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CHAPTER 16

ANALYSIS USING THE

STATEMENT OF CASH FLOWS

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Statement of Cash Flows

As the cartoon implies, business investments with good long-term cash flow prospects frequently provide poor cash flow in their early years. Measuring net income by means of the accrual basis of accounting mitigates the short-sightedness of cash flow measures.

Purpose of the Statement of Cash Flows

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The statement summarizes the effects on cash of the operating, investing, and financing activities of a company during an accounting period.

(i.e., it tells where the cash came from and where it went while explaining the change in the cash balance.)

Purpose of the Statement of Cash Flows

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The statement summarizes the effects on cash of the operating, investing, and financing activities of a company during an accounting period.
We need to sell our inventory and collect our receivables, if we plan to have a good year.

Purpose of the Statement of Cash Flows

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The statement summarizes the effects on cash of the operating, investing, and financing activities of a company during an accounting period.
In addition, we have to make an investment in new equipment to improve our productivity.

Purpose of the Statement of Cash Flows

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The statement summarizes the effects on cash of the operating, investing, and financing activities of a company during an accounting period.
I guess we will have to borrow some money to afford all this new equipment.

Helps Financial Statement Users Assess the...

Ability to generate positive future net cash flows.

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Ability to meet obligations.

P. 582

Ability to pay dividends.

Need for external financing.

Reasons for differences between accrual and cash-basis income.

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Cash Flow Terminology

Operating Activities
Transactions that enter into the determination of net income

Investing Activities
Transactions involving acquisition or disposal of noncurrent assets

Financing Activities
Transactions involving creditors and stockholders

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Operating Activities
Cash inflows from: Sale of goods or services Interest revenue Dividend revenue Sale of trading securities Other
583

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Operating Activities
Cash outflows for: Purchase of inventory Payment of salaries and wages Interest expense Other expenses Purchase of trading securities
583

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Operating Activities
Direct Method
Deducts from cash sales only those operating expenses that consumed cash.

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Operating Activities
Indirect Method
Starts with accrual basis net income and adjusts net income for items that affected net income but did not involve cash.
This is the most popular method and is used by about 95% of companies.

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Investing Activities
Cash inflows from:

Cash outflows for:

Sale of property, plant, and equipment. Sale of securities. Collections of longterm loans.

Purchase of property, plant, and equipment. Purchase of securities. Making loans.

583

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Financing Activities
Cash inflows from:

Cash outflows for:

Issuing capital stock.

Issuing debt.

Purchase of treasury stock. Payment of cash dividends. Payment of debt.

What about payment of interest on debt?

583

Steps in Preparing the Statement of Cash Flows

Determine cash flows from operating
activities using the indirect method. Analyze all noncurrent accounts for changes in cash resulting from investing or financing activities. Arrange the information from 1 and 2 in the proper format.

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Indirect Method
Operating Activities
Accrual basis net income
Add: Non-cash expenses (e.g., Depreciation, Depletion and Amortization) Add: Losses not affecting cash Deduct: Gains not affecting cash Adjust: For changes in current assets and current liabilities

Cash provided by operating activities (i.e., cash-basis net income)

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Indirect Method
Operating Activities Section
For Changes in: Add Change to Net Income Deduct Change from Net Income

Current assets. . . . Current liabilities. .

Decreases Increases

Increases Decreases

589

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Operating Activities Example

East, Inc. reports $125,000 Net Income for the year ended December 31, 1999. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 1999, East reported $12,500 of Depreciation Expense.

Calculate cash provided by operating activities during 1999.

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Operating Activities Solution

Net Income $ 125,000 Add: Depreciation Expense 12,500 Add: Increase in A/P 10,000 Deduct: Increase in A/R (7,500) Cash provided by operating activities $ 140,000

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Cash Flow Statement

XYZ Corporation Statement of Cash Flows For the year ended December 31, 1999
Operating Activities $xx,xxx Investing Activities x,xxx Financing Activities x,xxx Net Increase (decrease) in cash xxx Cash at beginning of year x,xxx Cash at end of year $ x,xxx Optional - see p. 593

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Cash Flows Question

On the Statement of Cash Flows, the sale of the companys own Capital Stock for cash would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. b. c. d.

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Cash Flows Question

On the Statement of Cash Flows, the sale of the companys own Capital Stock for cash would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. a. b. b. c. c. d. d.

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Cash Flows Question

On the Statement of Cash Flows, the purchase of plant assets would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. b. c. d.

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Cash Flows Question

On the Statement of Cash Flows, the purchase of plant assets would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. a. b. b. c. c. d. d.

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Cash Flows Question

On the Statement of Cash Flows, the payment of cash dividends would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. b. c. d.

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Cash Flows Question

On the Statement of Cash Flows, the payment of cash dividends would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. a. b. b. c. c. d. d.

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Cash Flows Question

On the Statement of Cash Flows, the change in Accounts Receivable balance for the year would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. b. c. d.

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Cash Flows Question

On the Statement of Cash Flows, the change in Accounts Receivable balance for the year would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. a. b. b. c. c. d. d.

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Cash Flows Question

On the Statement of Cash Flows, the purchase of plant assets through the issuance of Capital Stock would be classified as Cash flow from operating activities. Cash flow from investing activities. Cash flow from financing activities. None of the above.

a. b. c. d.

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Cash Flows Question

On the Statement of Cash Flows, the purchase of plant assets through the issuance of Capital Stock would be classified as This should be classified as a non-cash financing Cash flow from operating activities. and investing activity and disclosed in a separate Cash or footnote investing activities. schedule flow from to the financial statements. Cash flow from financing activities. None of the above.

a. a. b. b. c. c. d. d.

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Non-Cash Activities
The reason that non-cash investing and financing activities must be disclosed in notes to the statement of cash flows:
The reader wants to know why all amounts on the comparative balance sheet changed from the beginning to end of year, whether cash was involved or not. Therefore, this is a good place to disclose it.

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Cash Flow Statement Example

Sample Company is preparing its annual financial statements. The Company provides you with Balance Sheets for 12/31/98 and 12/31/99, and the Income Statement for the year ended 12/31/99. During 1999, the Company paid cash dividends of $10,000.

Prepare a Statement of Cash Flows, using the indirect method.

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Cash Flow Statement Example

Additional information:
On June 8, 1999, Sample purchased land for cash of $11,000. During 1999, Sample purchased new equipment for $13,000 cash. On March 18, 1999, Sample sold additional shares of common stock for cash of $10,000.

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Cash Flow Statement Example

Sample Company Income Statement For the Year Ended December 31, 1999 Revenues $ 153,000 Cost of sales $ 50,000 Wages 30,000 Depreciation 5,000 Insurance 4,000 89,000 Net income $ 64,000

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Sample Company Comparative Balance Sheet At December 31, 1999 and 1998 1999 1998 Change Cash $ 82,000 $ 30,000 $ 52,000 Acct. Receivable 120,000 100,000 20,000 Inventory 87,000 82,000 5,000 Land 101,000 90,000 11,000 Equipment 113,000 100,000 13,000 Accum. Depr. (20,000) (15,000) (5,000) Total $ 483,000 $ 387,000 $ 96,000 Acct. Payable $ 76,000 Wages Payable 33,000 Notes Payable 50,000 Capital Stock 170,000 Retained Earnings 154,000 Total $ 483,000 $ 60,000 17,000 50,000 160,000 100,000 $ 387,000 $ 16,000 16,000 10,000 54,000 $ 96,000

Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Cash flows from operating activities: Net income $ 64,000 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense 5,000 Increase in with accrual basis net(20,000) and Start Acct. Receivable income Increase in inventory (5,000) make all necessary adjustments. Increase in Acct. Payable 16,000 Increase in Wages Payable 16,000 Net cash provided by operating activities $ 76,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Cash flows from operating activities: Net income $ 64,000 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense 5,000 Increase in Acct. Receivable (20,000) Add depreciation, depletion Increase in inventory (5,000) and amortization. Increase in Acct. Payable 16,000 Increase in Wages Payable 16,000 Net cash provided by operating activities $ 76,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Cash flows from operating activities: Net income $ 64,000 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense 5,000 Increase in Acct. Receivable (20,000) Increase in Inventory (5,000) Increase in Acct. Payable increase 16,000 Deduct the in Increase in Wages Payable - accounts 16,000 the current assets Net cash provided by operating receivable and Inventory. activities $ 76,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Cash flows from operating activities: Net income $ 64,000 Add the increases in the Adjustments to reconcile net current to net cash provided income liabilities - accounts payable and wages payable. by operating activities Depreciation expense 5,000 Increase in Acct. Receivable (20,000) Increase in Inventory (5,000) Increase in Acct. Payable 16,000 Increase in Wages Payable 16,000 Net cash provided by operating activities $ 76,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Cash flows from operating activities: Net income $ 64,000 Adjustments to reconcile net income to net cash provided Now that we have completed the by operating activitiesoperating activities cash flows from section of the statement lets look at the Depreciation expense 5,000 cash flows for investing (20,000) Increase in Acct. Receivable activities. Increase in Inventory (5,000) Increase in Acct. Payable 16,000 Increase in Wages Payable 16,000 Net cash provided by operating activities $ 76,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Net cash flows from operating activities: $ 76,000 Cash flows from investing activities: Purchase of Land $(11,000) Purchase of Equipment (13,000) (24,000)
Sample purchased land for cash during 1999. Cash flows from financing activities:

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Sale of Capital Stock Payment of Cash Dividends Net Increase in Cash Cash, January 1, 1999 Cash, December 31, 1999

$ 10,000 (10,000)

$ 52,000 30,000 $ 82,000

Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Net cash flows from operating activities: $ 76,000 Cash flows from investing activities: Purchase of Land $(11,000) Purchase of Equipment (13,000) (24,000)
During activities: Cash flows from financingthe year Sample purchased new equipment Sale of Capital Stock $ 10,000 paying $13,000 cash. Payment of Cash Dividends (10,000) Net Increase in Cash $ 52,000 Cash, January 1, 1999 30,000 Cash, December 31, 1999 $ 82,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Net cash flows from operating activities: $ 76,000 Cash flows from investing activities: Purchase of Land $(11,000) Purchase of Equipment (13,000) (24,000) Cash flows from financing activities: Sale of Capital Stock $ 10,000 Payment of Cash Dividends capital Sample (10,000) To raise addition Net Increase in shares of stock for $10,000 cash. $ 52,000 sold Cash Cash, January 1, 1999 30,000 Cash, December 31, 1999 $ 82,000

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Sample Company Statement of Cash Flows For the Year Ended December 31, 1999 Net cash flows from operating activities: $ 76,000 Cash flows from investing activities: Purchase of Land $(11,000) Purchase of Equipment (13,000) (24,000) Cash flows from financing activities: Sale of Capital Stock $ 10,000 Payment of Cash Dividends (10,000) Net Increase inThe company paid $10,000 in Cash $ 52,000 Cash, January 1, dividends to its shareholders. 30,000 cash 1999 Cash, December 31, 1999 $ 82,000

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Sample Company We have now explained what Statement of Cash Flows caused the cash account to For the Year Ended December 31, 1999 increase by $52,000 during Net cash flowsthe year. from operating activities: $ 76,000 Cash flows from investing activities: Purchase of Land $(11,000) Purchase of Equipment (13,000) (24,000) Cash flows from financing activities: Sale of Capital Stock $ 10,000 Payment of Cash Dividends (10,000) Net Increase in Cash $ 52,000 Cash, January 1, 1999 30,000 Cash, December 31, 1999 $ 82,000

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Analyzing the Comparative Balance Sheet

Illustration 16.3, p. 587

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Retained Earnings Dividends 4,000 30,000 Beg. Bal. 10,000 Net Income X 30,000 + X - 4,000 = 36,000 X = 10,000 36,000 End. Bal.

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Hey, dude, how about going over that stuff one more time?
.