“How Well Am I Doing?” Statement of Cash Flows Chapter 15 McGrawHill/Irwin Copyright © 2010 by The McGrawHill Companies, Inc. All rights reserved Purpose of the Statement of Cash Flows Are Arecash cashflows flows sufficient sufficientto to support supportongoing ongoing operations? operations? Will Willthe the company company have haveto to borrow borrow money moneyto to make make needed needed investments? investments? Can Canwe wemeet meet our our obligations obligations to to creditors? creditors? Why Why is isthere thereaa difference difference between betweennet net income income and and net net cash cashflow? flow? Can Canwe we pay pay dividends? dividends? 15-2 Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents Currency and Bank Accounts Treasury Bills Cash Money Market Funds Commercial Paper 15-3 Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts 15-4 Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Increases in noncash asset accounts imply uses of cash Example: Inventory is purchased on credit from a supplier It is implied that cash was used to acquire the inventory 15-5 Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Increases in liability accounts imply sources of cash Example: Inventory is purchased on credit from a supplier It is implied that an increase in a payable has the effect of increasing cash available for other uses 15-6 Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Decreases in noncash assets accounts imply sources of cash Example: Accounts receivable decreases when a customer pays their bill When the customer pays the bill, the company’s cash increases 15-7 Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Decreases in liability accounts imply uses of cash Example: Example: A A company company pays pays aa note note payable payable held held by by aa creditor creditor When the payment is made, cash decreases 15-8 The Full-Fledged Statement of Cash Flows: Operating Activities Operating activities are those activities that enter into the determination of net income Transactions affecting current assets Transactions affecting current liabilities Changes in noncurrent balance sheet accounts that directly affect net income 15-9 The Full-Fledged Statement of Cash Flows: Investing Activities Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets Acquiring or selling property, plant and equipment Acquiring or selling securities Lending money to another entity and subsequently collecting on the loan 15-10 The Full-Fledged Statement of Cash Flows: Financing Activities Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners Issuing stock and purchasing treasury stock Issuing longterm debt and repayment of debt Payment of dividends (note that interest on debt is classified as an operating activity) 15-11 The Full-Fledged Statement of Cash Flows: An Overview Operating Activities: Net income Changes in current assets Changes in noncurrent assets that affect net income (e.g., depreciation) Changes in current liabilities (except for debts to lenders and dividends payable) Changes in noncurrent liabilities that affect net income Investing Activities: Changes in noncurrent assets that are not included in net income Financing Activities: Changes in the current liabilities that are debts to lenders rather than obligations to suppliers, employees, or the government Changes in noncurrent liabilities that are not included in net income Changes in capital stock accounts Dividends 15-12 The Full-Fledged Statement of Cash Flows: An Overview Operating Activities Investing Activities Financing Activities Reconciliation of the beginning cash balance with the ending cash balance Noncash Investing and Financing Activities 15-13 Operating Activities Sources of cash are added to net income and uses of cash are deducted from net income 15-14 Other Issues: Direct Method or Indirect Method? Two Formats for Reporting Operating Activities Direct Method Indirect Method Reports the cash effects of each operating activity Starts with accrual net income and converts to cash basis No matter which format is used, the same amount of net cash provided by operating activities is generated 15-15 A Full-Fledged Statement of Cash Flows: An Example Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut 15-16 A Full-Fledged Statement of Cash Flows: An Example Let’s also refresh our memory regarding the following additional information There There was was aa net net loss loss for for the the year year of of $27,000 $27,000 Depreciation Depreciation charges charges for for the the year year were were $6,000 $6,000 During During the the year, year, Ed Ed sold sold land land originally originally costing costing $32,000 $32,000 for for $32,000 $32,000 During During the the year, year, Ed Ed purchased purchased equipment equipment for for $28,000 $28,000 During During the the year, year, Ed Ed paid paid dividends dividends of of $3,000 $3,000 to to the the stockholders stockholders Ed Ed issued issued $50,000 $50,000 of of common common stock stock to to settle settle the the note note due due to to Joe Joe Doe Doe 15-17 Example – Indirect Method In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity 15-18 Free Cash Flows Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities 15-19 Computing Net Cash Provided by Operating Activities The direct method computes net cash provided by operating activities by reconstructing the income statement on a cash basis from top to bottom Net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method 15-20 Similarities and Differences in Handling Data Revenue or Expense Item Sales revenue (as reported) Adjustments to a cash basis: Increases in accounts receivable Decreases in accounts receivable Cost of goods sold (as reported) Adjustments to a cash basis: Increase in merchandise inventory Decrease in merchandise inventory Increase in accounts payable Decrease in accounts payable Operating expenses (as reported) Adjustments to a cash basis: Increase in prepaid expenses Decrease in prepaid expenses Increase in accrued liabilities Decrease in accrued liabilities Period's depreciation, depletion and amortization charges Income tax expense (as reported) Adjustments to a cash basis: Increase in accrued taxes payable Decrease in accrued taxes payable Increase in deferred income taxes Decrease in deferred income taxes Add (+) or Deduct (-) to Adjust to a Cash Basis + + + + + - + + Adjustments for accounts that affect revenue are the same in the direct and indirect methods Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods 15-21 The Direct Method: An Example Notice that the net cash provided by operating activities agrees with that computed using the indirect method 15-22 End of Chapter 15 15-23 ... its net cash provided by operating activities 15-19 Computing Net Cash Provided by Operating Activities The direct method computes net cash provided by operating activities by reconstructing the... of cash Example: Example: A A company company pays pays aa note note payable payable held held by by aa creditor creditor When the payment is made, cash decreases 15-8 The Full-Fledged Statement... and converts to cash basis No matter which format is used, the same amount of net cash provided by operating activities is generated 15-15 A Full-Fledged Statement of Cash Flows: An Example Let’s