Cash Flow Statement Chapter 14
Cash Flow Statement • Explains how a company obtained and used cash during a period of time. • Helps managers answers questions such as: Are ongoing operations generating sufficient cashflows to remain viable? Will we have toborrow funds to makeneeded investments? Why is there a difference between net income and net cash flow? Will we be able to meetour financial obligations? Will we be able to paythe usual dividend?
Cash Flow Statement Classifies cash inflows and outflows into three categories. Also includes reconciliation of beginning cash to ending cash.
Direct Method Net income is reconstructed on a cash basis. Requires a supplemental reconciliation of net income to cash flow from operating activities. Used by less than 5% of companies. Indirect Method Net income is reconciled to cash flow from operating activities. No supplemental schedule is required. Used by more than 95% of companies. Direct Method or Indirect Method?
Cash Flow Statement Increases in noncash asset accountsimply uses of cash. Example: The inventory balance increases. It is implied that cash was used to acquire the additional inventory.
Cash Flow Statement Increases in liability accounts implysources of cash. Example: Accounts payable increases due to purchases on credit from a supplier. It is implied that an increase in a payable has the effect of increasing cash available for other uses.
Cash Flow Statement Decreases in noncash assets accountsimply sources of cash. Example: A customer paid his bill. When the customer pays his bill, the company’s cash increases.
Cash Flow Statement Decreases in liability accountsimply uses of cash. Example: The company made a payment on a note payable held by a creditor. When the company makes the payment, its cash decreases. I.O.U.
Operating Activities Includes those activities that enter into the determination of net income
Operating Activities • Changes in current assets and current liabilities imply changes in cash. • Changes in current assets and current liabilities are treated as indicated below:
Operating Activities Amortization expense is added back to net income because it is a non-cash expense.
Operating Activities Losses are added back to net income. Gains are subtracted from net income.
Investing Activities Includes transactions that involve the acquisition or disposal of noncurrent assets
Financing Activities Includes transactions involving receipts from or payments to creditors and owners
Example: Bobo, Inc. acquires a building in exchange for 2,000 shares of common stock. This is reported in a separate supplemental schedule attached to the statement of cash flows. Direct exchange transactions occurwhen noncurrent balance sheet itemsare swapped. Such exchangesmust be disclosed. Noncash Investing and Financing Transactions
Cash Flow Statement Let’s preparea Cash Flow Statement using the T-account method.
Cash Flow Statement-Indirect Method • The previous statement of cash flow was presented under the direct method, a method recommended by the Canadian Institute of Chartered Accountants. • Most companies, however, use the indirect method. • The main difference is in the presentation of the operating activities section. The indirect method • starts with net income as reported on the income statement; then, • shows the adjustments necessary to convert the accrual-based net income figure to a cash-basis equivalent.
Cash Flow Statement-Indirect Method • The conversion process is accomplished by the application of three basic rules. • Rule 1: Increases in current assets are deducted from net income, and decreases in current assets are added to net income. • Rule 2: Increases in current liabilities are added to net income, and decreases in current liabilities are deducted from net income. • Rule 3: All noncash expenses and losses are added to net income, and all noncash revenue and gains are subtracted from net income.
Cash Flow Statement Let’s preparea Cash Flow Statementusing theindirect method.
Cash Flow Statement – Indirect Method Al’s Bakery supplies a variety of pastry products to restaurants in a large city. Al’s Bakery has prepared an adjusted trial balance as of 12/31/X1 and needs help preparing the Cash Flow Statement. Examine the information provided and prepare a Cash Flow Statement using the indirect method.
Cash Flow Statement – Indirect Method Additional Information During the year, Al’s Bakery: • Sold land originally costing $32,000 for $32,000. • Paid dividends of $20,000 to the stockholders. • Issued $50,000 of common stock to settle the note due to Smith Supplies.
Cash Flow Statement – Indirect Method Always start with the net income or net loss for the period. NL = Revenue – Expenses NL = $727,000 – ($748,000 + $6,000) NL = $727,000 – $754,000 NL = $27,000 Loss
Cash Flow Statement – Indirect Method Depreciation expense is a noncash expense that must be added back to net income.
Cash Flow Statement – Indirect Method The Statement of Cash Flows has three major sections and shows a reconciliation of beginning cash with ending cash.
Cash Flow Statement – Indirect Method Cash flow from operating activities comes from the schedule just prepared.
Cash Flow Statement – Indirect Method Cash flows from financing and investing activities may come from sources other than the trial balance.
Cash Flow Statement – Indirect Method These amounts come from the trial balance and can be used as “check figures” to verify the completeness of the statement.
Importance of Cash Flow From Operations Negative cash flow from operations is usually a sign of fundamental difficulties. Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.
Cash The term cashon the statement of cash flows refers broadly to both currency and cash equivalents. Currency and Bank Accounts T-bills Cash Commercial Paper Money Market Funds
End of Chapter 14 This is my kind of CA$H FLOW!