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“How Well Am I Doing?” Statement of Cash Flows Chapter 15 Purpose of the Statement of Cash Flows Why is there a difference between net income and net cash flow? Are cash flows sufficient to support ongoing operations? Can we meet our obligations to creditors?

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

Chapter 15


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Purpose of the Statement of Cash Flows

Why is there a difference between net income and net cash flow?

Are cash flows sufficient to support ongoing operations?

Can we meet our obligations to creditors?

Will the company have to borrow money to make needed investments?

Can we pay dividends?


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Learning Objective 1

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


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

Cash

Currency and Bank Accounts

Treasury Bills

Cash

Commercial Paper

Money Market Funds


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4. Changes in Capital Stock

3. Changes in Liabilities

5. Dividends Paid to Stockholders

2. Changes in Noncash Assets

1. Net Income

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

Net Cash Flows for a Period



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

Increases in noncash assetaccounts imply uses of cash.

Example: Inventory is purchased on credit from a supplier.

It is implied that cash was used to acquire the inventory.


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

Increases in liability accounts imply sourcesof 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.


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

Decreases in noncash assetsaccounts imply sourcesof cash.

Example: Accounts receivable decreases when a customer pays their bill.

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


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

Decreases in liabilityaccounts imply uses of cash.

Example: A company pays a note payable held by a creditor.

When the payment is made, cash decreases.


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A Simplified Statement of Cash Flows: An Example Noncash Balance Sheet Accounts


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A Simplified Statement of Cash Flows: An Example Noncash Balance Sheet Accounts

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 purchased equipment for $28,000.

  • 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.


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A Simplified Statement of Cash Flows: An Example Noncash Balance Sheet Accounts

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


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A Simplified Statement of Cash Flows: An Example Noncash Balance Sheet Accounts

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

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


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A Simplified Statement of Cash Flows Noncash Balance Sheet Accounts

This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only.


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Learning Objective 2 Noncash Balance Sheet Accounts

Classify transactions as operating, investing, or financing activities.


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The Full-Fledged Statement of Cash Flows: Operating Activities

Operating activities are those activities that enter into the determination of net income.

1. Transactions affecting current assets

3. Changes in noncurrent balance sheet accounts that directly affect net income

2. Transactions affecting current liabilities


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The Full-Fledged Statement of Cash Flows: Investing Activities

Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets.

1. Acquiring or selling property, plant and equipment

3. Lending money to another entity and subsequently collecting on the loan

2. Acquiring or selling securities


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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.

1. Issuing stock and purchasing treasury stock

3. Payment of dividends (note that interest on debt is classified as an operating activity)

2. Issuing long-term debt and repayment of debt.



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The Full-Fledged Statement of Cash Flows: An Overview Activities

Operating Activities

Investing Activities

Reconciliation of the beginning cash balance with the ending cash balance

Financing Activities

Noncash Investing and Financing Activities


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Operating Activities Activities

Includes those activities that affect current assets, current liabilities, or net income.


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Operating Activities Activities

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




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Operating Activities Activities

Depreciation and Amortization charges are added back because they are decreases in noncash assets.


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Operating Activities Activities

Gains are subtracted.

Losses are added.


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Investing Activities Activities

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


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Financing Activities Activities

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


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Example: Activities

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.

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.


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Direct Method Activities

Indirect Method

Reports the cash effects of each operating activity

Starts with accrual net income and converts to cash basis

Other Issues: Direct Method or Indirect Method?

Two Formats for Reporting Operating Activities

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


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Learning Objective 3 Activities

Prepare a statement of cash flows using the indirect method to determine the net cash provided by operating activities.


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A Full-Fledged Statement of Cash Flows: ActivitiesAn Example

Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut.


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A Full-Fledged Statement of Cash Flows: ActivitiesAn Example

Let’s also refresh our memory regarding the following 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 purchased equipment for $28,000.

  • 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.


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Preparing the Statement of Cash Flows: Step 1 Activities

List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings.


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Preparing the Statement of Cash Flows: Step 2 Activities

Compute the change from the beginning balance to the ending balance for each account.


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{ Activities

Recall that the transaction involving the Notes Payable and Common Stock was noncash.

Preparing the Statement of Cash Flows: Step 3

Code each entry on the worksheet as a source or use of cash.


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Preparing the Statement of Cash Flows: Step 4 Activities

Code sources of cash as positive numbers and uses of cash as negative numbers.


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{ Activities

We need to make an adjustment for the noncash transaction relating to Notes Payable and Common Stock.

Preparing the Statement of Cash Flows: Step 5

Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero.


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Preparing the Statement of Cash Flows: Step 6 Activities

Classify each entry as operating, investing or financing activity.


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Preparing the Statement of Cash Flows: Step 7 Activities

Copy the data from the worksheet into the Statement of Cash Flows section by section.


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Preparing the Statement of Cash Flows: Step 8 Activities

Prepare a cash reconciliation at the bottom of the statement.


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Example – Indirect Method Activities

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.


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Examine the operating activities section carefully. Activities

Ed’s Pizza Hut generated a negative net cash provided by operating activities of $20,000. 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.

Interpretation of the Statement of Cash Flows


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Learning Objective 4 Activities

Compute free cash flow.


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Free Cash Flows Activities

Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities.


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Free Cash Flows Activities

Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities.



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Learning Objective 5 Operating Activities

Use the direct method to determine the net cash provided by operating activities. (Appendix 15A)


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Computing Net Cash Provided by Operating Activities 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.

Net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method.


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Similarities and Differences in Handling Data Operating Activities

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.


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Direct Method: Gains and Losses Operating Activities

Under the direct method, no adjustments for gains and losses on the sale of assets are needed.


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The Direct Method: An Example Operating Activities

Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut.


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The Direct Method: An Example Operating Activities

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


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The Direct Method: An Example Operating Activities

Step 1: Translate sales revenue into cash collected from customers.


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The Direct Method: An Example Operating Activities

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


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The Direct Method: An Example Operating Activities

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

No adjustment for income taxes is required because Ed’s Pizza Hut has a net loss of $27,000.


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The Direct Method: An Example Operating Activities

Notice that the net cash provided by operating activities agreeswith that computed using the indirect method.


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End of Chapter 15 Operating Activities


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