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“How Well Am I Doing?” Statement of Cash Flows

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  1. Chapter17 “How Well Am I Doing?”Statement of Cash Flows

  2. Purpose of the Statement of Cash Flows Can we meet our obligations to creditors? Are cash flows sufficient to support ongoing operations? Why is there a difference between net income and net cash flow? Will the company have to borrow money to make needed investments? Can we pay dividends?

  3. Currency and Bank Accounts T-bills Commercial Paper Money Market Funds Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Cash

  4. Changes in Capital Stock Changes in Liabilities Dividends Paid to Stockholders Changes in Noncash Assets Net Income Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts Net Cash Flows for a Period

  5. Sources Uses Net Income Always Net Loss Always Changes in noncash assets Decreases Increases Changes in liabilities* Increases Decreases Changes in capital stock accounts Increases Decreases Dividends paid to stockholders Always * Contra assets follow the rules for liabilities. Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts

  6. Constructing the Statement of Cash Flows Using 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.

  7. Constructing the Statement of Cash Flows Using 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.

  8. Constructing the Statement of Cash Flows Using 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 his bill, the company’s cash increases.

  9. I.O.U. Constructing the Statement of Cash Flows Using Noncash Balance Sheet Accounts Decreases in liability accounts imply uses of cash. Example: The company made a payment on a note payable held by a creditor. When the company makes the payment, cash decreases.

  10. XYZ Company Cash Flow Statement For the Period Ending MM/DD/YY I. Operating Activities $ XXX II. Investing Activities XXX III. Financing Activities XXX Net Cash Flows for the Period $ XXX Add: Beg. Cash Balance XXX Ending Cash Balance $ XXX Organizing a Full-Fledged Statement of Cash Flows Cash flows are divided into three categories.

  11. XYZ Company Cash Flow Statement For the Period Ending MM/DD/YY I. Operating Activities $ XXX II. Investing Activities XXX III. Financing Activities XXX Net Cash Flows for the Period $ XXX Add: Beg. Cash Balance XXX Ending Cash Balance $ XXX Organizing a Full-Fledged Statement of Cash Flows A reconciliation of beginning cash to ending cash is also required. {

  12. Net Income (Loss) $ XXX Add: Decr. in Current Noncash Assets XXX Incr. in Current Liabilities XXX Depreciation Charges XXX Losses XXX Less: Incr. in Current Noncash Assets (XXX) Decr. in Current Liabilities (XXX) Gains (XXX) Net Cash Flows from Operating Activities $ XXX Operating Activities Includes those activities that enter into the determination of net income

  13. Change in Account Balance during Period Increase Decrease Current Subtract from Add to Noncash Assets net income net income Current Add to Subtract from Liabilities net income net income Operating Activities Changes in current assets and current liabilities imply changes in cash, as indicated below.

  14. Net Income (Loss) $ XXX Add: Decr. in Current Noncash Assets XXX Incr. in Current Liabilities XXX Depreciation Charges XXX Losses XXX Less: Incr. in Current Noncash Assets (XXX) Decr. in Current Liabilities (XXX) Gains (XXX) Net Cash Flows from Operating Activities $ XXX Change in Account Balance during Period Increase Decrease Current Subtract from Add to Noncash Assets net income net income Current Add to Subtract from Liabilities net income net income Operating Activities

  15. Net Income (Loss) $ XXX Add: Decr. in Current Noncash Assets XXX Incr. in Current Liabilities XXX Depreciation Charges XXX Losses XXX Less: Incr. in Current Noncash Assets (XXX) Decr. in Current Liabilities (XXX) Gains (XXX) Net Cash Flows from Operating Activities $ XXX Change in Account Balance during Period Increase Decrease Current Subtract from Add to Noncash Assets net income net income Current Add to Subtract from Liabilities net income net income Operating Activities

  16. Net Income (Loss) $ XXX Add: Decr. in Current Noncash Assets XXX Incr. in Current Liabilities XXX Depreciation Charges XXX Losses XXX Less: Incr. in Current Noncash Assets (XXX) Decr. in Current Liabilities (XXX) Gains (XXX) Net Cash Flows from Operating Activities $ XXX Operating Activities Depreciation and Amortization charges are added back to net income because they are decreases in noncash assets.

  17. Net Income (Loss) $ XXX Add: Decr. in Current Noncash Assets XXX Incr. in Current Liabilities XXX Depreciation Charges XXX Losses XXX Less: Incr. in Current Noncash Assets (XXX) Decr. in Current Liabilities (XXX) Gains (XXX) Net Cash Flows from Operating Activities $ XXX Operating Activities Gains are subtracted from net income. Losses are added back to net income.

  18. Add: Proceeds from sale of land, buildings, equipment, or other noncurrent assets $ XXX Receipt of principal from investments XXX Less: Payments to acquire land, buildings, equipment, or other noncurrent assets (XXX) Payments to acquire investments (XXX) Net Cash Flows from Investment Activities $ XXX Investing Activities Includes transactions that involve the acquisition or disposal of noncurrent assets.

  19. Add: Proceeds from borrowings $ XXX Proceeds from issuing capital stock XXX Proceeds from sale of bonds XXX Less: Principal payments on borrowed funds (XXX) Payments related to bond maturities (XXX) Dividend payments (XXX) Net Cash Flows from Investment Activities $ XXX Financing Activities Includes transactions involving receipts from or payments to creditors and owners.

  20. For investing activities and financing activities, like-kind inflows and outflows of cash must be shown separately on the statement of cash flows. Example: XYZ sells an old building for $700,000 and purchases a new building for $1,000,000. The $700,000 inflow of cash and the $1,000,000 outflow of cash must be shown separately. Other Cash Flow Issues

  21. Indirect Method Net income is reconciled to cash flow from operating activities. No supplemental schedule is required. Used by 98.8% of companies. Direct Method Net income is reconstructed on a cash basis. Requires a supplemental reconciliation of net income to cash flow from operating activities. Used by 1.2% of companies. Direct Method or Indirect Method?

  22. Example: Bobo, Inc. acquires a building in exchange for 2,000 shares of common stock. This is reported in a separate supplemental schedule attached to the statement of cash flows. Direct exchange transactions occur when noncurrent balance sheet items are swapped. Such exchanges must be disclosed. Other Cash Flow Issues

  23. Interpretation of the Statement of Cash Flows Examine the operating activities section carefully. • Negative cash flow is usually a sign of fundamental difficulties. • Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.

  24. Let’s work an Indirect Method Example

  25. Example - Indirect Method Ed’s Hut is a local pizza restaurant. Ed has prepared an adjusted trial balance as of March 31, 2000. Ed needs help preparing the Statement of Cash Flows. Examine the information provided and prepare a Statement of Cash Flows using the indirect method.

  26. Ed's Hut Comparative Trial Balances 3/31/00 3/31/99 Change DR (CR) DR (CR) Incr. (Decr.) Cash $ 71,000 $ 90,000 $ (19,000) Accounts Receivable 23,000 40,000 (17,000) Inventory 350,000 300,000 50,000 Land 68,000 100,000 (32,000) Equipment 84,000 84,000 - Accumulated Depr. (45,000) (39,000) 6,000 Accounts Payable (38,000) (27,000) 11,000 Salaries Payable (9,000) (14,000) (5,000) Note Payable - Joe Doe - (50,000) (50,000) Common Stock (500,000) (450,000) 50,000 R/E, 3/31/2000 (4,000) N/A R/E, 3/31/1999 (34,000) N/A $ - $ - Example - Indirect Method

  27. Example - Indirect Method • Additional Information: • There was a net loss for the year of $27,000. • Depreciation charges for the year were $6,000. • During the year, Ed sold land originally costing $32,000 for $32,000. • During the year, Ed paid dividends of $3,000 to the stockholders. • Ed issued $50,000 of common stock to settle the note due to Joe Doe.

  28. Ed's Hut Operating Activities Net Loss $ (27,000) Example - Indirect Method Always start with the net income or net loss for the period.

  29. Ed's Hut Operating Activities Net Loss $ (27,000) Add: Decrease in A/R 17,000 Increase in A/P 11,000 Change in Account Balance during Period Increase Decrease Current Subtract from Add to Noncash Assets net income net income Current Add to Subtract from Liabilities net income net income Example - Indirect Method

  30. Ed's Hut Operating Activities Net Loss $ (27,000) Add: Decrease in A/R 17,000 Increase in A/P 11,000 Increase in Depr. Charges 6,000 Example - Indirect Method Depreciation charges represent a decrease in a noncash asset that must be added back to net income.

  31. Ed's Hut Operating Activities Change in Account Balance during Period Net Loss $ (27,000) Increase Decrease Add: Decrease in A/R 17,000 Current Subtract from Add to Noncash Assets net income net income Increase in A/P 11,000 Current Add to Subtract from Increase in Depr. Charges 6,000 Liabilities net income net income Less: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000) Net Cash Flow from Operations (48,000) Example - Indirect Method

  32. Ed's Hut Operating Activities Net Loss $ (27,000) Add: Decrease in A/R 17,000 Increase in A/P 11,000 Increase in Depr. Charges 6,000 Less: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000) Net Cash Flow from Operations (48,000) Example - Indirect Method

  33. Ed's Hut Statement of Cash Flows For the Period Ending March 31, 2000 I. Operating Activities $ (48,000) II. Investing Activities Proceeds from sale of land 32,000 III. Financing Activities Dividends paid to stockholders (3,000) Net Cash Flows for the Period (19,000) Add: Beginning Cash Balance 90,000 Ending Cash Balance $ 71,000 Example - Indirect Method

  34. Ed's Hut Statement of Cash Flows For the Period Ending March 31, 2000 I. Operating Activities $ (48,000) II. Investing Activities Proceeds from sale of land 32,000 III. Financing Activities Dividends paid to stockholders (3,000) Net Cash Flows for the Period (19,000) Add: Beginning Cash Balance 90,000 Ending Cash Balance $ 71,000 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.

  35. End of Chapter 17 Now, this is what I call CA$H FLOW!