)
Interest received 10,000
Interest paid (net of amount capitalized) (4,000)
Income taxes paid (15,000)
Net cash provided by operations 51,000
Presents the income statement on a cash basis
Cash Flows From Operations:
Indirect Method
Net earnings $ 40,000
Provision for depreciation 6,000
Provision for allowance for doubtful accounts 1,000
Deferred income taxes 1,000
Loss on property, plant, and equipment disposals 2,000
Changes in operating assets and liabilities:
Receivables increase (2,000)
Inventories increase (4,000)
Accounts payable increase 5,000
Accrued income taxes increase 2,000
Net cash provided by operations $51,000
Adjusts net income for items that affected net income

but did not affect cash
Cash Flows From Operations
Cash received from customers $ 370,000
Cash paid to suppliers and employees (310,000)
Interest received 10,000
Interest paid (net of amount capitalized) (4,000) Direct
Income taxes paid (15,000)
Net cash provided by operations 51,000

Net earnings $ 40,000
Provision for depreciation 6,000
Provision for allowance for doubtful accounts 1,000
Deferred income taxes 1,000
Loss on property, plant, and equipment disposals 2,000
Indirect Changes in operating assets and liabilities:
Receivables increase (2,000)
Inventories increase (4,000)
Accounts payable increase 5,000
Accrued income taxes increase 2,000
Net cash provided by operations $51,000
Cash Flows From Investing Activities
Cash flows from investing activities:

Capital expenditures $ (30,000)
Proceeds from property, plant and equipment
disposals 6,000
Net cash used in investing activities (24,000)
Cash Flows From Financing Activities
Cash flows from financing activities:

Net proceeds from repayment of
commercial paper $ (4,000)
Proceeds from issuance of long-term debt 6,000
Dividends paid (5,000)
Net cash used in financing activities (3,000)
Statement of Cash Flows – Direct Method
(supplemental disclosures not illustrated)
O P E R A TIN G A C TIV ITIE S
C as h rec eived from c us tom ers $ 370,000
C as h paid to s uppliers and em ploy ees (310,000)
Interes t rec eived 10,000
Interes t paid (4,000)
Inc om e tax es paid (15,000)
N et c as h provided (us ed) by operating ac tivities 51,000
IN V E S TIN G A C TIV ITIE S
C apita l ex penditures (30,000)
P roc eeds from property , plant, and equipm ent dis pos als 6,000
N et c as h provided (us ed) by operating ac tivities (24,000)
F IN A N C IN G A C TIV ITIE S
N et proc eeds from repay m ent of c om m erc ial paper (4,000)
P roc eeds from is s uanc e of long-term debt 6,000
D ividends paid (5,000)
N et c as h provided (us ed) by financ ing ac tivities (3,000)
Inc reas e in C as h 24,000
B e ginning c as h balanc e 8,000
E nding c as h balanc e $ 32,000
Statement of Cash Flows – Indirect Method
(supplemental disclosures not illustrated)
O P E R A T IN G A C T IV IT IE S
N e t e a r n in g s $ 4 0 ,0 0 0
P r o v is io n fo r d e p r e c ia tio n 6 ,0 0 0
P r o v is io n fo r a llo w a n c e fo r d o u b tfu l a c c o u n ts 1 ,0 0 0
D e fe r r e d in c o m e ta x e s 1 ,0 0 0
L o s s o n p r o p e r ty , p la n t, a n d e q u ip m e n t d is p o s a ls 2 ,0 0 0
C h a n g e s in o p e r a tin g a s s e ts a n d lia b ilitie s :
R e c e iv a b le s in c r e a s e (2 ,0 0 0 )
In v e n to r ie s in c r e a s e (4 ,0 0 0 )
A c c o u n ts p a y a b le in c r e a s e 5 ,0 0 0
A c c r u e d in c o m e ta x e s in c r e a s e 2 ,0 0 0
N e t c a s h p r o v id e d (u s e d ) b y o p e r a tin g a c tiv itie s 5 1 ,0 0 0
IN V E S T IN G A C T IV IT IE S
C a p ita l e x p e n d itu r e s (3 0 ,0 0 0 )
P r o c e e d s fr o m p r o p e r ty , p la n t, a n d e q u ip m e n t d is p o s a ls 6 ,0 0 0
N e t c a s h p r o v id e d (u s e d ) b y o p e r a tin g a c tiv itie s (2 4 ,0 0 0 )
F IN A N C IN G A C T IV IT IE S
N e t p r o c e e d s fr o m r e p a y m e n t o f c o m m e r c ia l p a p e r (4 ,0 0 0 )
P r o c e e d s fr o m is s u a n c e o f lo n g -te r m d e b t 6 ,0 0 0
D iv id e n d s p a id (5 ,0 0 0 )
N e t c a s h p r o v id e d (u s e d ) b y fin a n c in g a c tiv itie s (3 ,0 0 0 )
In c r e a s e in C a s h 2 4 ,0 0 0
B e g in n in g c a s h b a la n c e 8 ,0 0 0
E n d in g c a s h b a la n c e $ 3 2 ,0 0 0
Alternative Cash Flow Analysis
P e rc ent
Inflow s O utflow s Inflow s O utflow s
O P E R A TIN G A C TIV ITIE S
C as h rec eived from c us tom ers $ 370,000 94%
C as h paid to s uppliers and em ploy ees $ (310,000) 84%
Interes t rec eived 10,0 00 3%
Interes t paid (4,0 00) 1%
Inc om e tax es paid (15,000) 4%
N et c as h provided (us ed) by o perating ac tivities 380,000 (329,000) 97% 89%
IN V E S TIN G A C TIV ITIE S
C apital ex penditures (30,000) 8%
P roc eeds from property , plant, and equipm ent
dis pos als 6,000 2%
N et c as h provided (us ed) by o perating ac tivities 6,000 (30,000) 2% 8%
F IN A N C IN G A C TIV ITIE S
N et pro c eeds from repay m ent of c om m erc ial paper (4,0 00) 1%
P roc eeds from is s u anc e of long-term debt 6,000 2%
D ividends paid (5,0 00) 1%
N et c as h provided (us ed) by financ ing ac tivities 6,000 (9,0 00) 2% 2%
C hanges in c as h:
Total c as h inflo w s (ou tflo w s ) 392,000 (368,000) 100% 100%
Total c as h outflow (368 ,000)
Inc reas e in C as h $ 24,0 00
Financial Ratios and the
Statement of Cash Flows
• Statement of cash flows is relatively new

– Required presentation began in 1987
• Cash flow financial ratios were slowly

developed
• Traditional ratios relate balance sheet to

income statement
Operating Cash Flow/Current Maturities of
Long-Term Debt and Current Notes Payable
Operating Cash Flow

Current Maturities of Long-Term Debt
and Current Notes Payable
• Indicates a firm’s abilities to meet its current

maturities of debt
• Higher ratio indicates better liquidity
Operating Cash Flow to Total Debt
Operating Cash Flow

Total Debt
• Indicates a firm’s ability to cover total debt with

the yearly operating cash flow
• Conservative approach is to include all

possible balance sheet debt
Operating Cash Flow per Share
Operating Cash Flow - Preferred Dividends
Diluted Weighted Average
Common Shares Outstanding
• A better indication of a firm’s ability to make

capital expenditure decisions and pay
dividends than is earnings per share
• Does not reflect firm’s profitability
– Firms are prohibited from reporting this
statistic in financial statements or in the notes
thereto
Operating Cash Flow to Cash Dividends
Operating Cash Flow
Cash Dividends
• Indicates a firm’s ability to cover cash

dividends with the yearly operating cash flow
Alternative Cash Flow
• No standard definition of cash flow
• Alternative definition
– Net income plus depreciation expense
– Less useful than the net cash flow from operating
activities
Procedures to Develop
the Statement of Cash Flows
Analyze all balance sheet accounts other than

cash and cash equivalents.
Increase Decrease
Current assets Operating outflow Operating inflow
Noncurrent assets Investing outflow Investing inflow
Current liabilities Operating inflow Operating outflow
Long-term liabilities Financing inflow Financing outflow
Stockholders’
Financing inflow Financing outflow
equity
Procedures to Develop the
Statement of Cash Flows (cont’d)
1. Determine change in cash and cash

equivalents
2. Compute the change in all other balance

sheet accounts
3. Classify as operating, investing, and

financing
Direct Operating Cash Flows
1. Operating section describes income statement

accounts as receipts or payments
2. Cash receipts
• From customers
• From other operating sources
3. Cash payments
• For merchandise
• To employees
• For other operating expenses
Indirect Operating Cash Flows
1. Begin with net income

2. Adjust net income (loss) for noncash expenses (like
depreciation expense) and noncash revenues.
3. Eliminate non cash gains and losses that relate to
investing and financing activities
4. Add back or deduct adjustments to change accrual-
based net income to cash basis
• Changes in current noncash assets
-Changes in noncash assets go in the inverse direction
of changes in cash
• Changes in current liabilities
-Changes in noncash liabilities go in the same direction
of changes in cash

AGibson 12e Ch10

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AGibson 12e Ch10

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Chapter 10

COPYRIGHT ©2011 South-Western, a part of Cengage Learning.

• Required presentation since 1987

• Cash and cash equivalents

• Internal (management) users

Cash flows from operations

Supplemental disclosure: non-cash financing and

The cash effects of transactions and other

Lending money and collecting on those loans

Borrowing and repaying long-term loans;

Presents the income statement on a cash basis

Adjusts net income for items that affected net income

Cash flows from operations:

Cash flows from investing activities:

Cash flows from financing activities:

• Statement of cash flows is relatively new

• Cash flow financial ratios were slowly

• Traditional ratios relate balance sheet to

Operating Cash Flow

• Indicates a firm’s abilities to meet its current

Operating Cash Flow

• Indicates a firm’s ability to cover total debt with

• Conservative approach is to include all

• A better indication of a firm’s ability to make

• Indicates a firm’s ability to cover cash

• No standard definition of cash flow

Analyze all balance sheet accounts other than

1. Determine change in cash and cash

2. Compute the change in all other balance

3. Classify as operating, investing, and

1. Operating section describes income statement

1. Begin with net income

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