13–1
Chapter 13
The Statement of Cash Flows
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Statement of Cash Flows
Shows how a company’s operating, investing, and financing activities have affected cash during an accounting period
Explains the net increase or decrease in cash
Statement of Cash Flows includes: Cash Cash equivalents Money market accounts Commercial paper U.S. Treasury bills
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How Is the Statement of Cash Flows Used?
Pay dividends and interest
Pay its liabilities
Generate positive future cash flows
Manage cash flows
Investors and creditors assess the company’s ability to
Evaluate financing decisions
Evaluate investment decisions
Determine dividend policy
Assess liquidity
Managers
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Classification of Cash Flows
The statement of cash flows classifies cash receipts and cash payments into categories
Operating Activities
Investing Activities
Financing Activities
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Operating Activities
Involve the cash inflows and outflows from activities that enter into the determination of net income
Cash Inflows Receipts from sale of
goods and services Receipts from sale of
trading securities Interest and dividends
Cash Outflows Payments for wages,
inventory, expenses, taxes
Payments for purchase of trading securities
Trading securities are a type of marketable security that a company buys and sells for the purpose of making a profit in the near term.
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Investing Activities
Involve the acquisition and sale of property, plant, and equipment and other long-term assets, including long-term investments; the acquisition and sale of short-term marketable securities, other than trading securities, and the making and collecting of loans
Cash Inflows Receipts from selling
marketable securities and long-term assets
Collections on loans
Cash Outflows Expenditures on
purchase of securities and assets
Outflows of cash lent to borrowers
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Financing Activities
Obtaining resources from stockholders and providing them with a return on their investments, and obtaining resources from creditors and repaying the amounts borrowed (settling the obligations)
Cash InflowsProceeds from stock
issues and from short- and long-term borrowing
Sales of treasury stock
Cash OutflowsRepayments of loans
(excluding interest) Payments to owners,
including cash dividends
Purchases of treasury stock
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Noncash Investing and Financing Transactions
Significant transactions that involve only long-term assets, long-term liabilities, or stockholders’ equity
Noncash examples: Exchange of long-term
asset for a long-term liability
Settle a debt by issuing capital stock
Take out a long-term mortgage to purchase real estate
Not reflected on the statement of cash flows;
no cash inflows or outflows
Future cash flows are affected, so required to
disclose these transactions in a
separate schedule or at the bottom of the
statement
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Format of the Statement of Cash FlowsSE1/HwkE3
Operating Activities section
Investing Activities section
Financing Activities section
Reconciliation of beg. and end. balances of cash
Indirect method begins with net income and ends with cash flows from operating activities
Cash transactions involving capital expenditures
Ties to cash balances of the balance sheet
Debt, cash stock transactions, dividends, and treasury stock transactions
1
2
3
4
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Analyzing Cash Flows
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Cash-Generating Efficiency (CGE)
Shows the company’s ability to generate cash from its current or continuing operations
Ratios used to calculate CGE:
Cash flow yield Cash flows to sales Cash flows to assets
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Cash Flow Yield
IncomeNet
Activities Operating from FlowsCash Net Yield FlowCash
times3.0 $476
$1,405
Shows how much of net income actually results in operating cash inflows
Amazon.com’s operating activities were generating about $3 of cash for every dollar of net income
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Cash Flows to Sales
Shows how much of net sales actually results in cash inflows
Amazon.com generated positive cash flows to sales of 9.5 percent or in other words that every dollar
of sales generates 9.5 cents in cash
SalesNet
Activities Operating from FlowsCash Net Sales toFlowsCash
9.5% $14,835
$1,405 *
* Rounded
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Cash Flows to Assets
2007 2006 2005
Total Assets 6,485 4,363 3,696
Amazon.com's 2007 Annual Report (in millions)
Shows how much cash is being generated by operations for each dollar of assets
Assets Total Average
Activities Operating from FlowsCash Net Assets toFlowsCash
25.9% 2 $4,363) ($6,485
$1405
*
*Rounded
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Free Cash Flow
Amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level
Net Cash Flows from Operating Activities– Dividends – Purchases of Plant Assets + Sales of Plant Assets Free Cash Flow
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Free Cash Flow (continued) SE2-3/HwkE4
• If free cash flow is positive, the company– Has met all of its planned cash commitments – Has cash available to reduce debt or expand
• If free cash flow is negative, the company will have to– Sell investments– Borrow money – Issue stock in the short term
to continue at its planned level of operation
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Determining Cash Flows from Operating Activities
1. The direct method• Adjusts each item on the income statement to its
cash equivalent• More easily understood by the average reader
There are two methods of converting the income statement from an accrual basis to a cash basis.
Both methods produce the same net figure
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Determining Cash Flows from Operating Activities
2. The indirect method• Lists only necessary adjustments to convert net income
to net cash flows• Superior from an analyst’s perspective• Used by most companies
We will be using the indirect method for determining operating activity cash flows.
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Using the Indirect Method
We start with Net Income and then adjust for those income statement items that do not affect cash.
Cash flows from operating activities
Net income $16,000 Adjustments to reconcile net income to net cash flows from operating activitiesDepreciation $37,000
Gain on sale of investments (12,000)
Loss on sale of plant assets 3,000Changes in current assets and current liabilities
Decrease in accounts receivable 8,000Increase in inventory (34,000)Decrease in prepaid expenses 4,000Increase in accounts payable 7,000Increase in accrued liabilities 3,000Decrease in income taxes payable (2,000) 14,000Net cash flows from operating activities $30,000
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Using the Indirect MethodDepreciation
Depreciation expense appears on the income statement, but involves no outlay of cash
Adjustment: Depreciation
expense added back to net
income for the period
Cash flows from operating activities
Net income $16,000 Adjustments to reconcile net income to net cash flows from operating activitiesDepreciation $37,000
Gain on sale of investments (12,000)
Loss on sale of plant assets 3,000Changes in current assets and current liabilities
Decrease in accounts receivable 8,000Increase in inventory (34,000)Decrease in prepaid expenses 4,000Increase in accounts payable 7,000Increase in accrued liabilities 3,000Decrease in income taxes payable (2,000) 14,000Net cash flows from operating activities $30,000
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Gains and Losses
Do not affect cash flows from operating activities; should be removed from net income
Adjustments: Gain/Losses
subtracted and added to net
income for the period
Cash flows from operating activities
Net income $16,000 Adjustments to reconcile net income to net cash flows from operating activitiesDepreciation $37,000
Gain on sale of investments (12,000)
Loss on sale of plant assets 3,000Changes in current assets and current liabilities
Decrease in accounts receivable 8,000Increase in inventory (34,000)Decrease in prepaid expenses 4,000Increase in accounts payable 7,000Increase in accrued liabilities 3,000Decrease in income taxes payable (2,000) 14,000Net cash flows from operating activities $30,000
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Treatment of Noncash Items
Noncash Item Add to or Deduct from Net Income
Depreciation Expense Add
Amortization Expense Add
Depletion Expense Add
Losses Add
Gains Deduct
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Changes in Current Assets
Decreases in current assets are added to net income Increases in current assets are deducted from net income
Example: Laguna Corporation’s Accounts Receivable decreased by $8,000 as illustrated below.
Accounts Receivable
Beg. Bal. 55,000
End. Bal. 47,000
698,000
706,000
Sales toCustomers
Cash Receipts from Customers
The $8,000 decrease in Accounts Receivable should be added to net income on the statement of cash flows.
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Changes in Current Liabilities
Decreases in current liabilities are deducted from net income Increases in current liabilities are added to net income
Example: Laguna Corporation’s accounts payable increased by $7,000 as illustrated below.
The $7,000 increase in Accounts Payable shouldbe added to net income on the statement of cash flows.
Accounts Payable
Beg. Bal. 43,000
End. Bal. 50,000
554,000
547,000Cash Payments to Suppliers Purchases
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Net Income versus Cash Flows from Operating Activities
Cash flows from operating activities
Net income $16,000 Adjustments to reconcile net income to net cash flows from operating activitiesDepreciation $37,000
Gain on sale of investments (12,000)
Loss on sale of plant assets 3,000Changes in current assets and current liabilities
Decrease in accounts receivable 8,000Increase in inventory (34,000)Decrease in prepaid expenses 4,000Increase in accounts payable 7,000Increase in accrued liabilities 3,000Decrease in income taxes payable (2,000) 14,000Net cash flows from operating activities $30,000
A net income of $16,000, after adjustments, actually yielded $30,000 in positive cash flows from operating activities
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Adjustments for Changes in Current Assets and Liabilities SE4-5/HwkE5-7
Add to Net Income
Deduct from Net Income
Current Assets:
Accounts receivable (net)
Decrease Increase
Inventory Decrease Increase
Prepaid expenses Decrease Increase
Current Liabilities:
Accounts payable Increase Decrease
Accrued liabilities Increase Decrease
Income taxes payable Increase Decrease
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Examining Investment Transactions
To determine cash flows from investing activities, accounts involving cash receipts and cash payments from investing activities are examined individually
Long-term assets
Short-term investments
Investment gains and losses
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Investment Transactions Cash Flows Illustrated
1. Laguna Corporation’s purchases of investments totaled $78,000 during 2010. These transactions, caused a $78,000 decrease in cash flows (cash paid).
2. Laguna sold investments that cost $90,000 for $102,000. This transaction resulted in a gain of $12,000 and caused an increase in cash flows of $102,000 (cash received) .
Investing activities section, statement of cash flows:
Purchase of investments ($78,000) Sale of investments 102,000
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Plant Asset Transactions Cash Flows Illustrated
Examine the Plant Assets account and the related Accumulated Depreciation account
1. Laguna Corporation purchased plant assets totaling $1200,000. These transactions, caused a $120,000 decrease in cash flows (cash paid).
2. Laguna sold plant assets that cost $10,000 and that had accumulated depreciation of $2,000 for $5,000. This transaction resulted in a loss of $3,000 and caused an increase in cash flows of $3,000 (cash received) .
Investing activities section, statement of cash flows:
Purchase of plant assets ($120,000) Sale of plant assets 5,000
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Cash Flows from Investing ActivitiesSE6/HwkE8-9
Cash flows from investing activitiesPurchase of investments ($78,000)Sale of investments 102,000Purchase of plant assets (120,000)Sale of plant assets 5,000Net cash flows from investing activities (91,000)
The transactions for Laguna Corporation we have examined are listed below on its statement of cash flows in the investing activities section:
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Examining Financing Transactions
To determine cash flows from financing activities, accounts involving cash receipts and cash payments from financing activities are examined individually
Short-term borrowings
Long-term liabilities
Stockholders’ equity
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Bonds Payable Transactions Cash Flows Illustrated
Laguna Corporation repaid $50,000 of bonds at face value at maturity. This transaction caused a $50,000 decrease in cash flows (cash paid).
Financing activities section, statement of cash flows: Repayment of bonds ($50,000)
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Common Stock Transactions Cash Flows Illustrated
Laguna Corporation issued 15,200 shares of $5 par value common stock for $175,000. The Common Stock account increased by $76,000, and the Additional Paid-in Capital account increased by $99,000. This transaction caused an $175,000 increase in cash flows (cash received).
Financing activities section, statement of cash flows:
Issue of common stock $175,000
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Dividend Transactions Cash Flows Illustrated
Laguna Corporation paid cash dividends in the amount of $8,000. This amount decreased Retained Earnings. This transaction caused a $8,000 decrease in cash flows (cash paid).
Financing activities section, statement of cash flows: Payment of dividends ($8,000)
Only the payment of dividends appears on the statement of cash flows, not the declaration of dividends.
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Treasury Stock Transactions Cash Flows Illustrated
Laguna Corporation purchased treasury stock for $25,000. This transaction created a cash outflow of $25,000.
Financing activities section, statement of cash flows:
Purchase of treasury stock ($25,000)
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Cash Flows from Financing ActivitiesSE7/HwkE10
Cash flows from financing activitiesRepayment of bonds ($50,000)Issue of common stock 175,000Payment of dividends (8,000)Purchase of treasury stock (25,000)Net cash flows from financing activities 92,000
The transactions of Laguna Corporation that we have examined are presented in the financing section of the statement of cash flows:
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Statement of Cash FlowsHwkE11
Laguna Corporation Statement of Cash Flows
For the Year Ended December 31, 2010
Net cash flows from operating activities $30,000 Net cash flows from investing activities (91,000)Net cash flows from financing activities 92,000Net increase (decrease) in cash $31,000 Cash at beginning of year 15,000Cash at end of year $46,000
All three sections are presented in summary form here, followed by the net increase or decrease in cash:
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Noncash Transaction Illustrated
Laguna Corporation issued bonds at face value ($100,000) for plant assets. There are no cash inflows or outflows, but it is a significant transaction.
Schedule of Noncash Investing and Financing Transactions:
Issue of bonds payable for plant assets $100,000
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