STATEMENT OF CASH FLOWS

1. STATEMENT OF CASH FLOWS Accounting ASW Summer 2007

2. Overview of statement of cash flows • Explains changes in “Cash” during the period • “Cash” is cash plus cash equivalents - Equivalents are highly liquid short-term investments - E.g., bank accounts, certificates of deposits, treasury bills and uncashed checks • There are typically no “SCF” accounts - infer SCF amounts from income statement and balance sheet - typically prepared after the other statements - hardest statement to interpret

4. Uses of SCF • Assess liquidity • Alternate measure of performance • Helpful in predicting free cash flows

5. Free Cash Flows • Free cash flows=Cash from Operations + Cash from Investing • Popular valuation approaches uses FCF - Firm value = net present value of future FCF • However, net income is the best predictor of future free cash flows

6. Relation between NI and FCF • In general, over the life of the firm Total(FCF) = Total(NI) • The only difference is timing • Most differences between NI and FCF reverse quickly - E.g., credit sales CFnow < NInow CFlate r > NIlater

7. Classification on the SCF • Specified by the FASB • Follows the structure of the firm - Operating - Investing - Financing

10. Components of the Statement of Cash Flows Operating Cash InflowsCash Outflows Collect from customers Pay suppliers Collect interest and dividends Pay interest Other operating receipts Other operating payments Pay taxes Pay employees

11. Cash Inflows Sell PP&E Sell securities owned Receive loan repayments Cash Outflows Purchase PP&E Purchase securities Make loans Investing

12. Cash Inflows Borrow from creditors Issue equity securities Cash Outflows Repay amounts borrowed Repurchase stock Pay dividends Financing

13. Formats for SCF • Both direct and indirect are allowed • In both formats • investing and financing formats are the same • list sources and uses of cash • total operating cash flows is the same • format for getting there differs

15. Direct method also lists sources and uses of cash for operating • preferred by FASB • rare in practice • Indirect method operating section starts with net income • explains why cash from operations  NI • uses changes in other accounts to explain

17. When CF  NI, slack is picked up by changes in other balance sheet accounts • if sales > cash receipts, Accts. Receivable s • if sales < cash receipts, Accts. Receivable s • if purchases > cash paid, Accts. Payable s • if purchases < cash paid, Accts. Payable s • if purchases > cost of goods sold, Inventory s • if purchases < cost of goods sold, Inventory s

18. Preparing SCF (Indirect Method) • Start with attached worksheet with beginning and ending balances of non-cash accounts at ends & change in middle • As you work through, note each change that you’ve accounted for • If every change is accounted for, it must add

19. Preparing the Statement of Cash Flows Changes in Assets OperatingInvestingFinancing (1) Accounts Receivable x(-) (2) Inventories x(-) (3) Other Current Assets (Usually) x(-) (4) Investments in Securities1 x(-) Property, Plant & Equipment (5) Cost2 (Purchases) x(-) (6) Acc. Depr.2 (Current Yr’s Depr.) x(+) (7) Other Noncurrent Assets (Usually)1 x(-)

20. Changes in Liabilities and Shareholders’ Equity OperatingInvestingFinancing (8) Accounts Payable x(+) (9) Notes Payable1 x(+) (10) Current Portion of Long- Term Debt3 x(+) (11) Other Current Liabilities (Usually) x(+) (12) Long-Term Debt1 x(+) (13) Deferred income Taxes x(+) (14) Other Noncurrent Liabilities (Usually)1 x(+) (15) Contributed Capital x(+)

21. Changes in Liabilities and Shareholders’ Equity OperatingInvestingFinancing (16) Retained Earnings x(Net Inc)(+) x (Div.)(-) (17) Treasure Stock __________ _________ x(-) (18) Cash 1Increases and decreases are generally disclosed separately. 2For sales of PP&E (or other investments), profits are subtracted from net income in the operating section and the entire proceeds is included as a source of cash in the investing section. 3Generally combined with long-term debt. Problem 4-26

23. Formats for the SCFIndirect Format (most common) Cash From Operations Net Income + Depreciation - Gain on Sale of PP&E - Increase in Accounts Receivable - Increase in Inventory - Increase in Other Current Assets + Increase in Accounts Payable + Increase in Other Current Liab. + Increase in Def. Income Taxes

24. Cash From Investing - Investments in Securities + Proceeds from Sales of Sec. - Investments in PP&E + Proceeds from Sales of PP&E - Invest. in Other NC Assets + Proceeds from Other NC Assets

25. Cash From Financing + Issuance of Notes Payable - Repayments of Notes Payable + Issuance of Long-Term Debt - Repayments of Long-Term Debt + Issuance of Common Stock - Dividends Paid - Repurchase of Common Stock

27. Sales of PP&E • Recreate the journal entry Cash Selling Price Acc. Depr. AD on Asset PP&E HC on Asset Gain on Sale Plug • goal is for only selling price to appear in investing • to do that, subtract gain (add loss) in operating • show selling price as a source of investing cash • that takes care of the AD and PP&E on worksheet • Problem 4-34, etc.

35. Direct Format (rare) • Financing and investing sections are the same as in the indirect method • The operating section is stated in terms of sources and uses of cash

36. Cash From Operations Cash Inflows + Collections from Customers + Interest and Dividends Received + Other Operating Receipts Cash Outflows - Payments to Suppliers - Payments to Employees - Interest Paid - Taxes Paid - Other Operating Cash Payments