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©2008 Pearson Prentice Hall. All rights reserved.12-2
Learning Objective 1
Identify the purpose the statement of
cash flows
©2008 Pearson Prentice Hall. All rights reserved.12-3
Cash Flow Statement
• Shows cash receipts and payments during a period
• Purposes: Predicts future cash flows Evaluates management decisions Determines ability to pay dividends and
interest Shows relationship of net income to cash
flows
©2008 Pearson Prentice Hall. All rights reserved.12-4
Importance of Cash Flow
A company needs both net income and strong cash flow to succeed
©2008 Pearson Prentice Hall. All rights reserved.12-5
Learning Objective 2
Distinguish among operating, investing and financing cash flows
©2008 Pearson Prentice Hall. All rights reserved.12-6
Cash Flow Categories
• Operating activities Related to the transactions that result in net income Most important as they reflect core of the business
• Investing activities Related to long-term assets How a company uses its resources in the long-term
• Financing activities Related to long-term debt and equity How a company obtains resources
©2008 Pearson Prentice Hall. All rights reserved.12-7
Formats for Operating Cash Flows
• Indirect Reconciles net income to cash provided by
operating activities Easier to prepare
• Direct Shows cash inflows and outflows by type Easier to interpret
©2008 Pearson Prentice Hall. All rights reserved.12-8
Learning Objective 3
Prepare a statement of cash flows by the indirect method
©2008 Pearson Prentice Hall. All rights reserved.12-9
The Indirect Method
Net Income
Reconciling adjustments:
+ Depreciation/depletion/amortization
+ Losses on sales of long-term assets
- Gains on sales of long-term assets
+ or - changes in current assets & current liabilities
Net cash provided by operating activities
©2008 Pearson Prentice Hall. All rights reserved.12-10
Reconciling Items
• Goal: To convert accrual net income to operating cash flow
• Start with net income and adjust for noncash items Add back noncash expenses Subtract gains and add losses
• These amounts do not reflect cash flows Add or subtract changes in current assets and
current liabilities
©2008 Pearson Prentice Hall. All rights reserved.12-11
Current Assets and Current Liabilities
• Each account relates to an income statement item Accounts receivable Sales Salaries payable Salaries expense
• The change in each account is computed Change = Current year balance – prior year balance
• Current assets inverse relationship Subtract increases from net income; add decreases
• Current liabilities direct relationship Add increases to net income; subtract decreases
©2008 Pearson Prentice Hall. All rights reserved.
12-12
E12-15
Item O I or F + or -
a. Net Income O +
b. Cash dividend F -
c. Sale of LT investment I +
d. Loss on sale of equip. O +
e. Amortization O +
f. Issuance of LTNP F +
g. Depreciation expense O +
h. Issuance of stock ___ +
What type of account is
stock?
©2008 Pearson Prentice Hall. All rights reserved.
12-13
E12-15Item O I or F + or -
j. Increase in accts pay O +
k. Purchase of equipment with note payable
NIF
l. Payment of long-term debt
F -
m. Purchase building I -
n. Accrual of salary expense N
o. Purchase of long-term investment
I -
©2008 Pearson Prentice Hall. All rights reserved.
12-14
E12-15
Item O I or F + or -
p. Decrease in inventory O +
q. Increase in prepaid expenses
O -
r. Sale of land I +
s. Decrease in accrued liabilities
O -
©2008 Pearson Prentice Hall. All rights reserved.12-15
Preparing the Operating Section – Indirect Method
• Use current year income statement for the following amounts Net Income Depreciation, depletion and amortization
expense Gains or losses on sales of assets
• Use comparative balance sheets to compute the changes in current assets and current liabilities
©2008 Pearson Prentice Hall. All rights reserved.12-16
The Indirect Method
Revenues 100,000$ Cost of Goods Sold 40,000 Gross Profit 60,000 Operating expenses:
Salaries expense 20,000 Depreciation expense 10,000 Other expenses 5,000
Total operating expenses 35,000 Other income: Gain on sale of plant assets 3,000 Net Income 38,000$
Income Statement
Use as first line in operating section
Add back to net income
Subtract from net income
©2008 Pearson Prentice Hall. All rights reserved.12-17
12-31-09 12-31-08 ChangeCash 20,000$ 18,000$ Accounts Receivable 25,000 30,000 (5,000) Inventory 42,000 30,000 12,000 Long-term assets 150,000 162,000 Total assets 237,000$ 240,000$ Accounts payable 15,000 18,000 (3,000) Salaries payable 10,000 6,000 4,000 Long-term liabilities 98,000 105,000 Stockholders' equity 114,000 111,000 Total liabilities & equity 237,000$ 240,000$
Comparative Balance Sheets December 31, 2009 and 2008
Added to net income
Subtracted from net income
Added to net income
Subtracted from net income
©2008 Pearson Prentice Hall. All rights reserved.12-18
E12-17
Net Income $ 35,000
Reconciling items:
Depreciation 18,000
Loss on sale of land 5,000
Changes in current assets & current liabilities
Increase in current assets _______
Decrease in current liabilities (20,000)
Net cash provided by operating activities $ 11,000
Remember: inverse
relationship
©2008 Pearson Prentice Hall. All rights reserved.12-19
Investing Activities
• Affect long-term assets: Plant assets Investments Notes receivable
Purchases = outflows
Sales = inflows
Loans made = outflows
Collections = inflows
©2008 Pearson Prentice Hall. All rights reserved.12-20
Computing Purchases and Sales of Plant Assets
Plant assets, net, beginning balance
+ Acquisitions
- Depreciation
- Book value of assets sold
= Plant assets, net, ending balance
From Balance Sheet
From Balance Sheet
From Income Statement
©2008 Pearson Prentice Hall. All rights reserved.12-21
Proceeds from Sales of Plant Assets
• Compare book value of assets sold to gain or loss Gain or loss located on income statement
Book value + Gain on sale
Book value – Loss on sale
Cash Proceeds
©2008 Pearson Prentice Hall. All rights reserved.12-22
Computing Purchases and Sales of Investments
Investments, beginning balance
+ Purchases
- Cost of investments sold
= Investments, ending balance
Cost + Gain on sale
Cost – Loss on sale
Cash Proceeds
To compute cash proceeds of investments sold:
©2008 Pearson Prentice Hall. All rights reserved.12-23
Computing Loans Made and Collections on Notes
Notes receivable, beginning balance
+ Loans made
- Collections
= Notes receivable, ending balance
©2008 Pearson Prentice Hall. All rights reserved.12-24
Financing Activities
• Affect long-term liabilities & equity: Long-term Debt
• Notes payable• Bonds payable
Common stock and Paid-in Capital Retained earnings
Payments = outflows Borrowings = inflows
Cash dividends = outflows Issuance of new shares = inflows
©2008 Pearson Prentice Hall. All rights reserved.12-25
Computing Issuance and Payments of Long-Term Debt
Long-term debt, beginning balance
+ Issuance of new debt
- Payments of debt
= Long-term debt, ending balance
©2008 Pearson Prentice Hall. All rights reserved.12-26
Computing Issuance of Stock and Purchases of Treasury Stock
Common stock, beginning balance
+ Issuance of new stock
= Common stock, ending balance
Treasury stock, beginning balance
+ Purchase of treasury stock
= Treasury stock, ending balance
Inflow of cash
Outflow of cash
©2008 Pearson Prentice Hall. All rights reserved.12-27
Computing Dividend Payments
Retained earnings, beginning balance
+ Net Income
- Dividends declared
= Retained earnings, ending balance
From income statement
©2008 Pearson Prentice Hall. All rights reserved.12-28
Noncash Investing and Financing Activities
• Transactions that involve long-term assets, long-term debt and/or equity But do not increase or decrease cash
• Examples: Purchasing plant assets by signing a note
payable Issuing stock for land Stock dividends
©2008 Pearson Prentice Hall. All rights reserved.12-29
Cash flows from operating activities:Net IncomeReconciling adjustments: + Depreciation/depletion/amortization + Losses on sales of long-term assets - Gains on sales of long-term assets + or - changes in current assets & current liabilities
Net cash provided by operating activitiesCash flows from investing activities:
Purchase of plant assets & investmentsSale of plant assets & investments
Net cash provided by investing activitiesCash flows from financing activities:
Issuance of stockPayment of dividendsIssuance of long-term note payable Purchase of treasury stock
Net cash provided by financing activitiesNet increase (decrease) in cash
Cash balance, beginning of yearCash balance, end of year
Statement of Cash Flows
Proves that cash flow statement “works”
©2008 Pearson Prentice Hall. All rights reserved.12-30
Learning Objective 4
Prepare a cash flow statement by the direct method
©2008 Pearson Prentice Hall. All rights reserved.12-31
Direct Method
• FASB prefers as it provides clearer information Rarely used as it requires more calculations
• Refers to how operating section is prepared Investing and Financing activities always prepared
using the direct method
• Goal: Convert each income statement item into a cash amount Or exclude if a noncash item
©2008 Pearson Prentice Hall. All rights reserved.12-32
Direct Method
Collections from customers
Sales
Cost of goods sold Payments to suppliers
Salaries expense Payments to employees
Interest expenseInterest payments
Income Statement Cash Flow Statement
Income tax expense Income tax paid
©2008 Pearson Prentice Hall. All rights reserved.12-33
Direct Method Formulas
RECEIPTS
Income Statement
Balance Sheet Change
From customers
Sales
+ Decrease in accounts receivable
- Increase in accounts receivable
Of interest Interest revenue
+ Decrease in interest receivable
- Increase in interest receivable
©2008 Pearson Prentice Hall. All rights reserved.12-34
Direct Method Formulas
PAYMENTS
Income Statement
Balance Sheet Change
To suppliers Cost of goods sold
+ Increase in inventory
- Decrease in inventory
AND
+ Decrease in accounts Payable
- Increase in accounts payable
©2008 Pearson Prentice Hall. All rights reserved.12-35
Direct Method Formulas
PAYMENTS
Income Statement
Balance Sheet Change
For expenses
Operating expenses
+ Increase in prepaid
- Decrease in prepaids
OR
+ Decrease in accrued liabilities
- Increase in accrued liabilities
©2008 Pearson Prentice Hall. All rights reserved.12-36
Direct Method Formulas
PAYMENTS
Income Statement
Balance Sheet Change
To employees
Salaries expense
+ Decrease in salaries payable
- Increase in salaries payable
For interest Interest expense
+ Decrease in interest payable
- Increase in interest payable
©2008 Pearson Prentice Hall. All rights reserved.12-37
Direct Method Formulas
PAYMENTS
Income Statement
Balance Sheet Change
For income taxes
Income tax expense
+ Decrease in income tax payable
- Increase in income tax payable
©2008 Pearson Prentice Hall. All rights reserved.12-38
E12-27
Credit sales $60,000
Ending accounts receivable 32,000
Beginning accounts receivable 22,000
Increase in accounts receivable 10,000
Collections from customers
If more customers buy on account, how would that
affect cash flow?
Add or subtract?
©2008 Pearson Prentice Hall. All rights reserved.12-39
E12-27
Cost of goods sold $111,000
Ending inventory 21,000
Beginning inventory 24,000
Decrease in inventory (3,000)
Ending accounts payable 8,000
Beginning accounts payable 14,000
Decrease in accounts payable 6,000
Payments to suppliers $114,000
©2008 Pearson Prentice Hall. All rights reserved.12-40
Direct Method
• Noncash expenses not listed Depreciation, depletion and amortization
• Gains and losses not included Gain or loss does not equal cash received Cash proceeds included as an investing
inflow
• Investing and financing activities reported as explained previously
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