Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Chapter Fifteen “How Well Am I Doing?” Statement of Cash Flows.

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Chapter Fifteen

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


15-2

Purpose of the Statement of Cash Flows

Are cash flows sufficient to

support ongoing operations?

Are cash flows sufficient to

support ongoing operations? Can we meet

our obligations to creditors?

Can we meet our obligations

to creditors?

Can we pay dividends?

Can we pay dividends?

Why is there a difference

between net income and net

cash flow?

Why is there a difference

between net income and net

cash flow?

Will the company have to borrow money to make

needed investments?

Will the company have to borrow money to make

needed investments?


15-3

Learning Objective 1

Classify changes in Classify changes in noncash balance noncash balance sheet accounts as sheet accounts as sources or uses of sources or uses of

cash.cash.


15-4

Cash

The term cash on the statement of cash flows refers broadly to both currency and

cash equivalents.

Cash

T-bills

Money Market Funds

Commercial Paper

Currency and Bank Accounts


15-5

Net Cash Flows for a

Period

Net Cash Flows for a

Period

Net IncomeNet Income

Dividends Paid to

Stockholders

Dividends Paid to

Stockholders

Changes in Noncash Assets

Changes in Noncash Assets

Changes in Liabilities

Changes in Liabilities

Changes in Capital StockChanges in

Capital Stock

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts


15-6



15-7


Example: Inventory is purchased on credit from

a supplier.


a supplier.

It is implied that cash was used to acquire the

inventory.

Increases in noncash assetnoncash asset accounts imply usesuses of cash.


15-8


It is implied that an increase in a payable has the effect

of increasing cash available for other uses.

Increases in liabilityliability accounts imply sourcessources of cash.


a supplier.


a supplier.


15-9


Decreases in noncash assetsnoncash assets accounts imply sourcessources of cash.

Example: Accounts receivable decreases when a company

pays its bill.

Example: Accounts receivable decreases when a company

pays its bill.

When the customer pays the bill, the company’s cash

increases.


15-10


Decreases in liabilityliability accounts imply usesuses of cash.

When the payment is made, cash decreases.

Example: A company pays a note payable held

by a creditor.

Example: A company pays a note payable held

by a creditor.


15-11

A Simplified Statement of Cash Flows: An Example

Ed's Pizza HutComparative Balance Sheet Account Balances

3/31/2008 3/31/2007 ChangeDR (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 Retained Earnings (4,000) (34,000) (30,000)

-$ -$


15-12

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.


$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




15-13


Decrease in A/R 17,000$ Decrease in Land 32,000 Increase in A/P 11,000 Depreciation charges 6,000 Total sources of cash 66,000$

Ed's Pizza HutSources of Cash

Here is a summary of the sources of cash for Ed’s Pizza Hut.


15-14


Here is a summary of the uses of cash for Ed’s Pizza Hut.

Net loss 27,000$ Increase in Inventory 50,000 Increase in Salaries Payable 5,000 Dividends paid 3,000 Total uses of cash 85,000$

Ed's Pizza HutUses of Cash

The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.


15-15

A Simplified Statement of Cash Flows

Decrease in A/R 17,000$ Decrease in Land 32,000 Increase in A/P 11,000 Depreciation charges 6,000 Total sources of cash 66,000$

Ed's Pizza HutSources of Cash

Net loss 27,000$ Increase in Inventory 50,000 Increase in Salaries Payable 5,000 Dividends paid 3,000 Total uses of cash 85,000$

Ed's Pizza HutUses of Cash

This simplified approach does not follow the

format required for external reporting

purposes. It is for illustrative purposes only.


15-16


Classify transactions Classify transactions as operating, as operating, investing, or investing, or

financing activities.financing activities.


15-17 The Full-Fledged Statement of Cash Flows: Operating Activities

Operating activities are those activities that enter into the determination of

net income.

Transactions affecting current

assets

Transactions affecting current

liabilities

Changes in noncurrent

balance sheet accounts that

directly affect net income


15-18 The Full-Fledged Statement of Cash Flows: Investing Activities

Investing activities relate to transactions involving the acquiring or disposing of

noncurrent assets.

Acquiring or selling property,

plant and equipment

Acquiring or selling securities

Lending money to another entity and

subsequently collecting on the

loan


15-19 The Full-Fledged Statement of Cash Flows: Financing Activities

Financing activities relate to transactions involving borrowing

from creditors or repaying creditors and engaging in

transactions with the company’s owners.

Issuing stock and purchasing

treasury stock

Payment of dividends (note that interest on

debt is classified as an operating

activity)Issuing long-term debt and

repayment of debt.


15-20The Full-Fledged Statement of Cash Flows: An Overview

Operating Activities:Net incomeChanges in current assetsChanges in noncurrent assets that affect net income (e.g., depreciation)Changes in current liabilities (except for debts to lenders and dividends payable)Changes in noncurrent liabilities that affect net income

Investing Activities:Changes in noncurrent assets that are not included in net income

Financing Activities:Changes in the current liabilities that are debts to lenders rather than obligations to suppliers, employees, or the governmentChanges in noncurrent liabilities that are not included in net incomeChanges in capital stock accountsDividends


15-21The Full-Fledged Statement of Cash Flows: An Overview

Operating Activities

Investing Activities

Financing Activities

Reconciliation of the beginning cash balance

with the ending cash balance

Noncash Investing and Financing

Activities


15-22


Includes those activities that enter into the determination of net income.

Includes those activities that enter into the determination of net income.


15-23


Sources of cash are added to net income and uses of cash are subtracted from net income.

Sources of cash are added to net income and uses of cash are subtracted from net income.


15-24



15-25



15-26

Depreciation and Amortization charges are added back to net income because they are decreases in

noncash assets.

Depreciation and Amortization charges are added back to net income because they are decreases in

noncash assets.



15-27

Losses are added back to net income.

Losses are added back to net income.


Gains are subtracted from net

income.

Gains are subtracted from net

income.


15-28

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 Investing Activities $ XXX

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 Investing Activities $ XXX

Includes transactions that involve the acquisition or disposal of noncurrent assets.

Includes transactions that involve the acquisition or disposal of noncurrent assets.

Investing Activities


15-29

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 Financing Activities $ XXX

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 Financing Activities $ XXX

Includes transactions involving receipts from or payments to creditors and owners.

Includes transactions involving receipts from or payments to creditors and owners.

Financing Activities


15-30

Other Issues: Gross or Net?

For investing and financing

activities, items on the statement of

cash flows should be presented in gross amounts

rather than in net amounts.

Example: Assume Macy’s

purchases $50 million in property during the year and sells other property for $30 million.

Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.

Example: Assume Macy’s

purchases $50 million in property during the year and sells other property for $30 million.

Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.


15-31

Other Issues: Direct Method or Indirect Method?

Two Formats for Reporting Operating Activities

Reports the cash effects of each operating

activity

Starts with accrual net income and converts to cash basis

Direct Method Indirect Method

No matter which format is used, the same amount of net cash flows from operating activities is generated.


15-32


Prepare a statement Prepare a statement of cash flows using of cash flows using

the indirect method to the indirect method to determine the net determine the net cash provided by cash provided by

operating activities.operating activities.


15-33 A Full-Fledged Statement of Cash Flows: An Example

Let’s revisit the comparative

balance sheet account balances for Ed’s Pizza Hut.




-$ -$


15-34 A Full-Fledged Statement of Cash Flows: An Example


$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



$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


Let’s also refresh our memory regarding the following additional information.


15-35

ChangeSource or Use?

Cash Flow Effect

Adjust-ments

Adjusted Effect

Classifi- cation

Accounts receivableInventory

LandEquipment

Accumulated depreciation

Accounts payableSalaries payable

Notes payable

Common stock

Net lossDividends

Total (net cash flow)

Retained earnings

Ed's Pizza HutStatement of Cash Flows Worksheet

Noncurrent liabilities

Stockholders' equity

Current liabilities

Assets (except cash and Current assets

Noncurrent assets

Contra Assets, Liabilities, Contra assets

Preparing the Statement of Cash Flows: Step 1

List each account appearing on the

comparative balance sheets except for cash and cash equivalents

and retained earnings.


15-36


Cash Flow Effect

Adjust-ments

Adjusted Effect

Classifi- cation

Accounts receivable (17,000)$ Inventory 50,000

Land (32,000) Equipment -

Accumulated depreciation 6,000

Accounts payable 11,000 Salaries payable (5,000)

Notes payable (50,000)

Common stock 50,000

Net loss (27,000) Dividends 3,000




Current liabilities


Noncurrent assets



Retained earnings


Compute the change from the beginning

balance to the ending balance for each

account.


15-37


Cash Flow Effect

Adjust-ments

Adjusted Effect

Classifi- cation

Accounts receivable (17,000)$ SourceInventory 50,000 Use

Land (32,000) SourceEquipment -

Accumulated depreciation 6,000 Source

Accounts payable 11,000 SourceSalaries payable (5,000) Use

Notes payable (50,000) Use

Common stock 50,000 Source

Net loss (27,000) UseDividends 3,000 Use



Retained earnings




Current liabilities


Noncurrent assets


Code each entry on the worksheet as a

source or use of cash.

Recall that the transaction involving the Notes Payable and

Common Stock was noncash.{


15-38


Cash Flow Effect

Adjust-ments

Adjusted Effect

Classifi- cation

Accounts receivable (17,000)$ Source 17,000$ Inventory 50,000 Use (50,000)

Land (32,000) Source 32,000 Equipment - -

Accumulated depreciation 6,000 Source 6,000

Accounts payable 11,000 Source 11,000 Salaries payable (5,000) Use (5,000)

Notes payable (50,000) Use (50,000)

Common stock 50,000 Source 50,000

Net loss (27,000) Use (27,000) Dividends 3,000 Use (3,000)

(19,000)$ Total (net cash flow)

Retained earnings




Current liabilities


Noncurrent assets



Code sources of cash as

positive numbers and uses of cash as negative numbers.


15-39


Cash Flow Effect

Adjust-ments

Adjusted Effect

Classifi- cation

Accounts receivable (17,000)$ Source 17,000$ - 17,000$ Inventory 50,000 Use (50,000) - (50,000)

Land (32,000) Source 32,000 - 32,000 Equipment - - - -

Accumulated depreciation 6,000 Source 6,000 - 6,000

Accounts payable 11,000 Source 11,000 - 11,000 Salaries payable (5,000) Use (5,000) - (5,000)

Notes payable (50,000) Use (50,000) 50,000 -

Common stock 50,000 Source 50,000 (50,000) -

Net loss (27,000) Use (27,000) - (27,000) Dividends 3,000 Use (3,000) - (3,000)

(19,000)$ -$ (19,000)$




Current liabilities


Noncurrent assets



Retained earnings


Make any necessary

adjustments, including

adjustments for gains and losses. The net effect of these should equal zero.

We need to make an adjustment for the noncash transaction

relating to Notes Payable and Common Stock.

{


15-40



Cash Flow Effect

Adjust-ments

Adjusted Effect

Classifi- cation

Accounts receivable (17,000)$ Source 17,000$ - 17,000$ OperatingInventory 50,000 Use (50,000) - (50,000) Operating

Land (32,000) Source 32,000 - 32,000 InvestingEquipment - - - -

Accumulated depreciation 6,000 Source 6,000 - 6,000 Operating

Accounts payable 11,000 Source 11,000 - 11,000 OperatingSalaries payable (5,000) Use (5,000) - (5,000) Operating

Notes payable (50,000) Use (50,000) 50,000 -

Common stock 50,000 Source 50,000 (50,000) -

Net loss (27,000) Use (27,000) - (27,000) OperatingDividends 3,000 Use (3,000) - (3,000) Financing

(19,000)$ -$ (19,000)$



Retained earnings




Current liabilities


Noncurrent assets Classify each

entry as operating, investing

or financing activity.


15-41 Preparing the Statement of Cash Flows: Step 7

Operating ActivitiesNet 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) Investing Activities

Proceeds from sale of Land 32,000 Financing Activities

Dividends paid (3,000) Net change in cash (19,000)

Ed's Pizza HutStatement of Cash Flows

For the Period Ending 3/31/2008

Copy the data from the worksheet into the Statement of

Cash Flows section by section.


15-42 Preparing the Statement of Cash Flows: Step 8






Dividends paid (3,000) Net change in cash (19,000) Cash, beginning 90,000 Cash, ending 71,000$



Prepare a cash reconciliation at the

bottom of the statement.


15-43

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.

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.

Example – Indirect Method










15-44

Interpretation of the Statement of Cash Flows

Examine the operating activities section carefully.

Ed’s Pizza Hut generated a negative cash flow from operations of $48,000. This 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.

Examine the operating activities section carefully.

Ed’s Pizza Hut generated a negative cash flow from operations of $48,000. This 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.


The Direct Method of Determining the Net Cash

Provided by Operating Activities

Appendix 15A


15-46


Use the direct method Use the direct method to determine the net to determine the net

cash provided by cash provided by operating activities. operating activities.

(Appendix 15A)(Appendix 15A)


15-47 Computing Net Cash Provided by Operating Activities

The direct method computes net cash provided by operating activities by reconstructing the

income statement on a cash basis from top to bottom.

Cash provided by operating activities under the direct method will always

agree with the amount computed using the indirect method.


15-48

Similarities and Differences in Handling DataAdd (+) or

Deduct (-) to Adjust to a Cash Basis

Sales revenue (as reported)

Increases in accounts receivable -Decreases in accounts receivable +

Cost of goods sold (as reported)

Increase in merchandise inventory +Decrease in merchandise inventory -Increase in accounts payable -Decrease in accounts payable +

Operating expenses (as reported)

Increase in prepaid expenses +Decrease in prepaid expenses -Increase in accrued liabilities -Decrease in accrued liabilities +Period's depreciation, depletion and amortization charges

-

Income tax expense (as reported)

Increase in accrued taxes payable -Decrease in accrued taxes payable +Increase in deferred income taxes -Decrease in deferred income taxes +

Adjustments to a cash basis:

Revenue or Expense Item




Adjustments for accounts that affect revenue are the

same in the direct and indirect methods.

Adjustments for accounts that affect expenses are

handled in opposite ways for the direct and indirect

methods.


15-49

Direct Method: Gains and Losses

Under the direct method, no adjustments for gains and losses on the sale of

assets are needed.


15-50

The Direct Method: An Example

Let’s revisit the comparative

balance sheet account balances for Ed’s Pizza Hut.




-$ -$


15-51


Sales 1,000,000$ Cost of goods sold 750,000 Gross margin 250,000 Operating expenses 277,000 Net loss (27,000)$

Ed's Pizza HutIncome Statement

For the Year Ended 3/31/2008

Let’s assume that Ed’s Pizza Hut prepared this income statement.


15-52


Step 1: Translate sales revenue into cash

collected from customers.Sales (as reported) 1,000,000$ Add: Decrease in accounts receivable 17,000 Cash collected from customers 1,017,000$


15-53


Step 2: Translate cost of goods sold into cash disbursements for purchases.

Cost of goods sold (as reported) 750,000$ Add: Increase in inventory 50,000 Less: Increase in accounts payable (11,000) Cash paid for purchases 789,000$


15-54


Step 3: Translate operating expenses into cash paid for operating expenses.

Operating expenses (as reported) 277,000$ Add: Decrease in salaries payable 5,000 Less: Increase in depreciation (6,000) Cash paid for operating expenses 276,000$

No adjustment for income taxes is required because Ed’s Pizza Hut has a net

loss of $27,000.


15-55


Operating ActivitiesCash received from customers 1,017,000$ Cash paid for purchases (789,000) Cash paid for operating expenses (276,000) Net Cash Flow from Operations (48,000) Investing Activities

Proceeds from sale of land 32,000 Financing Activities



For the Period Ending 3/31/2008Notice that the

net cash provided by

operating activities agrees

with that computed using

the indirect method.


15-56

End of Chapter 15

Copyright © 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin Chapter Fifteen “How Well Am I Doing?” Statement of Cash Flows.

Documents

uses of cash

sources of cash

net cash flows

cash decreases

mcgrawhill companies

term cash

cash equivalents

cash flows sufficient