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Financial Accounting: Tools for Business Decision Making, 2nd Ed.
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Financial Accounting: Tools for Business Decision Making, 2nd Ed.

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  1. Financial Accounting:Tools for Business Decision Making, 2nd Ed. ELS Kimmel, Weygandt, Kieso Prepared by: Ellen L. Sweatt Georgia Perimeter College

  2. Statement of Cash Flows Chapter 13 `

  3. Chapter 13Statement of Cash Flows After studying Chapter 13, you should be able to: • Indicate the primary purpose of the statement of cash flows. • Distinguish among operating, investing, and financing activities. • Explain the impact of the product life cycle on a company's cash flows. • Prepare a statement of cash flows using one of two approaches: • (a) the indirect method, or • (b) the direct method. • Use the statement of cash flows to evaluate a company.

  4. The Primary Purpose of the Statement of Cash Flows Is... • To provide information about: • cash receipts, • cash payments, and • the net change in cash resulting from: • operating, • investing, and • financing activities of a company during a period.

  5. What was the change in the cash balance? Questions the Statement of Cash Flow Answers Where did the cash come from? What was the cash used for?

  6. Involve Income Statement Items Operating Activities... Include: • The cash effects of transactions that create revenues and expenses and • Enter into determination of net income.

  7. Involve Investments and Long-Term Asset Items Investing Activities... Include: • Purchasing and disposing of investments and productive long-lived assets using cash and • Lending money and collecting the loans.

  8. Involve Long-Term Liability and Stockholders’ Equity Items Financing Activities... Include: • Obtaining cash from issuing debt and repaying the amounts borrowed and • Obtaining cash from stockholders and paying them dividends.

  9. Illustration 13-1 Types of Cash Flows -Operating Activities • Cash inflows: • From sale of goods or services • From interest received and dividends received • Cash outflows: • To suppliers for inventory • To employees for services • To government for taxes • To lenders for interest • To others for expenses

  10. Illustration 13-1 Types of Cash Flows -Investing Activities • Cash inflows: • From sale of property, plant, and equipment • From sale of debt or equity securities of other entities • From collection of principal on loans to other entities • Cash outflows: • To purchase property, plant, and equipment • To purchase debt or equity securities of other entities • To make loans to other entities

  11. Illustration 13-1 Types of Cash Flows -Financing Activities • Cash inflows: • From issuance of equity securities (company's own stock) • From issuance of debt (bonds and notes) • Cash outflows: • To stockholders as dividends • To redeem long-term debt or reacquire capital stock

  12. Operating Activities - ALERT • Some cash flows relating to investing or financing activities are classified as operating activities. For example... • Receipts of investment revenue (interest and dividends) and • Payments of interest to lenders are classified as operating activities because these items are reported in the income statement.

  13. Significant Noncash Activities... • That do not affect cash are NOT reported in the body of the statement of cash flows. • Are reported: • In a separate schedule at the bottom of the statement of cash flows or • In a separate note or supplementary schedule to the financial statements.

  14. Significant Noncash Activities... 1. Issuance of common stock to purchase assets. 2. Conversion of bonds into common stock. 3. Issuance of debt to purchase assets. 4. Exchanges of plant assets.

  15. Format of the Statement of Cash Flows Four parts: • operating • investing • financing • noncash investing and financing activities

  16. The Product Life Cycle • A series of phases all products go through • The phases are often referred to as the: • introductory phase • growth phase • maturity phase • decline phase. • The phase a company is in affects its cash flows.

  17. Introductory Phase To support asset purchases the company may issue stock or debt. Expect: • cash from operations to be negative • cash from investing to be negative. • cash from financing to be positive.

  18. Growth Phase The company is striving to expand its production and sales. Expect: • small amounts of cash to be generated from operations. • cash from investing to be negative. • cash from financing to be positive

  19. Maturity Phase Sales and production level-off Expect: • cash from operations to exceed investing needs • cash from investing to be neutral • cash from financing to be negative

  20. Decline Phase Sales and production decline Expect: • cash from operations to decline • cash from investing to possibly become positive • cash from financing to possibly become negative

  21. Illustration 13-3 Impact of Product Life Cycle on Cash Flows 0

  22. Why Report the Causes of Changes in Cash? Because investors, creditors, and other interested parties want to now what is happening to a company’s most liquid asset, CASH

  23. Statement of Cash Flows Helps Users Evaluate 1. The entity's ability to generate future cash flows 2. The entity's ability to pay dividends and meet obligations 3. The reasons for the difference between net income and net cash provided (used) by operating activities 4. The investing and financing transactions during the period

  24. Statement of Cash Flows Helps Answer the Following Questions • How did cash increase when there was a net loss for the period? • How were the proceeds of the bond issue used? • How was the expansion in the plant and equipment financed? • Why were dividends not increased? • How was the retirement of debt accomplished? • How much money was borrowed during the year? • Is cash flow greater or less than net income?

  25. Sources of Information for the Statement of Cash Flows • Comparative balance sheet • Current income statement • Additional information

  26. Comparative Balance Sheet Indicates the amount of changes in assets, liabilities, and stockholders' equities from the beginning to the end of the period.

  27. COMPUTER SERVICES COMPANY Comparative Balance Sheet December 31, 2000 Illustration 13-5

  28. Current Income Statement Information in this statement helps the reader determine the amount of cash provided or used by operations during the period.

  29. Illustration 13-6 Income Statement and Additional Information COMPUTER SERVICES COMPANY Income Statement For the Year Ended December 31, 2000 Revenues $85,000 Operating expenses 40,000 Income before income taxes 45,000 Income tax expense 10,000 Net income $35,000 Additional Information: (a) Examination of selected data indicates that a dividend of $15,000 was declared and paid during the year. (b) The equipment was purchased at the end of 2000. No depreciation was taken in 2000.

  30. Indirect and Direct Methods • Convert net income from an accrual basis to a cash basis. • This conversion may be done by two methods: • indirect • direct

  31. Indirect and Direct Methods • Both methods arrive at the same total amount for “Net cash.” provided by operating activities. • The methods differ in disclosing the items that make up the total amount. • The choice of methods affects only the operating activities section; the investing and financing activities sections are the same.

  32. Indirect Method • The indirect method is used extensively in practice. • Most companies favor the indirect method for the following reasons: • it is easier to prepare • it focuses on the differences between net income and net cash flow from operating activities • it tends to reveal less company information to competitors.

  33. Direct Method • The FASB prefers the direct method but allows the use of either method. • When the direct method is used, the net cash flow from operating activities as computed using the indirect method must also be reported in a separate schedule.

  34. Illustration 13-4 Steps in Preparing Statement of Cash Flows $34,000 - 0 = $34,000

  35. Statement Of Cash Flows - Indirect Method • The transactions of Computer Services Company for the year ended 2000 are used to illustrate the preparation of a statement of cash flows . • Computer services Company started in January 1, 2000, when it issued 50,000 shares of $1 par value common stock for $50,000 cash. • The company rented its office space and furniture and performed consulting services throughout the first year.

  36. Illustration 13-4 Steps in Preparing Statement of Cash Flows

  37. Determine Net Cash Provided/Used By Operating Activities • Adjust net income for items that did not affect cash. • Net income must be converted because earned revenues may include credit sales that have not been collected in cash and expenses incurred that may not have been paid in cash.

  38. Illustration 13-7 Net Income Versus Net Cash Provided by Operating Activities Add Cash advances Add prepaid expenses

  39. Determine Net Cash Provided/Used By Operating Activities Receivables, payables, prepayments, and inventories must be analyzed for their effects on cash.

  40. Determine Net Cash Provided/Used By Operating Activities • Computer Services Company had revenues of $85,000 in its first year of operations. • However, CSC collected only $55,000 in cash. Accrual basis revenue was $85,000, cash basis revenue would be $55,000. • The increase in accounts receivable of $30,000 must be deducted from net income. • If accounts receivable decrease, the decrease must be added to net income.

  41. Illustration 13-12 COMPUTER SERVICES COMPANY Statement of Cash Flows--Indirect Method (Partial) For the Year Ended December 31, 2000 Cash flows from operating activities Net income $35,000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $(30,000)

  42. Determine Net Cash Provided/Used By Operating Activities • Accounts payable - When accounts payable increase during a year, operating expenses on an accrual basis are higher than they are on a cash basis. • For CSC, operating expenses reported in the income statement were $40,000. • Since Accounts Payable increased $4,000, $36,000 ($40,000 – $4,000) of the expenses were paid in cash. • To convert net income to net cash provided by operating activities, an increase in accounts payable must be added to net income, a decrease subtracted.

  43. Illustration 13-12 COMPUTER SERVICES COMPANY Statement of Cash Flows--Indirect Method (Partial) For the Year Ended December 31, 2000 Cash flows from operating activities Net income $35,000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $(30,000) Increase in accounts payable 4,000(26,000) Net cash provided by operating activities $ 9,000

  44. Illustration 13-4 Steps in Preparing Statement of Cash Flows

  45. Determine Net Cash Provided/Used By Investing and Financing Activities • No data are given for the increases in Equipment of $10,000 and Common Stock of $50,000. Assume any differences involve cash. • The increase in equipment is from a purchase of equipment for $10,000 cash. This purchase is reported as a cash outflow in the investing activities section. • The increase of common stock results from the issuance of common stock for $50,000 cash. It is reported as an inflow of cash in the financing activities section of the statement of cash flows.

  46. COMPUTER SERVICES COMPANY Comparative Balance Sheet December 31, 2000 Illustration 13-5

  47. Determine Net Cash Provided/Used By Investing and Financing Activities • Reasons for the increase of $20,000 in the Retained Earnings. • Net income increased retained earnings by $35,000. REPORTED IN THE OPERATING ACTIVITIES SECTION. • The additional information indicates that a cash dividend of $15,000 was declared and paid.REPORTED IN THE FINANCING ACTIVITIES SECTION.

  48. Illustration 13-12 COMPUTER SERVICES COMPANY Statement of Cash Flows--Indirect Method (Partial) For the Year Ended December 31, 2000 Cash flows from operating activities Net income $35,000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $(30,000) Increase in accounts payable 4,000(26,000) Net cash provided by operating activities $ 9,000 Cash flows from investing activities Purchase of equipment (10,000) Cash flows from financing activities Issuance of Common Stock $50,000 Payment of cash dividends (15,000) Net cash provided by financing activities 35,000 Net increase in cash $34,000

  49. YEAR TWO

  50. Second-Year Operations Illustration 13-13 COMPUTER SERVICES COMPANY Comparative Balance Sheet December 31