Chapter 12

Reporting and Analyzing Cash Flows

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2010

C1

Purpose of the Statement of Cash Flows
How does a company obtain its cash? Where does a company spend its cash?

What explains the change in the cash balance?

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2010

C1

Importance of Cash Flows
Does the business have sufficient cash to pay its debts as they mature?

How did the business fund its operations?

Did the business make any dividend payments?

Did the business borrow any funds or repay any loans?

McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2010

highly liquid investments. Sufficiently close to maturity so that market value is unaffected by interest rate changes. © The McGraw-Hill Companies. 2010 McGraw-Hill/Irwin ..C1 Measurement of Cash Flows Cash Equivalents Cash Currency    Short-term. Readily convertible into cash. Inc.

C2 Classifying Cash Flows ‡ ‡ ‡ The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities © The McGraw-Hill Companies. 2010 McGraw-Hill/Irwin . Inc..

2010 . Inc.C2 Operating Activities Examples of Inflows ‡ ‡ ‡ Receipts from customers Cash dividends received Interest from borrowers Examples of Outflows ‡ ‡ ‡ ‡ McGraw-Hill/Irwin Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders © The McGraw-Hill Companies..

C2 Investing Activities Examples of Inflows ‡ ‡ ‡ ‡ ‡ ‡ Selling long-term productive assets Selling equity investments Collecting principal on loans Examples of Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments © The McGraw-Hill Companies. 2010 McGraw-Hill/Irwin . Inc..

C2 Financing Activities Examples of Inflows ‡ ‡ ‡ Issuing its own equity securities Issuing bonds and notes Issuing short. 2010 McGraw-Hill/Irwin . Inc..and long-term liabilities Examples of Outflows ‡ ‡ ‡ ‡ Pay cash dividends Purchasing treasury stock Repaying cash loans Paying owners¶ withdrawals © The McGraw-Hill Companies.

Inc. 2010 .C2 Classification of Cash Flow Items Operating Interest received Dividends received Interest paid Dividends paid Yes Yes Yes Yes Investing Yes Yes Yes Yes Financing McGraw-Hill/Irwin © The McGraw-Hill Companies..

C3 Noncash Investing and Financing Items requiring separate disclosure include: Retirement of debt by issuing equity securities. 2010 ‡ ‡ ‡ McGraw-Hill/Irwin . Leasing of assets in a capital lease transaction. © The McGraw-Hill Companies. Conversion of preferred stock to common stock. Inc..

2010 . Inc.C4 Format of the Statement of Cash Flows Company Name Statement of Cash Flows For Period Ended Date Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites Cash flows from investing activities: [List of individual inflows and outflows] Net cash provided (used) by investing activites Cash flows from financing activities: [List of individual inflows and outflows] Net cash provided (used) by financing activites Net increase (decrease) in cash Cash (and equivalents) balance at beginning of period Cash (and equivalents) balance at end of period $ ##### ##### ##### $ ##### ##### $ ##### McGraw-Hill/Irwin © The McGraw-Hill Companies..

Inc.C4 Format of the Statement of Cash Flows There are two acceptable methods to determine Cash Flows from Operating Activities: ‡Direct Method ‡Indirect Method McGraw-Hill/Irwin © The McGraw-Hill Companies.. 2010 .

P1 Preparing the Statement of Cash Flows Let¶s look at the Indirect Method for preparing the Cash Flows from Operating Activities section. Inc. 2010 .. McGraw-Hill/Irwin © The McGraw-Hill Companies.

Inc.. 2010 McGraw-Hill/Irwin .P1 Relationship to the Accounting Equation Assets = Liabilities  Equity Cash + = Noncash Assets Liabilities Equity = _ Liabilities + Equity Cash Changes in Cash Account + Noncash Assets Changes in Noncash Accounts © The McGraw-Hill Companies.

to go from its Income to Cash: Income ± Increase in AR = 80 ± 100 = (20) .P1 ACCRUAL AND CASH: BASIC IDEAS 1st year of operations: Scenario 1 Company A all cash sales and cash payments of expenses Company B all credit sales and cash payments of expenses Dr Cash 100 Cr Rev 100 Dr Exp 20 Cr Cash 20 Income Cash = 80 = 80 Dr AR 100 Cr Rev 100 Dr Exp 20 Cr Cash 20 Income Cash = 80 = (20) For company B.

P1 ACCRUAL AND CASH: BASIC IDEAS 1st year of operations: Scenario 2 Company A all cash sales and cash payments of expenses Company B all cash sales and accrued expenses Dr Cash 100 Cr Rev 100 Dr Exp 20 Cr Cash 20 Income Cash = 80 = 80 Dr Cash 100 Cr Rev 100 Dr Exp 20 Cr Payable 20 Income Cash = 80 = 100 For company B. to go from its Income to Cash: Income + Increase in Payable = 80 + 20 = 100 .

2010 ..P2 Indirect Method Change in Account Balance During Year Increase Decrease Subtract from Add to income income Add to income Subtract from income Current Assets Current Liabilities Use this table when adjusting Income or Profit to Operating Cash Flows. McGraw-Hill/Irwin © The McGraw-Hill Companies. Inc.

. Inc. Income before taxes + Losses and . 2010 . Cash Flows from Operating Activities Most companies use the indirect method. McGraw-Hill/Irwin © The McGraw-Hill Companies.Gains + Noncash expenses such as depreciation and amortization.P2 Indirect Method Changes in current assets and current liabilities.

.500 during the year and Accounts Payable increased by $10. reports $125. Inc. What is East.000. 2010 . Inc. Inc. 2010. East reported $12. During 2010.000 income before taxes for the year ended December 31.¶s Operating Cash Flow for 2010? McGraw-Hill/Irwin © The McGraw-Hill Companies. Accounts Receivable increased by $7.500 of Depreciation Expense.P2 Indirect Method Example    East.

2010 ..P2 Indirect Method Example Income before taxes Net income $ 125.000 For the indirect Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable method. activities activities McGraw-Hill/Irwin © The McGraw-Hill Companies. Inc. start with income before Cash provided by operating Cash provided by operating taxes.000 $ 125.

activities $ 125.500 activities McGraw-Hill/Irwin © The McGraw-Hill Companies.000 12.000 $ 125.. Inc. or badoperating Cash provided by operating Cash provided by debt expense.P2 Indirect Method Example Income before taxes Income before taxes Add: Depreciation expense Add: Depreciation expense Deduct: Increase in accounts Deduct: Increase in accounts receivable Add noncash receivable expenses such as depreciation. 2010 . amortization.500 12. depletion.

P2 Indirect Method Example Income before taxes Income before taxes Add: Depreciation expense Add: Depreciation expense Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable $ 125.000 12.000 $ 125. 2010 .500) Change in operating Cash provided byAccount Balance During Year Increase Decrease activities Subtract from Current Add to income Assets Current Liabilities income Add to income Subtract from income McGraw-Hill/Irwin © The McGraw-Hill Companies.500 12..500) (7. Inc.500 (7.

.000 Cash provided by in Account Balance During Year Change operating activities Increase Decrease Current Assets Current Liabilities Subtract from income Add to income Add to income Subtract from income © The McGraw-Hill Companies.500) receivable (7. Inc.000 Add: Increase in accounts payable Add: Increase in accounts payable 10.P2 Indirect Method Example Income before taxes $ 125.500 Add: Depreciation expense 12.000 Income before taxes $ 125. 2010 McGraw-Hill/Irwin .000 Add: Depreciation expense 12.500) 10.500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7.

Inc.500 Add: Depreciation expense 12.500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7.500) Add: Increase in accounts payable 10.000 Add: Increase in accounts payable 10.000 activities $ 140.500) receivable (7.000 Income before taxes $ 125.000 McGraw-Hill/Irwin © The McGraw-Hill Companies.000 Add: Depreciation expense 12.P2 Indirect Method Example Income before taxes $ 125.000 Cash generated by operating Cash provided from operations $ 140. 2010 ..

Since interest and dividend income are added to derive income amount. Dividend revenue and income taxes paid Interest and dividends received. 2010 . Interest expenses are added to income to cancel the earlier deduction. and income taxes and interest paid must be separately disclosed.. interest expenses. Inc. adjustments involve deducting these amounts from income. McGraw-Hill/Irwin © The McGraw-Hill Companies.P2 Interest revenue.

Inc. 2010 .P2 Solving for tax and interest paid Income Tax Payable Beg bal Income tax paid Income Tax Exp End Bal Beginning balance + Income tax expense ± Ending balance = Income tax paid Interest Payable Beg bal Interest paid Interest Exp End Bal Beginning balance + Interest expense ± Ending balance = Interest paid McGraw-Hill/Irwin © The McGraw-Hill Companies..

McGraw-Hill/Irwin © The McGraw-Hill Companies. Inc.P2 Indirect Method Let¶s prepare a Statement of Cash Flows for B&G Company using the Indirect Method.. 2010 .

P2 Indirect Method B&G Company Comparative Balance Sheets December 31 Increase or (Decrease) 2010 Assets Cash Accounts receivable Inventories Land Equipment Accumulated depreciation-equipment Total Assets Liabilities and Stockholders' Equity Accounts payable Bonds payable Common stock.000 76.000) 174.000 70.000 (32.000 209.000 $ 47.000 555.000 $ 42.000 $ 41.000) 200.000 35. 2010 .000 75.000 597.000 $ 22.000 (19.000) (34.000 9.000 199..000 $ 150.000 (50.000) 597.000 $ 42.000 270.000 189.000 65.000) 100.000 (66. $1 par Retained earnings Total Liabilities and Stockholders' Equity McGraw-Hill/Irwin 2009 $ $ 63.000 $ $ 39.000 (8. Inc.000 134.000 (25.000 $ 85.000) 555.000 170.000 © The McGraw-Hill Companies.000) 200.

‡ Bonds payable of $50. ‡ There was no sale of old equipment. ‡ Income tax expense (the same as tax paid for the year) was $20.000 cash.000..000.000. ‡ Cash dividends declared and paid were $40. Inc. ‡ Common stock was issued for $35.P2 Indirect Method Additional Information for 2010: ‡ Net income was $105.000 were redeemed for $50.000 cash. 2010 . McGraw-Hill/Irwin © The McGraw-Hill Companies.

000 Add noncash expenses and losses. analyze the changes in current assets and current liabilities. 2010 . 2010 Cash flows from operating activities Income before taxes Adjustments to accrual-basis income: $ 125. Inc. Then. Subtract noncash revenues and gains.P1 B&G Company Statement of Cash Flows For the Year Ended December 31. Start with accrual-basis income. McGraw-Hill/Irwin © The McGraw-Hill Companies..

000 Current Assets Current Liabilities Change in Account Balance During Year Increase Decrease Subtract from Add to income income Add to income Subtract from income . Cash flows from operating activities Income before taxes Adjustments to accrual-basis income: Depreciation expense $ Increase in accounts receivable Decrease in inventory Decrease in accounts payable Total adjustments Cash generated from operations Income taxes paid Net cash provided by operating activites 2010 $ 34.000 161.000) 36.000 141.000 125.000 (8.000 20.000) 19.000 (9.P2 B&G Company Statement of Cash Flows For the Year Ended December 31.

000 141.000 141.000 105.000 (8.000) 36. .000 161.000 Let¶s do the investing section next.000) 19.000 20. Cash flows from operating activities Income before taxes Net income Adjustments to accrual-basis net income: income: Depreciation expense $ Increase in accounts receivable Decrease in inventory Decrease in accounts payable Total adjustments Cash generated from operating activities Net cash provided by operations Cash flows taxesinvesting activities Income from paid Net cash provided by operating activites 2010 2008 $ 34.P3 B&G Company Statement of Cash Flows For the Year Ended December 31.000 (9.000 125.

000 Finally.000) 36.P3 B&G Company Statement of Cash Flows For the Year Ended December 31.000 (70. Cash flows from operating activities Income before taxes Adjustments to accrual-basis income: Depreciation expense $ Increase in accounts receivable Decrease in inventory Decrease in accounts payable Total adjustments Cash generated from operations Income taxes paid Net cash provided by op operating activities Cash flows from investing activities Proceeds from sale of land Purchase of equipment Net cash used by investing activities 2010 $ 34. let¶s complete the financing section.000 20.000 161.000 141.000 (9.000 (8.000) 19.000 25.000) 125.000) (45. .

000 141.P3 B&G Company Statement of Cash Flows For the Year Ended December 31.000) (55.000 63. January 1.000) 35. 2010 Cash.000 22.000 25.000) 19.000) (45.000 (8.000) (40.000 20.000 (50. 2010 2010 $ 34.000 125.000) 41.000 161.000 (70. December 31.000) 36.000 $ . Cash flows from operating activities Income before taxes Adjustments to accrual-basis income: Depreciation expense $ Increase in accounts receivable Decrease in inventory Decrease in accounts payable Total adjustments Cash generated from operations Income taxes paid Net cash provided by operating activites Cash flows from investing activities Proceeds from sale of land Purchase of equipment Net cash used by investing activities Cash flows from financing activities Proceeds from issuance of common stock Redemption of bonds Payment of dividends Net cash used by financing activities Net increase in cash Cash.000 (9.

Cash flow on total assets = Operating cash flows Average total assets McGraw-Hill/Irwin © The McGraw-Hill Companies.. to assess company performance. 2010 . along with income-based ratios. Inc.A2 Cash Flow on Total Assets Used.

Inc. 2010 . McGraw-Hill/Irwin © The McGraw-Hill Companies..P4 Preparing the Statement of Cash Flows Let¶s look at the Direct Method for preparing the Cash Flows from Operating Activities section.

000 145.000 50.P4 Analyzing the Cash Account Cash 22. 2010 Let¶s use this Cash account to prepare B&G Company¶s Statement of Cash Flows under the Direct Method. 2010 Receipts from customers Receipts from sale of land Receipts from stock issuance Balance.000 10.000 20.000 70.000 40. Inc. 31..000 Payments for interest 35.000 Balance. McGraw-Hill/Irwin © The McGraw-Hill Companies.000 150. Dec.000 Payments for wages 25.000 Payments for merchandise 466. Jan.000 Payments for taxes Payments for equipment Payments for bond retirement Payments for dividends 63. 2010 . 1.

2010 .000 Purchase of equipment (70. Inc.000) Net cash provided by operating activities Cash flows from investing activities Proceeds from sale of land 25.000) 41. 2010 $ McGraw-Hill/Irwin 141.000) Payment of dividends (40.000 Cash paid for merchandise (150.000) Cash paid for taxes (20.000 (45. 2010 Cash flows from operating activities Cash received from customers $ 466. 2010 Cash. December 31.000) Net cash used by financing activities Net increase in cash Cash.P4 Preparing the Statement of Cash Flows B&G Company Statement of Cash Flows For the Year Ended December 31.000) (55.. January 1.000 Redemption of bonds (50.000) Cash paid for wages (145.000 63.000) Cash paid for interest (10.000 22.000) Net cash used by investing activities Cash flows from financing activities Proceeds from issuance of common stock 35.000 © The McGraw-Hill Companies.

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