Statement of Cash Flows

Statement of Cash Flows
Chapter 13
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
13-1
Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Understanding the Business

Positive cash flows permit a company to . . .
Pay
dividends to
owners.
Take advantage
of market
opportunities.
Expand its
operations
.
Replace
needed assets.
Wall
Wall Street
Street analysts
analysts consider
consider cash
cash flow
flow an
an
important
important indicator
indicator of
of aa companys
companys
financial
financial health.
health.
13-2
Classifications of the Statement of

Cash Flows
Cash
Equivalents
Cash
Cash
Short-term,
Short-term,highly
highlyliquid
liquidinvestments.
investments.
Readily convertible into cash.
13-3
Currency
Readily convertible into cash.
So
Sonear
nearmaturity
maturitythat
that market
marketvalue
value is
isunaffected
unaffected by
by
interest
interest rate
ratechanges
changes(i.e.,
(i.e.,original
original maturities
maturitiesof
ofless
less
than
than33months).
months).
Classifications of the Statement of

Cash Flows
13-4
Operating
Activities
Cash inflows and outflows

directly related to earnings
from normal operations.
Investing
Activities
Cash inflows and outflows related to

the acquisition or sale of productive
facilities and investments in the
securities of other companies.
Financing
Activities
Cash inflows and outflows related to

external sources of financing
(owners and creditors) for the
enterprise.
CASH INFLOWS
Operating Activities
Cash received
from revenues
Investing Activities
Sale of operational assets
Sale of investments
Collections of loans
Financing Activities
Issuance of stock
Issuance of bonds
and notes
Business
Cash paid for
expenses
Purchase of operational
assets
Purchase of investments
Loans to others
Payment of dividends
Repurchase of stock
Repayment of debt
CASH OUTFLOWS
13-5
This
Thisending
endingcash
cash
balance
balanceshould
should
agree
agreewith
withthe
the
balance
balance sheet.
sheet.
13-6
Direct Method vs. Indirect Method

Two Formats for Reporting Operating Activities
13-7
Direct Method
Indirect Method
Reports the
cash effects of
each operating
activity
Starts with
accrual net
income and
converts to
cash basis
Note that no matter which format is used, the same

amount of net cash flows from operating activities is
generated.
Cash Flows from Operating Activities

Inflows
Inflows
Cash
Cashreceived
receivedfrom:
from:
Customers
Customers
Dividends
Dividendsand
andinterest
intereston
on
investments
investments
Outflows
Outflows
Cash
Cashpaid
paidfor:
for:
Purchase
Purchase of
of goods
goods for
forresale
resale
and
andservices
services(electricity,
(electricity,etc.)
etc.)
Salaries
Salariesand
andwages
wages
Income
Incometaxes
taxes
Interest
Intereston
onliabilities
liabilities
13-8
Cash
Cash
Flows
Flows
from
from
Operating
Operating
Activities
Activities
Cash Flows from Investing Activities

Inflows
Inflows
Cash
Cashreceived
receivedfrom:
from:
Sale
Saleor
ordisposal
disposalof
of property,
property,
plant
plantand
andequipment
equipment
Sale
Saleor
ormaturity
maturity of
of investments
investments
in
insecurities
securities
Outflows
Outflows
Cash
Cashpaid
paidfor:
for:
Purchase
Purchaseof
ofproperty,
property,plant
plant and
and
equipment
equipment
Purchase
Purchaseof
ofinvestments
investmentsin
in
securities
securities
13-9
Cash
Cash
Flows
Flows
from
from
Investing
Investing
Activities
Activities
Cash Flows from Financing Activities

Inflows
Inflows
Cash
Cashreceived
receivedfrom:
from:
Borrowings
Borrowingson
onnotes,
notes,
mortgages,
mortgages,bonds,
bonds,etc.
etc.from
from
creditors
creditors
Issuing
Issuingstock
stock to
toowners
owners
Outflows
Outflows
Cash
Cashpaid
paidfor:
for:
Repayment
Repaymentof
ofprincipal
principalto
to
creditors
creditors(excluding
(excludinginterest,
interest,
which
whichisisan
anoperating
operating activity)
activity)
Repurchasing
Repurchasingstock
stockfrom
from
owners
owners
Dividends
Dividendsto
toowners
owners
13-10
Cash
Cash
Flows
Flows
from
from
Financing
Financing
Activities
Activities
Relationships to the Balance Sheet and

the Income Statement
Information
Information needed
needed to
to prepare
prepare aa
statement
statement of
of cash
cash flows:
flows:
Comparative
Comparative Balance
Balance Sheets.
Sheets.
Income
Income Statement.
Statement.
Additional
Additional details
details concerning
concerning
selected
selected accounts.
accounts.
13-11

Cash
Cash == Liabilities
Liabilities Stockholders
Stockholders
Equity
Equity Noncash
Noncash Assets
Assets
Derives from . . .
Assets
Assets == Liabilities
Liabilities Stockholders
Stockholders Equity
Equity
13-12

13-13
Reporting and Interpreting Cash Flows

from Operating
The
Theindirect
indirectmethod
methodadjusts
adjustsnet
netincome
income by
byeliminating
eliminating
noncash
noncashitems.
items.
+/+/-Changes
Changesin
incurrent
current
assets
assetsand
andcurrent
current
liabilities.
liabilities.
Net
Net
Income
Income
++Losses
Lossesand
and
--Gains
Gains
13-14
++Noncash
Noncash
expenses
expensessuch
suchas
as
depreciation
depreciationand
and
amortization.
amortization.
Cash
Cash Flows
Flows
from
from Operating
Operating
Activities:
Activities:
Indirect
Indirect Method
Method
Reporting and Interpreting Cash Flows

from Operating
Use this table when adjusting Net Income

to Operating Cash Flows using the
indirect method.
13-15
Adjustment for Gains and Losses

Transactions that cause gains and losses should be
classified on the statement of cash flows as operating,
investing, or financing activities, depending on their
dominate characteristics. For example, if the sale of
equipment produced a gain, it would be classified as an
investing activity.
13-16
Gains
Gains must be subtracted from net

income to avoid double counting the
gain.
Losses
Losses must be added to net income

to avoid double counting the loss.
13-17
13-18
The
TheStatement
Statementof
ofCash
CashFlows
Flowswill
willbegin
begin
with
withnet
net income
incomefrom
fromthe
theIncome
Income
Statement.
Statement.
Step
Step 11
Adjust
Adjust net
net income
income for
for depreciation
depreciation and
and
amortization
amortization expense.
expense.
13-19
Step
Step 22
Adjust
Adjust net
net income
income for
for changes
changes in
in
current
current assets
assets and
and current
current liabilities.
liabilities.
13-20
13-21
Interpreting Cash Flows from Operating

Activities
A common rule of thumb followed by financial and credit
analysts is to avoid firms with rising net income but
falling cash flow from operations.
Investors will not invest in a company if they do
not believe that cash generated from operations
will be available to pay them dividends or expand
the company.
Creditors will not lend money if they do not believe

that cash generated from operations will be
available to pay back the loan.
13-22
International PerspectiveIFRS
Classification of Interest on the Cash Flow Statement
U.S. GAAP and IFRS differ in the

cash flow statement treatment of
interest received and interest paid.
These differences are currently on the agenda of

the joint FASB/IASB financial statement
presentation project.
13-23
Quality of Income Ratio

Quality of = Cash Flow from Operating Activities
Income Ratio
Net Income
In general, this ratio measures the portion of

income that was generated in cash. All other
things equal, a higher quality of income ratio
indicates greater ability to finance operating
and other cash needs from
operating cash inflows.
13-24
13-25
We
We must
must report
report
individually
individually the
the
cash
cash used
used to
to
purchase
purchase
equipment
equipment and
and
the
the cash
cash
proceeds
proceeds
received
received from
from
the
the sale
sale of
of
equipment.
equipment.
13-26
Although
Although
short-term
short-term
investments
investments
is
is aa current
current
asset,
asset, itit is
is
reported
reported in
in
the
the investing
investing
section
section on
on
the
the
statement
statement of
of
cash
cash flows.
flows.
13-27
Capital Acquisitions Ratio

Capital
Acquisitions = Cash Flow from Operating Activities
Cash Paid for Property, Plant,
Ratio
and Equipment
In general, this ratio reflects the portion

of purchases of property, plant and
equipment financed from operating
activities. A high ratio indicates less
need for outside financing for current
and future expansions.
13-28
Free Cash Flow

Free Cash Flow = Cash Flow from Operating
Activities Dividends Capital Expenditures
In general, this measures a firms

ability to pursue long-term
investment opportunities.
13-29
13-30
The
Thenet
netincrease
increasein
in
Contributed
Contributed
Capital
Capital of
of was
was
caused
caused by
bytwo
two
transactions:
transactions:
Repurchase
Repurchaseof
of
outstanding
outstanding stock
stock
and
and
Proceeds
Proceedsfrom
from the
the
issuance
issuanceof
of
common
common stock.
stock.
13-31
Interpreting Cash Flows from Financing

Activities
The long-term growth of a company is normally
financed from three sources: internally
generated funds, the issuance of stock, and
money borrowed on a long-term basis.
The statement of cash flows shows how
management has elected to fund its growth. This
information is used by analysts who wish to
evaluate the capital structure and growth
potential of a business.
13-32
Completing the Statement and

Additional Disclosures
Three Required Disclosures
1.Reconciliation of net income to cash
flow from operations
2.Noncash investing and financing
activities
3.Cash paid for interest and income
taxes
13-33
Supplement A: Reporting Cash Flows from

Operating ActivitiesDirect Method
Sales revenue
+ Decrease in accounts receivable
- Increase in accounts receivable
= Cash collected from customers
Interest/Dividend revenue
+ Decrease in interest/dividends
receivable
- Increase in interest/dividends
receivable
= Collections of interest/dividends
on investments
+
+
=
13-34
Cost of goods sold

Increase in inventory
Decrease in inventory
Increase in accounts payable
Decrease in accounts payable
Cash payments to suppliers
+
+
=
Other expenses
Increase in prepaid expenses
Decrease in prepaid expenses
Increase in accrued expenses
Decrease in accrued expenses
Cash paid for expenses
+
+
=
Income tax expense

Increase in prepaid income taxes
Decrease in prepaid income taxes
Increase in income taxes payable
Decrease in income taxes payable
Payments of income taxes
Remember that when we prepared the

operating section using the indirect method,
we also arrived at net cash inflow of $35,489.
13-35
Supplement B: Adjustments for Gains and Losses

on Sale of Long-term Assets: Indirect Method
Property, plant, and equipment with an original cost of
$10,000 and accumulated depreciation of $4,000 is sold
for $8,000 cash.
13-36
Because the gain was included in the computation of

income, it is necessary to remove (subtract) the $2,000
gain from the Operating Activities section of the
statement to avoid double counting.
Supplement C: Spreadsheet Approach

The spreadsheet approach offers a
systematic way to keep track of data. A
spreadsheet is organized as follows:
1. Four columns to record dollar amounts are
established (beginning balance, debit changes, credit
changes, and ending balance).
2. On the far left of the top half of the spreadsheet,
each account name from the balance sheet is
entered.
3. On the far left of the bottom half of the spreadsheet,
the name of each item that will be reported on the
statement of cash flows is entered.
13-37
After
entering all
the
transactions
illustrated in
the textbook,
this is what
the
spreadsheet
looks like.
13-38
End of Chapter 13
13-39

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Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Understanding the Business

Classifications of the Statement of

Readily convertible into cash.

Readily convertible into cash.

Classifications of the Statement of

Cash inflows and outflows

Cash inflows and outflows related to

Cash inflows and outflows related to

Direct Method vs. Indirect Method

Note that no matter which format is used, the same

Cash Flows from Operating Activities

Cash Flows from Investing Activities

Cash Flows from Financing Activities

Relationships to the Balance Sheet and

Relationships to the Balance Sheet and

Relationships to the Balance Sheet and

Reporting and Interpreting Cash Flows

Reporting and Interpreting Cash Flows

Use this table when adjusting Net Income

Adjustment for Gains and Losses

Gains must be subtracted from net

Losses must be added to net income

Interpreting Cash Flows from Operating

Creditors will not lend money if they do not believe

U.S. GAAP and IFRS differ in the

These differences are currently on the agenda of

Quality of Income Ratio

In general, this ratio measures the portion of

Capital Acquisitions Ratio

In general, this ratio reflects the portion

Free Cash Flow

In general, this measures a firms

Interpreting Cash Flows from Financing

Completing the Statement and

Supplement A: Reporting Cash Flows from

Cost of goods sold

Income tax expense

Remember that when we prepared the

Supplement B: Adjustments for Gains and Losses

Because the gain was included in the computation of

Supplement C: Spreadsheet Approach

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