Chapter 10

Statement of Cash
Flows
 Statement Of Cash Flows
(Background)
 Required presentation since 1987
Cash and cash equivalents includes
 Cash on hand
 Cash on deposit

 Investments in short-term, highly liquid securities

 Statement Use
 Internal users
 Determine dividend policy

 Evaluate cash generated by operations

 Review investing and financing policy

 External users
 Assess firm’s ability to increase dividends

 Assess firm’s ability to pay debt from operations

 Assess firm’s relationship of cash from

operations to total cash
 STATEMENT OF CASH FLOW

 Indirect Cash Flow Statement Method

 Direct Cash Flow Statement Method
 Statement Structure
(Indirect Method)
Cash flows from operations
+ Cash flows from investing activities
+ Cash flows from financing activities
= Change in cash
+ Beginning cash balance
= Ending cash balance

Supplemental disclosure: non-cash

financing and investing activities
 Operating Activities
The cash effects of transactions and other events that
enter into the determination of net income

Cash inflows from Cash outflows for

• Sale of goods or services • Payments for
• Returns on loans acquisitions of inventory
(interest) • Payments to employees
• Return on equity • Payments for taxes
securities (dividends) • Payments for interest
• Payments for other
expenses
 Investing Activities
Lending money and collecting on those loans and acquiring
and selling investments and productive long-term assets:

Cash inflows from Cash outflows for

• Receipts for loans • Loans to other entities
collected • Investment in debt or
• Sales of debt or equity equity securities
securities • Purchase of plant,
• Sales of plant, property, property, and equipment
and equipment
 Financing Activities

Borrowing and repaying long-term loans; issuing equity

securities; payment of dividends to shareholders:

Cash inflows from Cash outflows for

• Sale of equity securities • Payment of dividends
• Sale of bonds, • Reacquisition of capital
mortgages, notes, and stock
other short- and long- • Payment of amounts
term borrowings borrowed
 Procedures to Develop the Statement of
Cash Flows
Analyze all balance sheet accounts other than cash and cash
Equivalent.
Increase Decrease

Current assets Operating outflow Operating inflow

Non-current assets Investing outflow Investing inflow

Current liabilities Operating inflow Operating outflow

Long-term liabilities Financing inflow Financing outflow

Stockholders’ equity Financing inflow Financing outflow

Chapter 10, Slide #12

OPERATING Cash flow-- Procedure
 Classify all accounts in Balance Sheet &
Income Statement as OPERATING,
INVESTING ,FINANCING.
 Compute changes in all accounts balances.
 Procedure--OPERATING Cash Flow
 Begin with net income.
 OPERATING CASH FLOW
 Add back or deduct adjustments necessary to change income on
accrual basis to cash basis.
 Changes in :--
-- Current non cash assets
-- Current liabilities
-- Add/Deduct Non Cash Items of Income &
Expenditure.
-- Gains & losses (Which are non –cash items ) on Income Statement
relating to investing & financing ( i.e. sale /purchase of
Long Term Assets , bonds / equity securities )
 Add losses
 Deduct gains
 Procedure--Investing & Financing
Cash Flow
 INVESTING CASH FLOW.
Add.
---- Sale of debt and equity securities.
---- Proceeds from sale of fixed assets/equipment. (cash)
Deduct
----Payments made for purchase of fixed assets/equipment
( cash)
---- Purchase of debt and equity securities.

 FINANCING CASH FLOW

Add.
---- Increase in long term liabilities. Loans,
Bonds issued, Shares issued etc.
Deduct
---- Dividends paid. Loans repaid, Bonds retired
 Cash Flow Statement---FORMAT
 Net income (loss)
 Non cash flow items
 Add expenses
 Deduct revenues
 Changes in Balance Sheet accounts relating to operations.
(Current Assets and current liabilities)
 Add decrease in assets/increase in liabilities.
 Deduct increase in assets / decrease in liabilities.

 Gains and losses on Income statement

that are related to investing or financing
 Add losses
 Deduct gains
 NET CASH FROM OPERATIONS.
 Cash Flow Statement---FORMAT
 CASH FLOW FROM INVESTING ACTIVITY
 Add proceeds from sale of Fixed Assets/Equipment
 Deduct payments for purchase of Fixed Assets/Equipment.

 NET CASH FROM INVESTING ACTIVITY

 CASH FLOW FROM FINANCING ACTIVITY

 Add increase in long term liabilities loans ,/bonds issued ,shares
issued
 Deduct decrease in long term liabilities, retirement of bonds,
repayment of loans

 NET CASH FLOW FROM FINANCING ACTIVITY

 NET INCREASE/DECREASE IN CASH

 Balance sheet
December 31, 2004 December 31, 2005 Category
:Assets
Cash 2400 3000 Cash
Accounts Receivable, net 4000 3900 Operating
Inventories 5000 6000 Operating
Total Current Assets 11400 12900
Land 10000 19500 Investing
Equipment 72000 73000 Investing
Accumulated Depreciation )9500( )14000( Operating
Total Assets 83900 91400
Liabilities:
Accounts Payable 4000 2900 Operating
Taxes Payable 1600 2000 Operating
Total Current Liabilities 5600 4900
Bonds Payable 35000 40000 Financing
Shareholders Equity
Common Stock, $ 10 Par 36000 39000 Financing
Retained
Chapter 10, Earning
Slide #18 7300 7500
Total Liabilities & 83900 91400
 Income Statement
2005 )$( Category
Sales 22,000 Operating
Operating Expenses 17,500 Operating
Operating Income 4,500
Gain on Sale of Land 1000 Operating (Non Cash)
Income Before Tax Expense 5,500
Tax Expense 2,000 Operating
Net Income 3,500
Supplemental Information
Dividend declared & Paid 3,300 Financing
Land was Sold For 1,500 Investing
Equipment Purchased 1,000 Investing
Bond Payable Retired 5,000 Financing
Common Stock Sold 3,000 Financing
Chapter 10, Slide #19

Operating Expense Depreciating 4,500 Operating

 Indirect Cash Flow Statement

For The Year Ended December 31, 2005

:Cash Flow From Operating Activities
Net Income 3,500
Add\(Deduct) items not affecting operating
activities:
Depreciation Expense 4,500
Decrease in accounts receivable 100
Increase In Inventory: )1000(
Decrease in accounts payable )1100(
Increase in taxes payable 400
Gain on sale of land )1000(
Net Cash Provided by operating activities 5400
Cash flow from investing Activities:
Proceeds from sale of land 1500
Purchase of equipment )1000(
Net Cash provided by investing activities 500
Cash flow from financing activities
Dividends declared and paid )3300(
Retirement of bonds payable )5000(
Chapter 10, Slide #21
Proceeds from common stock 3000
Net cash used for financing activities )5300(
 CASH FLOW ( DIRECT METHOD)

OPERATING ACTIVITIES
Cash in Flows.

1- From sale of goods or services

2- From return (interest) on loans.
3- from return on equity securities
( dividend)
CASH OUT FLOWS.
1- Payment for purchase of inventories.
2- Payment to employees.
3- Payment to Govt. (Taxes.)
4- Payment of interest expense.
5- Payment to suppliers for other expenses.
 CASH FLOW (DIRECT METHOD)
 INVESTING ACTIVITIES.
Cash inflows
1- Receipts from loans collected.
2- sale of debt or equity securities of
others.
3- sale of property, plant, equipment.
Cash outflows.
1- loans to other entities
2- purchase of debt & equity securities of others.
3- purchase of property, plant & equipment.
CASH FLOW ( DIRECT METHOD)
FINANCING ACTIVITIES
Cash in flows.
1- sale of own equity securities.
2- sale of bonds, mortgages, notes, and
other long & short term borrowings
Cash outflows
1- payment of dividend
2- reacquisition of own capital stock.
3- payment of amount borrowed.
Financial Ratios and the Statement of Cash
Flows
 Statement of cash flows is relatively new
Required presentation began in 1987

 Cash flow financial ratios were slowly developed

 Traditional ratios relate balance sheet to income statement

 Operating Cash Flow/Current Maturities
of Long-Term Debt and Current Notes
Payable
Operating Cash Flow
Current Maturities of Long-Term Debt
and Current Notes Payable

• Indicates a firm’s abilities to meet its current maturities

of debt
• Higher ratio indicates better liquidity
 Operating Cash Flow/Current Maturities
of Long-Term Debt and Current Notes
Payable
 EXHIBIT 10-5 NIKE.INC
 YEAR ENDED MAY 31,2005 & 2004

Operating Cash Flow (A) 1,5707.7 1,518.5

Current Maturity of long
term debt, current notes payable (B) 76.0 152.6
Debt Coverage A / B 20.67 9.95
times times
 Operating Cash Flow to Total Debt

Operating Cash Flow

Total Debt
• Indicates a firm’s ability to cover total debt with the
yearly operating cash flow
• Conservative approach is to include all possible balance
sheet debt
Operating Cash Flow to Total Debt

 EXHIBIT-10-6
NIKE INC.
Year ended May 31, 2005 & 2004
Operating Cash Flow (A) 1,570.7 1,518.5
Total Debt (B) 3,149.4 3,127.0
Operating Cash Flow /
Total Debt 49.87 % 48.56 %
 Operating Cash Flow to Cash
Dividends

Operating Cash Flow

Cash Dividends

• Indicates a firm’s ability to cover cash dividends with

the yearly operating cash flow
 Operating Cash Flow to Cash
Dividends
 EXHIBIT 10-8
NIKE INC Year ended May 31, 2005 & 2004
Operating Cash Flow (A) 1,570.7 1,518.5
Cash Dividend (B) 236.7 179.2
Operating Cash Flow /
Cash Dividend 6.64 8.47
Times Times
 HEALTHY CASH FLOW
 Earnings retained can finance permanent
working investment.
 Cash “throw off “ from depreciation is
sufficient to maintain fixed assets.
 Firm can pay down its short term debts
without further borrowing.
 There is sufficient cash to amortize existing
long term debt and pay dividends.
Chapter 10, Slide #32
 UNHEALTHY CASH FLOW
 Use of retained earnings to pay dividends in
excess of profit.
 Cash throw-off from depreciation was used
to amortize the term loan.
 The firm is increasingly riding the trade to
finance permanent assets level.
 Bank credit lines could not be cleaned up.
 Cash Flow---Critical Examination
 In addition to Cash Flow Ratios the Cash Flow &
its use may be examined as under:—
 Cash Flow from operations in relation to net
income ( Percentage)
 Relationship of cash dividend to Cash Flow from
operations.
 Relationship of Cash Dividend to Net Income.
 Use of cash from investing (inflow)/ source of cash
used in investing (out flow).
 Use of long term funds (Cash from Financing)