CH - 05 Statement of Cash Flows

Statement of Cash Flows
CHAPTER
2006 Prentice Hall Business Publishing
Introduction to Financial Accounting, 9/e
Horngren/Sundem/Elliott/Philbrick
Learning Objectives
After studying this chapter, you should be able to
1. Identify the purposes of the statement of cash flows 2. Classify activities affecting cash as operating, investing, or financing activities 3. Compute and interpret cash flows from financing activities 4. Compute and interpret cash flows from investing activities 5. Use the direct method to calculate cash flows from operations
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Learning Objectives
After studying this chapter, you should be able to
6. Use the indirect method to explain the difference between net income and net cash provided by (used for) operating activities 7. Understand why depreciation is added to net income when using the indirect method for computing cash flow from operating activities 8. Show how the balance sheet equation provides a conceptual framework for the statement of cash flows
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Overview
The purpose of the statement of cash flows is to
Report cash receipts and cash payments of an entity over a period of time Classify the cash flows as operating, investing, and financing activities Detail the changes in the cash account on the balance sheet
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Overview
Balance Sheet December 31, 20X0 Balance Sheet December 31, 20X1
Statement of Income
Statement of Cash Flows
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Purpose of the Cash Flow Statement

A statement of cash flows
Shows the relationship of net income to changes in cash balances Helps to predict future cash flows Evaluates how management generates and uses cash Determines a companys ability to pay interest, dividends, and debts when they are due Identifies specific increases and decreases in a firms productive assets
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Purpose of the Cash Flow Statement

The term cash also refers to cash equivalents Cash equivalents are highly liquid short-term investments that a company can easily and quickly convert into cash
Money market funds Treasury bills
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Typical Activities Affecting Cash

Managers affect cash by three types of decisions:
Operating decisions Financing decisions Investing decisions
Operating decisions are concerned with the major day-to-day activities that generate revenues and expenses
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Operating activities are transactions that affect the purchase, processing, and selling of a companys products and services
Making sales Collecting accounts receivable Purchasing inventory Paying accounts payable
The first major section of the statement of cash flows is labeled cash flows from operating activities
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Financing decisions are concerned with how to obtain or repay cash Financing activities are a companys transactions that obtain resources from debt and equity transactions
Issuance of additional stock Borrowing money from the bank Repaying previous loans
The financing section on the statement is labeled cash flows from financing activities
2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 10 of 26

Investing decisions include the choices to acquire or dispose of long-term productive assets or long-term investments Investing activities are transactions that acquire or dispose of assets that are expected to provide services for more than one year
Purchasing or disposing of equipment
The investing section on the statement is labeled cash flows from investing activities

Cash Inflows Operating Activities: Collections from customers Interest and dividends collected Other operating receipts Investing Activities: Sale of property, plant, and equipment Sale of securities that are not cash equivalents Receipt of loan repayments Financing: Borrowing cash from creditors Issuing equity securities Issuing debt securities Cash Outflows
Cash payments to suppliers Cash payments to employees Interest and taxes paid Other operating cash payments
Purchase of property, plant, and equipment Purchase of securities that are not cash equivalents Making loans
Repayment of amounts borrowed Repurchase of equity shares (including the purchase of treasury stock) Payment of dividends
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Preparing the Statement of Cash Flows

The following two slides for Biwheels Company show the:
Changes in the balance sheet equation (transactions) during the first month of operations Income statement for the first month of operations and the January 31 balance sheet
Notice that the cash balance increased from $0 to $351,000 during the month
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Assets
Description of Transactions Cash Accounts + Receivable Merchandise + Inventory + Prepaid Rent +
=
Store Equipment =
Liabilities
Note Payable
+
+
Stockholders' Equity
Paid-in Capital + Retained Earnings
Accounts + Payable
(1) Initial investment (2) Loan from bank (3) Acquire store equipment for cash (4) Acquire inventory for cash (5) Acquire inventory on credit (6) Acquire inventory for cash plus credit (7) Sales of equipment (8) Return of inventory acquired on January 5 (9) Payments to creditors (10a) Sales on open account (10b) Cost of merchandise inventory sold (11) Collect accounts receibable (12) Pay rent in advance (13) Recognize expiration of rental services (14) Depreciation Balance January 31, 20X2
+400,000 +100,000 -15,000 -120,000
= = +100,000 +15,000 = = = = -1,000 = = = = = = = = -100 = +13,900 =
+400,000
+120,000 +10,000 +30,000
+10,000 +20,000
-10,000 +1,000
-800 -4,000 +160,000 -100,000 +5,000 -6,000 -5,000 +6,000 -2,000 351,000 +155,000 +59,200 +4,000
-800 -4,000 +160,000 -100,000
100,000
+25,200
+400,000
-2,000 -100 +57,900
583,100
583,100
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Biwheels Company Income Statement For the Month Ended January 31, 20X2
Sales (revenues) Deduct expenses: Cost of goods sold Rent Depreciation Total expenses Net income $160,000 $100,000 2,000 100 102,100 $ 57,900
Balance Sheet, January 31, 20X2

Assets Cash Accounts receivable Merchandise inventory Prepaid rent Store equipment $351,000 155,000 59,200 4,000 13,900 Liabilities and Stockholders Equity Liabilities Note payable $100,000 Accounts payable 25,200 Total liabilities $125,000 Stockholders equity Paid-in capital $400,000 Retained earnings 57,900 Total stockholders equity 457,900 Total liabilities and stockholders equity $583,100
Total assets
$583.100
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Cash Flows from Financing Activities

Two general rules apply for identifying financing activities:
Increases in cash (cash inflows) stem from increases in long-term liabilities or paid-in capital Decreases in cash (cash outflows) stem from decreases in long-term liabilities or paid-in capital
Biwheels had two such transactions in January:

Transaction 1: Initial investment, $400,000 Transaction 2: Loan from bank, $500,000
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Cash Flows from Investing Activities

Two general rules apply for identifying investing activities:
Increases in cash (cash inflows) from decreases in long-lived assets, loans, and investments Decreases in cash (cash outflows) stem from increases in long-lived assets, loans, and investments
There were two such transactions relating to store equipment in January:

Transaction 3: Acquire store equipment for cash, $15,000 Transaction 7: Sale of store equipment for cash, $1,000
Noncash Investing and Financing Activities

Sometimes financing and investing activities do not affect cash Example: If Biwheels acquires $8,000 of store equipment by issuing common stock
The purchase of store equipment is an investing activity The issuance of common stock is a financing activity
Companies must report such items in a schedule of noncash investing and financing activities
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Cash Flow from Operating Activities

Two approaches may be used:
Direct method:
Subtracts operating cash disbursements from operating cash collections Is preferred by the FASB
Indirect method:
Adjusts accrual-based net income from the income statement to reflect only cash receipts and disbursements Is used by most U.S. companies
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The Direct Method

Examining the cash column of Biwheels balance sheet equation, transactions 1, 2, 3, and 7 are financing and investing activities The remaining transactions must be operating activities:
Biwheels Company Cash Flows from Operating ActivitiesDirect Method For the Month of January 20X2 Cash payments for inventory (transactions 4 and 6) Cash payments to creditors for accounts payable (transaction 9) Cash collections on accounts receivable (transaction 11) Cash payments for rent (transaction 12) Net cash used by operating activities $(130,000) (4,000) 5,000 6,000 $(135,000)
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The Indirect Method

When the cash flow from a sale or outflow from an expense occurs in one accounting period and the revenue or expense occurs in another, net income differs from cash flows from operations
The indirect method highlights these differences by starting with net income, and adjusts it to cash flows from operating activities Example: Depreciation is added back to net income because it is a noncash expense
The Indirect Method

Net income
Adjust for revenues and expenses not requiring cash Add back depreciation Other adjustments Adjust for changes in noncash assets and liabilities relating to operating activities Add decreases in assets Deduct increases in assets Add increases in liabilities Deduct decreases in liabilities
The Indirect Method

Biwheels Company Cash Flows from operating ActivitiesIndirect Method For the Month of January 20X2 Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Net increase in accounts receivable Net increase in inventory Net increase in accounts payable Net increase in rent payable Net cash provided by operating activities $ 57,900
100 (155,000) (59,200) 25,200 (4,000) $(135,000)
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Reconciliation Statement
The FASB requires direct-method statements to include a supplementary schedule reconciling net income to net cash provided by operations In other words, companies that use the direct method must also prepare a report using the indirect method (reconciliation schedule) As a result, most companies use the indirect method
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Example of Statement of Cash Flows

Biwheels Company Statement of Cash Flows For the Month of January 20X2 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Net increase in accounts receivable Net increase in inventory Net increase in accounts payable Net increase in rent payable Net cash provided by operating activities Cash flows from investing activities: Purchase of store equipment Proceeds from sale of store equipment Net cash provided by investing activities Cash flows from financing activities: Proceeds from initial investment Proceeds from issuance of common stock Net cash provided by financing activities Net increase in cash Cash, January 2, 20X2 Cash, January 31, 20X2
$ 57,900
100 (155,000) (59,200) 25,200 (4,000) $(135,000)
$ (15,000) 1,000 (14,000)
$ 400,000 100,000 500,000 351,000 0 $351,000
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The Importance of Cash Flow

The income statement matches revenues and expenses using accrual concepts and provides a measure of economic performance The statement of cash flows explains changes in the cash account rather than owners equity Free cash flow
Is a measure of cash management performance Refers to cash flows from operations less capital expenditures (and sometimes less dividends)
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CH - 05 Statement of Cash Flows

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Statement of Cash Flows

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Statement of Cash Flows

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Purpose of the Cash Flow Statement

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Purpose of the Cash Flow Statement

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Typical Activities Affecting Cash

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Typical Activities Affecting Cash

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Typical Activities Affecting Cash

Typical Activities Affecting Cash

Typical Activities Affecting Cash

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Preparing the Statement of Cash Flows

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Preparing the Statement of Cash Flows

+400,000 +100,000 -15,000 -120,000

= = +100,000 +15,000 = = = = -1,000 = = = = = = = = -100 = +13,900 =

+120,000 +10,000 +30,000

-800 -4,000 +160,000 -100,000

-2,000 -100 +57,900

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Preparing the Statement of Cash Flows

Balance Sheet, January 31, 20X2

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Cash Flows from Financing Activities

Biwheels had two such transactions in January:

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Cash Flows from Investing Activities

There were two such transactions relating to store equipment in January:

Noncash Investing and Financing Activities

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

Cash Flow from Operating Activities

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

The Direct Method

2006 Prentice Hall Business Publishing

Introduction to Financial Accounting, 9/e

The Indirect Method

The Indirect Method

The Indirect Method

100 (155,000) (59,200) 25,200 (4,000) $(135,000)