How Well Am I Doing?

Statement of Cash Flows

Chapter 15
McGraw-Hill/Irwin
Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Purpose of the Statement of Cash Flows
Are cash flows
sufficient to
support ongoing
operations?
Can we meet
our obligations
to creditors?
Can we pay
dividends?
Why is there a
difference
between net
income and net
cash flow?
Will the company
have to borrow
money to make
needed
investments?
15-2
Cash
The term cash on the statement of cash flows refers
broadly to both currency and cash equivalents.
Cash
Treasury
Bills
Money Market
Funds
Commercial
Paper
Currency and
Bank Accounts
15-3
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Sources
Net Income Always
Net Loss
Changes in noncash assets Decreases
Changes in liabilities* Increases
Changes in capital stock
accounts Increases
Dividends paid to stockholders
Total sources - Total uses = Net cash flow
* Contra asset accounts, such as the Accumulated Depreciation and
Amortization account, follow the rules for liabilities.
Decreases
Decreases
Always
Uses
Always
Increases
15-4
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Example: Inventory is
purchased on credit from
a supplier.
It is implied that cash
was used to acquire the
inventory.
Increases in noncash asset
accounts imply uses of cash.
15-5
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
It is implied that an increase
in a payable has the effect
of increasing cash available
for other uses.
Increases in liability accounts imply
sources of cash.
Example: Inventory is
purchased on credit from
a supplier.
15-6
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Decreases in noncash assets
accounts imply sources of cash.
Example: Accounts receivable
decreases when a customer
pays their bill.
When the customer pays the
bill, the companys cash
increases.
15-7
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Decreases in liability accounts
imply uses of cash.
When the payment is made,
cash decreases.
Example: A company
pays a note payable held
by a creditor.
15-8
The Full-Fledged Statement of Cash Flows:
Operating Activities
Operating activities are
those activities that enter
into the determination of
net income.
1. Transactions
affecting current
assets
3. Changes in
noncurrent
balance sheet
accounts that
directly affect net
income
2. Transactions
affecting current
liabilities
15-9
The Full-Fledged Statement of Cash Flows:
Investing Activities
Investing activities relate to
transactions involving the
acquiring or disposing of
noncurrent assets.
1. Acquiring or
selling property,
plant and
equipment
3. Lending money
to another entity
and subsequently
collecting on the
loan 2. Acquiring or
selling securities
15-10
Financing activities relate to
transactions involving borrowing
from creditors or repaying
creditors and engaging in
transactions with the
companys owners.
1. Issuing stock
and purchasing
treasury stock
3. Payment of
dividends (note
that interest on
debt is classified
as an operating
activity)
2. Issuing long-
term debt and
repayment of debt.
The Full-Fledged Statement of Cash Flows:
Financing Activities
15-11
The Full-Fledged Statement of Cash Flows:
An Overview

Operating Activities:
Net income
Changes in current assets
Changes in noncurrent assets that affect net income (e.g., depreciation)
Changes in current liabilities (except for debts to lenders and dividends
payable)
Changes in noncurrent liabilities that affect net income
Investing Activities:
Changes in noncurrent assets that are not included in net income
Financing Activities:
Changes in the current liabilities that are debts to lenders rather than
obligations to suppliers, employees, or the government
Changes in noncurrent liabilities that are not included in net income
Changes in capital stock accounts
Dividends
15-12
The Full-Fledged Statement of Cash Flows: An
Overview
Operating Activities
Investing Activities
Financing Activities
Reconciliation of the
beginning cash balance
with the ending cash
balance
Noncash Investing
and Financing
Activities
15-13
Operating Activities
Sources of cash are added to net
income and uses of cash are
deducted from net income.
Impact on Net Cash Provided by Operating Activities
Sources of Cash
(Add to Net Income)
Uses of Cash
(Subtract from Net Income)
Current
Noncash Assets
Current
Liabilities
Decreases
Increases
Increases
Decreases
15-14
Other Issues: Direct Method or Indirect Method?
Two Formats for Reporting Operating Activities
Reports the
cash effects of
each operating
activity
Starts with
accrual net
income and
converts to
cash basis
Direct Method Indirect Method
No matter which format is used, the same amount of net
cash provided by operating activities is generated.
15-15
A Full-Fledged Statement of Cash Flows:
An Example
Lets revisit the
comparative
balance sheet
account balances
for Eds Pizza Hut.
Ed's Pizza Hut
Comparative Balance Sheet Account Balances
3/31/2008 3/31/2007 Change
DR (CR) DR (CR) Incr. (Decr.)
Cash 71,000 $ 90,000 $ (19,000) $
Accounts Receivable 23,000 40,000 (17,000)
Inventory 322,000 300,000 22,000
Land 68,000 100,000 (32,000)
Equipment 112,000 84,000 28,000
Accumulated Depr. (45,000) (39,000) 6,000
Accounts Payable (38,000) (27,000) 11,000
Salaries Payable (9,000) (14,000) (5,000)
Note Payable - Joe Doe - (50,000) (50,000)
Common Stock (500,000) (450,000) 50,000
Retained Earnings (4,000) (34,000) (30,000)
- $ - $
15-16
A Full-Fledged Statement of Cash Flows:
An Example
There was a net loss for the year of $27,000.
Depreciation charges for the year were $6,000.
During the year, Ed sold land originally costing
$32,000 for $32,000.
During the year, Ed purchased equipment for
$28,000.
During the year, Ed paid dividends of $3,000 to
the stockholders.
Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
Lets also refresh our memory regarding the
following additional information.
15-17
Operating Activities
Net Loss (27,000) $
Add: Decrease in A/R 17,000
Increase in A/P 11,000
Increase in Depr. Charges 6,000
Less: Increase in Inventory (22,000)
Decrease in Salaries Payable (5,000)
Net Cash Provided by Operating Activities (20,000)
Investing Activities
Proceeds from sale of Land 32,000
Purchase of equipment (28,000)
Net Cash Provided by Investing Activities 4,000
Financing Activities
Dividends paid (3,000)
Net change in cash (19,000)
Cash, beginning 90,000
Cash, ending 71,000
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
In addition, on the
face of the
statement or in a
supplemental
schedule, disclose
the issuance of
$50,000 of stock
to a creditor, a
noncash financing
activity.
Example Indirect Method
15-18
Free Cash Flows
Free Cash Flow =
Net Cash Provided by
Operating Activities
-
Capital
Expenditures
-
Dividends
Free cash flow measures a companys ability to
fund its capital expenditures and dividends from
its net cash provided by operating activities.
15-19
Computing Net Cash Provided by Operating
Activities
The direct method computes
net cash provided by operating
activities by reconstructing the
income statement on a cash
basis from top to bottom.
Net cash provided by operating
activities under the direct method will
always agree with the amount
computed using the indirect method.
15-20
Similarities and Differences in Handling Data
Add (+) or
Deduct (-) to
Adjust to a
Cash Basis
Sales revenue (as reported)
Increases in accounts receivable -
Decreases in accounts receivable +
Cost of goods sold (as reported)
Increase in merchandise inventory +
Decrease in merchandise inventory -
Increase in accounts payable -
Decrease in accounts payable +
Operating expenses (as reported)
Increase in prepaid expenses +
Decrease in prepaid expenses -
Increase in accrued liabilities -
Decrease in accrued liabilities +
Period's depreciation, depletion and
amortization charges
-
Income tax expense (as reported)
Increase in accrued taxes payable -
Decrease in accrued taxes payable +
Increase in deferred income taxes -
Decrease in deferred income taxes +
Adjustments to a cash basis:
Revenue or Expense Item
Adjustments to a cash basis:
Adjustments to a cash basis:
Adjustments to a cash basis:
Adjustments for accounts
that affect revenue are the
same in the direct and
indirect methods.
Adjustments for accounts
that affect expenses are
handled in opposite ways
for the direct and indirect
methods.
15-21
The Direct Method: An Example
Operating Activities
Cash received from customers 1,017,000 $
Cash paid for purchases (761,000)
Cash paid for operating expenses (276,000)
Net Cash Provided by Operating Activities (20,000)
Investing Activities
Proceeds from sale of land 32,000
Purchase of equipment (28,000)
Net Cash Provided by Investing Activities 4,000
Financing Activities
Dividends paid (3,000)
Net change in cash (19,000)
Cash, beginning 90,000
Cash, ending 71,000 $
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Notice that the
net cash
provided by
operating
activities agrees
with that
computed using
the indirect
method.
15-22
End of Chapter 15
15-23