Chapter 12 - Cash Flow

Chapter 12 - Cash Flow

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How does a company obtain its

cash?

How does a company obtain its

cash?

Where does a company spend its

cash?

Where does a company spend its

cash?

What explains the change in the cash

balance?

What explains the change in the cash

balance?

Purpose of the Statement of Cash Flows

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How did the business fund its

operations?

How did the business fund its

operations?

Did the business borrow any funds or

repay any loans?

Did the business borrow any funds or

repay any loans?

Does the business have sufficient cash to pay its debts as they mature?

Does the business have sufficient cash to pay its debts as they mature?

Did the business make any dividend

payments?

Did the business make any dividend

payments?

Importance of Cash FlowsA1

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CashCashCurrency

Cash Equivalents

A cash equivalent is:A short-term, highly liquid investments.Readily convertible into cash.Sufficiently close to maturity so that market value is unaffected by interest rate changes.

A cash equivalent is:A short-term, highly liquid investments.Readily convertible into cash.Sufficiently close to maturity so that market value is unaffected by interest rate changes.

Measurement of Cash FlowsC1

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The Statement of Cash Flows includes the following three sections:

• Operating Activities• Investing Activities• Financing Activities

Classifying Cash FlowsC 2

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Outflows• Salaries and wages• Payments to suppliers• Taxes and fines• Interest paid to lenders• Other

Outflows• Salaries and wages• Payments to suppliers• Taxes and fines• Interest paid to lenders• Other

Inflows• Receipts from customers• Cash dividends received• Interest from borrowers• Other.

Inflows• Receipts from customers• Cash dividends received• Interest from borrowers• Other.

Operating ActivitiesC 2

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Outflows• Purchasing long-term

productive assets• Purchasing equity

investments• Purchasing debt investments• Other

Outflows• Purchasing long-term

productive assets• Purchasing equity

investments• Purchasing debt investments• Other

Inflows• Selling long-term productive

assets• Selling equity investments• Collecting principal on loans• Other

Inflows• Selling long-term productive

assets• Selling equity investments• Collecting principal on loans• Other

Investing ActivitiesC 2

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Outflows• Pay dividends• Purchasing treasury stock• Repaying cash loans• Paying owners’ withdrawals

Outflows• Pay dividends• Purchasing treasury stock• Repaying cash loans• Paying owners’ withdrawals

Inflows• Issuing its own equity

securities• Issuing bonds and notes• Issuing short- and long-term

liabilities

Inflows• Issuing its own equity

securities• Issuing bonds and notes• Issuing short- and long-term

liabilities

Financing ActivitiesC 2

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Items requiring separate disclosure include:

• Retirement of debt by issuing equity securities.

• Conversion of preferred stock to common stock.

• Purchase of LT asset using a LT note payable (loan).

Items requiring separate disclosure include:

• Retirement of debt by issuing equity securities.

• Conversion of preferred stock to common stock.

• Purchase of LT asset using a LT note payable (loan).

Noncash Investing and Financing

C 3

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QS 12-1

Format of the Statement of Cash Flows

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There are two acceptable methods to determine Cash Flows from Operating Activities:

•Direct Method - Separately list each major item of operating cash payments (I.e. cash paid for merchandise) and operating cash receipts (I.e. cash from customers). Recommended by FASB but more difficult to prepare. Used by less than 5% of all companies.

•Indirect Method - reports net income and then adjusts for items necessary to determine the net cash provided or used by operating activities. Easier to prepare and used by nearly all companies.

There are two acceptable methods to determine Cash Flows from Operating Activities:

•Direct Method - Separately list each major item of operating cash payments (I.e. cash paid for merchandise) and operating cash receipts (I.e. cash from customers). Recommended by FASB but more difficult to prepare. Used by less than 5% of all companies.

•Indirect Method - reports net income and then adjusts for items necessary to determine the net cash provided or used by operating activities. Easier to prepare and used by nearly all companies.

Statement of Cash Flows FormatsC 4

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Both methods result in the same bottom line for the Operating Activities section.

Preparing the Statement of Cash Flows

Compute the net increase/decrease in cash. Compute net cash from operating activities. Compute net cash from investing activities. Compute net cash from financing activities. Prove and report beginning and ending cash

balances.

Net Income

Net Income

Cash Flows from Operating

Activities

Cash Flows from Operating

Activities

97.5% of all companies use the indirect method.97.5% of all companies use the indirect method.

Changes in current assets and current liabilities.

Changes in current assets and current liabilities.

+ Losses and - Gains

+ Losses and - Gains

+ Noncash expenses such as depreciation and

amortization.

+ Noncash expenses such as depreciation and

amortization.

Indirect Method for Operating ActivitiesP2

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Use this table when adjusting Net Income to Operating Cash Flows.

Indirect MethodP2

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East, Inc. reports $125,000 net income for the year ended December 31, 2015.

Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.

During 2015, East reported $12,500 of Depreciation Expense.

East, Inc. reports $125,000 net income for the year ended December 31, 2015.

Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.

During 2015, East reported $12,500 of Depreciation Expense.

What is East, Inc.’s Operating Cash Flow for 2015?

Indirect Method ExampleP2

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Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

For the indirect method, start with net income.

For the indirect method, start with net income.

Indirect Method ExampleP2

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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable

Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable

Cash provided by operating activities

Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

Indirect Method ExampleP2

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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)

Cash provided by operating activities

Indirect Method ExampleP2

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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities

Indirect Method ExampleP2

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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$

If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

Indirect Method ExampleP2

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P2

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Additional Information for 2015:

• Net income was $105,000.

• Cash dividends declared and paid were $40,000.

• Bonds payable of $50,000 were redeemed for $50,000 cash.

• Common stock was issued for $35,000 cash.

Additional Information for 2015:

• Net income was $105,000.

• Cash dividends declared and paid were $40,000.

• Bonds payable of $50,000 were redeemed for $50,000 cash.

• Common stock was issued for $35,000 cash.

P2

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Add noncash expenses and losses.

Subtract noncash revenues and gains.

Add noncash expenses and losses.

Subtract noncash revenues and gains.

Start with accrual-basis net income.

Start with accrual-basis net income.

Then, analyze the changes in current assets and current liabilities.

Then, analyze the changes in current assets and current liabilities.

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P2

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Ex 12-1

Now, let’s complete the investing section.Now, let’s complete the investing section.

P3

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Cash from Investing Activities

Purchase and sale of long-term assets,

Lending and collecting on notes receivable,

Purchase and sale of short-term investments other than cash equivalents & trading securities.

Now, let’s complete the financing section.Now, let’s complete the financing section.

P3

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QS 12-7

Cash Flows from Financing

Generally includes changes in non-current liabilities and equity accounts, such as: Receiving cash from issuing debt or

repaying debt. Receiving cash from or distributing cash

to owners/shareholders.

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QS 12-8

Analyzing Cash Sources and UsesA1

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Used, along with income-based ratios, to assess company performance.

Used, along with income-based ratios, to assess company performance.

Cash flow on total assets =

Operating cash flows Average total assets

Cash Flow on Total AssetsA2

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Let’s look at the Direct Method for preparing the

Cash Flows from Operating Activities section.

(For reference only)

Preparing the Statement of Cash FlowsP5

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Analyzing the Cash Account

Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows under the Direct Method.

P5

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P5

Preparing the Statement of Cash Flows – Direct Method

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