Managerial Accounting

Managerial Accounting

Dr. BaldwinUniversity of Arkansas – Fort

SmithFall 2010

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CHAPTER 12

Reporting and Analyzing Cash Flows

Purpose of Cash Flow Statement

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• The Income Statement is a summary of the income producing activities of a company during the period.

• The Balance Sheet shows what “stuff” we have at any point in time.

Purpose of Cash Flow Statement

• The Cash Flow Statement is needed to provide information about what happened to cash during the period.

Sources (Increases) of Cash?

Uses (Decreases) of Cash?

Why did cash ↑ or ↓?What is the change

in Cash?

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Why is the Cash Flow Stmt. Important?

• Can the business pay dividends?• Does it have the ability to pay its debts

when they become due?• Does current cash flow cover both

principal and interest?• Does it need additional financing?• What is the primary source of cash?

Management, creditors and investors are particularly interested in sources, uses and changes in cash.

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What is “Cash”

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• Cash = Cash in Bank• Cash Equivalents

– Readily convertible to cash– Typically have a maturity date of <90

days

Classifications of Cash Flows

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• Operating Activities

• Investing Activities

• Financing Activities

Operating Activities• Transactions or events that

occur during the normal operation of the business and determine net income.

• Typically involve changes in current assets or current liabilities.

• What are the sources (increases)?

• What are the uses (decreases)?

Operating ActivitiesInflows

• Receipts from customers• Cash dividends received• Interest from borrowers• Other.

Outflows• Salaries and wages• Payments to suppliers• Taxes and fines• Interest paid to lenders• Other

Investing Activities• Transactions or events

that affect long term assets

• Sources:– Proceeds from sales of

PP&E or LT Investments• Uses:

– Purchases of PP&E or LT Investments

Financing Activities• Transactions or events that affect long-term

debt or equity sections of the balance sheet.

• Sources:– Sales of stock or bonds– Bank loans

• Uses:– Purchase of treasury stock– Payment of dividends– Payment on loans

Three “Foolers”1. Interest Paid on Debt is an

OPERATING Activity2. Interest or Dividend Income is

an OPERATING Activity(Rationale: Once the decision to

finance or invest has been made, any further cash received or required in an operating activity.)

3. Dividends paid to shareholders is a FINANCING Activity.

Non-Cash Transactions• Significant financing and investing activities

that do not affect cash are reported separately.• Disclosed at the bottom of Cash Flow Stmt in

Schedule of Noncash Investing & Financing Activities

• Examples:– Issuing stock for land– Signing a mortgage and taking title to the related

property– Converting or retiring bonds to stock– Converting common stock to preferred stock

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Presentation of Cash Flows• There are two formats to present Cash

Flow from Operating Activities:– Direct method – Indirect method

• Indirect method is more prevalent (97.5% of companies)

• Direct method is easier to understand– Lists the sources and uses of cash from

operations as individual line items:• cash collected from customers• cash paid for inventory• cash paid for interest

• Each method produces the SAME amounts of Cash Flows Provided (Used) by Operating Activities

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Indirect Method for Calculating Cash Flow

from Operations• We will reconcile Accrual based Net Income to Cash flow from Operating Activities:

Step 1: Net incomeStep 2: +/- changes in Current asset accountsStep 3: + non-cash expensesStep 4 :+/- non-operating items= cash from operations

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Cash Flow from Operating Activities Example

East, Inc. reports $125,000 net income for the year ended December 31, 2008.

Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000.

During 2008, East reported $12,500 of Depreciation Expense.

What is East’s cash flow from operating activities for the period end 12/31/08?

Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

Net income 125,000$

Deduct: Increase in accounts receivable

Cash provided by operating activities

For the indirect method, start with

net income.

Indirect Method ExampleP2

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable

Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable

Cash provided by operating activities

Add noncash expenses such as depreciation, depletion,

amortization, or bad debt expense.

Indirect Method ExampleP2

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable (7,500)

Cash provided by operating activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable (7,500)

Cash provided by operating activities

Change in Account Balance During YearIncrease Decrease

Current Subtract from net Add to net income.Assets income.

Current Add to net income. Subtract from netLiabilities income.

Indirect Method ExampleP2

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating

activities

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating

activities Change in Account Balance During YearIncrease Decrease

Current Subtract from net Add to net income.Assets income.

Current Add to net income. Subtract from netLiabilities income.

Indirect Method ExampleP2

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating

activities 140,000$

Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts

receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating

activities 140,000$

If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

Indirect Method ExampleP2