STATEMENT OF CASH FLOWS

1. STATEMENT OF CASH FLOWS

2. CASH FLOW REPORTINGTHE TREND TOWARD CASH FLOWS • Increased Business Risk • Growing bankruptcy rate in the 70’s and 80’s • The problem of uneven cash flows for small companies • Cash flow information helps investors avoid losses from business failures.

3. CASH FLOW REPORTINGThe Trend Toward Cash Flows • Previous Funds Statements • Statement of Changes in Financial Position (APB Opinion No. 19) • Cash Basis or Working Capital Basis • Differences between Cash and Accrual Accounting • GAAP is increasingly complex. • Cash flow information is important in the short run.

4. ( ) Operating Necessary Operating Debt Cash and Capital Service Receipts Expenditures Payments - + CASH FLOW REPORTINGTHE USEFULNESS OF CASH FLOWS • Free cash flow • Financial flexibility • the ability to use cash flows to meet unexpected needs and opportunities

5. STATEMENT OF CASH FLOWSPURPOSES The Statement helps users assess : • a firm’s ability to generate cash. • a firm’s ability to meet its obligations. • the reasons for differences between income and associated cash flows. • the effect of cash and noncash investing and financing activities on a firm’s financial position. • The effectiveness with which a company’s management has fulfilled its cash stewardship function.

6. SFAS NO. 95 REQUIREMENTSCASH AND CASH EQUIVALENTS • Cash is characterized as those items immediately available to pay obligations. • Cash Equivalents are characterized as • Short-term, highly liquid investments. • Readily convertible into known and fixed amounts of cash. • So near maturity that there is insignificant risk of market value fluctuation from interest rate changes.

7. SFAS NO. 95 REQUIREMENTSCASH AND CASH EQUIVALENTS • Cash is characterized as those items immediately available to pay obligations. • Cash Equivalents are characterized as • Short-term, highly liquid investments. • Readily convertible into known and fixed amounts of cash. • So near maturity that there is insignificant risk of market value fluctuation from interest rate changes. Generally, only investments with an original maturity of 3 months or less.

8. Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Cash T-bills Money Market Funds

9. SFAS NO. 95 REQUIREMENTSCASH FLOW CATEGORIES • Cash Flows from Operating Activities • Can be determined using either the direct method or the indirect method • Cash Flows from Investing Activities • Cash Flows from Financing Activities • Investing and Financing Activities Not Involving Cash

10. Beginning Balance Sheet Ending Balance Sheet Relationship: SCF and the Balance Sheet Change in Cash

11. Beginning Balance Sheet Ending Balance Sheet Relationship: SCF and the Balance Sheet Change in Cash

12. Change in Cash Operating cash flow Investing cash flow Financing cash flow Statement of Cash Flows Beginning Balance Sheet Ending Balance Sheet Relationship: SCF and the Balance Sheet Change in Cash

13. Operating Activities ? • Two presentation methods are permissible: • Direct method • Indirect method • While either method is allowed, more than 90% of companies use the indirect method. Direct Method Indirect Method

14. Direct Method • Details actual net cash inflows and outflows from operations by category. • Indirect Method • Shows net cash inflow (outflow) from operations as an adjustment of net income.

20. OPERATING ACTIVITIES - DIRECT METHOD • Shows major classes of cash flows associated with producing and delivering goods and with providing services • Inflows include: • Receipts from customers from both accounts and trade notes • Advances from customers • Interest and dividends received • Refunds from suppliers • Income Tax Refunds • Proceeds from sale or redemption of trading securities • Proceed from Insurance claims • Other operating inflows (e.g. receipts from lawsuits) Direct Method

21. OPERATING ACTIVITIES - DIRECT • Outflows include: • Payments to suppliers including Notes payable to suppliers short and long term • Payments to employees • Interest payments (net of amount capitalized) • Income and other tax payments • Payments on Operating Leases (Rent) • Prepayments of Expenses • Purchase of trading securities • Other cash operating Expenses • Charitable contributions • Other operating outflows (e.g. remittance of amounts withheld from employees)

22. CASH COLLECTED FROM CUSTOMERS Gross Sales SG Sales Discounts Sales Allowances Sales Returns Net Sales SN Beg. Bal. A/R Gross (net)* A/RGB Beg. Bal. N/R--Trade Gross (net)* N/RGB End. Bal. Advances From Customers (unearned rev.) UE Total Possible Cash Collected from Customers Less What Was Not Collected: Beg. Bal. Advances From Customers (unearned rev.) UB End. Bal. A/R Gross (net)* A/RGE End, Bal. N/R--Trade Gross (net)* N/RGE Write-offs of A/R and N/R--Trade WA/R ; WN/RT Cash Collected from Customers CC Cash Flow and Accrual Accounting Relationships *If net A/R and N/R-T are used, then deduct Bad Debt Expense rather than Write-offs.

23. SALES ANDCASH COLLECTED FROM CUSTOMERS Cash Flow and Accrual Accounting Relationships ACCRUAL TO CASH BASIS CC = SN + A/RGB + N/RTGB+ UE - UB - A/RE - N/RTE - UB- W A/R - W N/RT OR CC = SN±  A/RG ±  N/RTG ±  U- W A/R - W N/RT Where: decreases in assets are added (increases are deducted) decreases in liabilities are deducted ( increases are added) CASH BASIS TO ACCRUAL SN = CC- A/RGB - N/RTGB - UE + UB + A/RE + N/RTE + UB +WA/R +W N/RT OR SN = CC ±  A/RG ±  N/RTG ±  U +WA/R +W N/RT Where: Increases in assets are added (decreases are deducted) increases in liabilities are deducted (decreases are added)

24. SALES ANDCASH COLLECTED FROM CUSTOMERS Cash Flow and Accrual Accounting Relationships ACCRUAL TO CASH BASIS CC = SN ±  A/RG ±  N/RTG ±  U- W A/R - W N/RT Where: decreases in assets are added (increases are deducted) decreases in liabilities are deducted ( increases are added) Note: decreases in assets such as A/R increase Cash; whereas, increases in unearned revenues increase Cash CASH BASIS TO ACCRUAL SN = CC ±  A/RG ±  N/RTG ±  U +WA/R +W N/RT Where: Increases in assets are added (decreases are deducted) increases in liabilities are deducted (decreases are added) Note: increases in assets such as A/R increase Sales; whereas, increases in unearned revenues increase cash but are not revenues until earned

25. Feel Like You're in over your head? DON’T ! While the symbolic notation allows for more parsimonious mathematical formulas. It need not be used. The instructor prefers to use the longer narrative and tabular form to write the equations. However, if you feel comfortable with mathematical notation. You may wish to use it and/or use your own symbols

26. CASH RECEIVED FROM INTEREST Interest Income I Beg. Bal. Interest Receivable IRRB Amortization of Bond Investment and Note Receivable Discounts DA Total Possible Cash Received from Interest Less Cash Not Received: End. Bal. Interest Receivable IRRE Amortization of Bond Investment and Note Receivable Premiums PA Cash Received from Interest CI Cash Flow and Accrual Accounting Relationships ACCRUAL TO CASH BASIS CI = (I + IRRB + DA - IRRE - PA ) CASH BASIS TO ACCRUAL I = (CI + IRRE + PA - IRRB - DA )

27. If you wish to digress to cover Bonds and amortization of premiums or discounts PRESS SPACE BAR OR CLICK MOUSE To Skip ENTER 40

28. Bond Premium and Discount? I can ‘t remember how it affects interest income or expense !! A Brief Digression will help you to understand more fully the effect of premium and discount on interest income and interest expense

29. Bond Investment 100 Five-year $1,000 Bonds; Cash Rate 8%, Market Rate 10% Interest Paid Semi-annually What would be the price of the bond at issue date if it is issued at an interest payment date, (I.e. there is no accrued interest on the bond)? • Two Cash Flow which must discounted: • Single sum to be received 5 years from now • A series of 10 interest payments $100,000 (PV 5%,10 pds.) = $100,000(.61391) = $61,391 $4,000 (PVA 5%, 10 pds.) = $4,000 (7,72173) = $30,887 $92,278 Bonds Were Purchased At A Discount

30. Bond Investment $100,000; Cash Rate 8%, Market Rate 10% Interest Paid Semi-annually

31. Bond Investment $100,000; Cash Rate 8%, Market Rate 10% Interest Paid Semi-annually 5%($92,278) Beg. Carrying Value 4%(100,000)

32. Bond Investment $100,000; Cash Rate 8%, Market Rate 10% Interest Paid Semi-annually Interest Income - Cash Interest $4,614 - $4,000 Beg. Bal - Amort. This period $7,722-$614 Face - End. Bal. of Unamortized Disc. $100,000 - $7,108 = $92,892

33. Bond Investment $100,000; Cash Rate 8%, Market Rate 10% Interest Paid Semi-annually Beg. Bal - Amort. This period $7,108-$614 Interest Income - Cash Interest $4,645 - $4,000 Face - End. Bal. of Unamortized Disc. $100,000 - $6,463

34. Bond Investment $100,000; Cash Rate 8%, Market Rate 10% Interest Paid Semi-annually

35. Bond Investment 100 Five-year $1,000 Bonds; Cash Rate 10%, Market Rate 8% Interest Paid Semi-annually What would be the price of the bond at issue date if it is issued at an interest payment date, (I.e. there is no accrued interest on the bond)? • Two Cash Flow which must discounted: • Single sum to be received 5 years from now • A series of 10 interest payments $100,000 (PV 4%,10 pds.) = $100,000(.67556) = $67,556 $5,000 (PVA 4%, 10 pds.) = $5,000 (8.1109) = $40,555 $108,101 BONDS WERE BOUGHT AT A PREMIUM

36. BOND INVESTMENT $100,000: CASH RATE 10%, MARKET RATE 8% INTEREST PAID SEMI-ANNUALLY 5%(100,000) $8,101 - $676 4%(108,101) $5,000 - $4,324 $100,000 + $7,425

37. BOND INVESTMENT $100,000: CASH RATE 10%, MARKET RATE 8% INTEREST PAID SEMI-ANNUALLY

38. Market Rate of Interest > Cash Rate = Discount • Market Rate of Interest < Cash Rate = Premium • BOND OR NOTE INVESTMENT • Discount increases interest income • Premium decreases interest income • BOND OR NOTE PAYABLE • Discount increases interest expense • Premium decreases interest expense OK I’ve got it !

39. Now Back To Cash Flow !

40. CASH RECEIVED FROM DIVIDENDS Dividend Income DI Beg. Bal. Dividends Receivable DRRB Dividends Received From Investments Under Equity Method DE ( under the equity method dividends received reduces the investment account ) Total Possible Cash Received from Interest Less Cash Not Received: End. Bal. Dividends Receivable DRRE Cash Received from Dividends CD Cash Flow and Accrual Accounting Relationships ACCRUAL TO CASH BASIS CD = (DI + DRRB + DE - DRRE ) CASH BASIS TO ACCRUAL DI = (CD + DRRE - DRRB - DE)

41. CASH RECEIVED FROM SALE OF TRADING SECURITIES Beg. Carrying Value of Trading Securities (Cost ± Market Value Adjustment Allowance) CVTB Unrealized Holding Gain ( - Loss) HG/L Purchases of Trading Securities PT Total Possible Ending Carrying Value Of Trading Securities Less : Actual Ending Carrying Value of Trading Securities CVTE Carrying Value of Trading Securities Sold or Redeemed Realized Gain(- Realized Loss) RG/L Cash Proceeds From Sale or Redemption of Trading Securities CTS Cash Flow and Accrual Accounting Relationships ACCRUAL TO CASH BASIS CASH BASIS TO ACCRUAL CTS = (CVTB ± HG/L + PT – CVTE ± RG/L) CVTE =(CVTB± HG/L + PT ± RG/L–CTS)

42. CASH RECEIVED FROM SALE OF TRADING SECURITIES Beg. Carrying Value of Trading Securities (Cost ± Market Value Adjustment Allowance) CVTB Unrealized Holding Gain ( - Loss) HG/L Purchases of Trading Securities PT Total Possible Ending Carrying Value Of Trading Securities Less : Actual Ending Carrying Value of Trading Securities CVTE Carrying Value of Trading Securities Sold or Redeemed Realized Gain(- Realized Loss) RG/L Cash Proceeds From Sale or Redemption of Trading Securities CTS Cash Flow and Accrual Accounting Relationships Please note that when dealing with accounts that are affected by numerous different types of transactions such as in this case, or for plant and equipment , land, bonds, stock, etc. Additional information must be obtained or given to complete the analysis. If there are both sales and purchases, one of them must be given or obtained from the accounting records. As with any equation with “n” variables, if you know “n-1”, you can solve for the missing value. We will use this same data and relationships to solve for Purchases ot Trading Securities for cash outflows. ACCRUAL TO CASH BASIS CASH BASIS TO ACCRUAL CTS = (CVTB ± HG/L + PT – CVTE ± RG/L) CVTE =(CVTB± HG/L + PT ± RG/L–CTS)

43. CASH PAID TO SUPPLIERS Cost of Goods Sold CGS Ending Inventory INE Goods Available for Sale Beginning Inventory INB Delivered Cost of Purchases (net of discounts, returns and allowances) P Beginning Balance of Accounts Payable A/PB Beginning Balance of Notes Payable--Trade N/PB End. Balance of Advances to Suppliers (special receivable) ASE Total Possible Cash Paid to Suppliers Less What Was Not Paid: Beg. Bal. Advances To Suppliers (special receivable) ASB Ending Balance of Accounts Payable A/PE Ending Balance of Notes Payable--Trade N/PE Cash Paid to Suppliers CPS Cash Flow and Accrual Accounting Relationships

44. Cash Flow And Accrual Accounting Relationships • CASH PAID TO EMPLOYEES • Wages Expense WE • Beginning Balance of Wages Payable W/PB • Ending Balance of Advances to Employees AEB • Total Possible Cash Paid to Employees • Less What Was Not Paid: • Beg. Bal. Advances To Employees (special receivable) AEB • Ending Balance of Wages Payable W/PE • Cash Paid to Employees CPE ACCRUAL TO CASH BASIS CPE = (WE + W/PB + AEB- IPPE - DA)

45. CASH PAID FOR INTEREST Interest Expense I Beg. Bal. Interest Payable IPPB Amortization of Bond and Note Payable Premiums PA Total Possible Cash Paid For Interest Less Cash Not Paid: End. Bal. Interest Payable IPPE Amortization of Bond and Note Payable Discounts DA Cash Paid For Interest CI Cash Flow and Accrual Accounting Relationships ACCRUAL TO CASH BASIS CI = (I + IPPB + PA- IPPE - DA) CASH BASIS TO ACCRUAL I = (CI + IPRE +DA- IPPB - PA)

46. CASH PAID FOR TAXES Tax Expense Beg. Bal. Tax Payable Intraperiod Tax on Gains on Disposal of Discontinued Operations Intraperiod Tax on Extraordinary Gains Interperiod Tax on Cumulative Change in Accounting Principle Decrease in Deferred Tax Liability Increase in Deferred Tax Asset Total Possible Cash Paid For Taxes Less Cash Not Paid: End. Bal. Taxes Payable Intraperiod Tax Benefit on Losses on Discontinued Operations Intraperiod Tax Benefit on Extraordinary Losses Interperiod Tax Benefits on Cumulative Change in Accounting Principle Increase in Deferred Tax Liability Decrease in Deferred Tax Asset Cash Paid For Taxes Cash Flow

47. Deferred Taxes ???

48. We will briefly explain inter-period tax allocation and how deferred tax liabilities and deferred tax assets arise. Detailed coverage is in the next course

49. Determined by applying measurement rules established by Internal Revenue Service Multiplied by the tax rate to determine the amount of income taxes currently payable Taxable Income

50. Pretax Accounting Income Determined by applying GAAP Computed only for financial reporting purposes No effect on the amount of taxes actually paid