Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER 18 CASH FLOW STATEMENT PURPOSE OF THE CASH FLOW STATEMENT • The primary purpose of the cash flow statement is to provide information about the cash receipts and cash payments of an entity during a period • A secondary objective is to provide information about its – Operating activities – Investing activities – Financing activities MEANING OF CASH FLOWS • The cash flow statement is usually prepared using cash and cash equivalents as its basis • Cash equivalents are short-term, highly liquid investments that are both readily convertible to known amounts of cash, and so near to their maturity that their market value is relatively insensitive to changes in interest rates CLASSIFICATION OF CASH FLOWS • Operating activities • Investing activities • Financing activities OPERATING ACTIVITIES • Include – Cash effects of transactions that create revenues and expenses and – Enter into determination of net income (loss) Balance Sheet: Noncash Cur r ent Assets and Cur r ent Liabilities; Income Statement Items INVESTING ACTIVITIES • Include – Purchasing and disposing of investments and productive long-lived assets using cash and – Lending money and collecting the loans Balance Sheet: Investment and Long-Ter m Asset Items FINANCING ACTIVITIES • Include – Obtaining cash from issuing debt and repaying the amounts borrowed and – Obtaining cash from owners/shareholders and paying them drawings/dividends Balance Sheet: Long-Ter m Liability and Equity Items SIGNIFICANT NONCASH ACTIVITIES • If it does not affect cash, NOT report in body of cash flow statement • Report in separate note to the financial statements ILLUSTRATION 18-2 FORMAT OF CASH FLOW STATEMENT Operating, investing, and financing plus the significant noncash investing and financing activities constitute the general format of the cash flow statement, an example of which is shown on the right COMPANY NAME Cash Flow Statement Period Covered Cash flows from operating activities (List of individual items) Net cash provided (used) by operating activities XXX Cash flows from investing activities (List of individual items) Net cash provided (used) by investing activities XXX Cash flows from financing activities (List of individual items) Net cash provided (used) by financing activities XXX Net increase (decrease) in cash XXX Cash at beginning of period XXX XX XX XX CASH PAYMENTS TO SUPPLIERS • The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is: Cash payments to suppliers = Cost of goods sold { + Increase in inventory or – Decrease in inventory { + Decrease in accounts payable or – Increase in accounts payable CASH PAYMENTS FOR OPERATING EXPENSES • The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is: Cash payments for services = Operating dxpenses { { + Increase in prepaid + Decrease in accrued expenses expenses or payable – Decrease in or prepaid expenses – Increase in accrued CASH PAYMENTS FOR INCOME TAX • The relationships among cash payments for income tax, income tax expense, and changes in income tax payable is: Cash payments for income tax = Income tax expense { + Decrease in income tax payable or – Increase in income tax payable NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Direct Method – Sample Format COMPUTER SERVICES CORPORATION Cash Flow Statement – Direct Method For the Year Ended December 31, 2002 Cash flows from operating activities Cash receipts from customers Cash payments: To suppliers For operating expenses For income tax Net cash used by operating activities $12 ($75,000) (36,000) (10,000) (121,000) ( STEP 3: DETERMINE NET CASH PROVIDED (USED) BY INVESTING AND FINANCING ACTIVITIES NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES • Study the balance sheet to determine changes in investments and long-term assets • Changes in each short-term investment (unless incorporated as part of cash definition) and longterm account are analysed using selected transaction data to determine the effect, if any, the changes had on cash NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES • Study the balance sheet to determine changes in noncurrent liabilities and owner’s/shareholders’ equity • Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash ILLUSTRATION 18-8 CASH FLOW STATEMENT INDIRECT METHOD COMPUTER SERVICES COMPANY Cash Flow Statement — Indirect Method For the Year Ended December 31, 2002 Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable Increase in inventory Increase in accounts payable Increase in accrued expenses payable Net cash used by operating activities Cash flows from investing activities Purchase of equipment Net cash used by investing activities Cash flows from financing activities Issue of common shares Payment of cash dividend Net cash provided by financing activities Net increase in cash Cash, January Cash, December 31 $ 35,000 $ (30,000) (25,000) 15,000 4,000 (36,000) (1,000) $ (10,000) (10,000) $ 60,000 (15,000) 45,000 34,000 $ 34,000 Operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash ILLUSTRATION 18-23 CASH FLOW STATEMENT DIRECT METHOD COMPUTER SERVICES CORPORATION Cash Flow Statement For the Year Ended December 31, 2002 Cash flows from operating activities The cash flow Cash receipts from customers $120,000 statement Cash payments: To suppliers shows that $(75,000) For operating expenses (36,000) operating For income tax activities used (10,000) (121,000) Net cash provided by operating activities$1,000 cash (1,000) Cash flows from investing activities and investing Purchase of equipment activities used $(10,000) Net cash used by investing activities (10,000) $10,000 cash, Cash flows from financing activities while Issue of common shares $ 60,000 financing Payment of cash dividends (15,000) activities Net cash provided by financing activities 45,000 provided Net increase in cash 34,000 $45,000 cash Cash, January Cash, December 31 $ 34,000 USING CASH FLOWS TO EVALUATE COMPANY • Liquidity – Cash current debt coverage ratio • Profitability – Cash return on sales ratio – Cash flow per share • Solvency – Cash total debt coverage These ratios are cash-based instead of accrual-based CASH CURRENT DEBT COVERAGE • Cash current debt coverage indicates the amount of cash to pay off current debt that is generated from operating activities • The ratio provides a better picture of liquidity than using the current ratio because it uses cash provided by operating activities rather than the year-end asset balance Cash Provided by Operating Activities ÷ Average Current Liabilities Cash Current Debt Coverage CASH RETURN ON SALES • Cash return on sales indicates how quickly sales are turned into cash • The company is efficient at turning sales into cash when its cash return on sales is greater than its accrual-based counterpart, the profit margin Cash Provided by Operating Activities ÷ Net Sales Cash Return on Sales CASH FLOW PER SHARE • Cash flow per share indicates the cash flow generated for each common share Cash Flow from Operating, Investing, and Financing Activities ÷ Number of Common Shares Cash Flow per Share CASH TOTAL DEBT COVERAGE • Cash total debt coverage indicates the amount of cash to pay off total debt that is generated from operating activities • The ratio is the cash based counterpart to the debt to total assets ratio Cash Provided by Operating Activities ÷ Average Total Liabilities Cash Total Debt Coverage COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd All rights reserved Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd The purchaser may make back-up copies for his / her own use only and not for distribution or resale The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the .. .CHAPTER 18 CASH FLOW STATEMENT PURPOSE OF THE CASH FLOW STATEMENT • The primary purpose of the cash... not affect cash, as shown below Accrual Basis of Accounting Eliminate noncash revenues Earned Revenues Net Income Incurred Expenses Cash Basis of Accounting Net Cash Provided (Used) by Operating... sources: Comparative balance sheet Current income statement Additional information ILLUSTRATION 18- 3 THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENT Step 1: Determine the net increase (decrease)