Financial accounting 9th jamie pratt chapter 14

Deriving Cash Flow from Accrual Financial Statements Operating – Sales and Bad Debt Expense Cash inflow from sales can be determined by analyzing changes in accounts receivable and the

Chapter 14

Statement of Cash Flows

 2

The Statement of Cash Flows

Summary of company’s transactions that involve cash over a period of time Transactions are classified as:

 Operations

 Investments

 Financing

Statement of Cash Flows

 Required for financial statements by SFAS 95 (1987).

 Primary purpose is to provide relevant information about cash receipts and cash disbursements of the company during the period.

 Serves to complement the other financial statements.

 Focus is on cash flows, not income.

 Reconciles the balance sheet and the income statement.

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Definition of Cash

 Cash consists of coin, currency, and available funds on deposit at the bank

Negotiable instruments such as money orders, certified checks, cashier’s checks, personal checks, and bank drafts are also considered cash

 Also certain cash equivalents, which include commercial paper and other debt

investments with maturities of less than three months are included in the statement of cash flows

Content of Statement of Cash Flows

 Explains change in cash and cash equivalents.

 Cash equivalents are defined as short-term, highly liquid investments near to maturity.

 Examples of cash equivalents are Treasury bills and money market funds.

 Format of SCF includes the following three sections:

 cash flow from operating activities.

 cash flow from investing activities.

 cash flow from financing activities.

 Like US GAAP, IFRS requires the presentation of a SCF, and the format is largely the same.

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General Description of the Statement of Cash Flows

Figure 14-2 Standard

Cash Provided (Used) by Operating Activities

 Cash Flows from operating activities is based on the income statement, and converts

income activity to a cash basis

 There are two formats for the presentation of CF from operating activity:

 Direct Method: this technique shows cash received from customers and cash paid to

various entities for operating activities

 Indirect Method: this technique starts with net income and makes adjustments to net

income to convert it to a cash basis

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Cash Provided (Used) by Operating Activities

 If the direct method is used, the indirect method must be presented in a supplementary

schedule

 FASB recommends companies use the direct method including the supplementary schedule

 The direct method is more straight-forward and provides more information with the

supplementary disclosure, but the vast majority of companies present only the indirect

method

Cash Provided (Used) by Investing Activities

 Cash Flows from investing activities explain the changes in cash from the purchase or sale

of the company’s (primarily) long-term assets.

 Examples of investing activity includes:

 Cash paid for purchase of equipment, land, buildings, marketable securities

(available-for-sale and equity), intangible assets, and most other long term assets

 Cash received from sale of equipment, land, buildings, marketable securities

(available-for-sale and equity), intangible assets, and most other long term assets

 Cash paid for issue of non-trade notes receivable (both short-term and long-term).

 Cash received for repayment on non-trade notes receivable (both short-term and term).

long- 10

Cash Provided (Used) by Financing Activities

 Cash Flows from financing activities explain the changes in cash from the issue or

retirement of the company’s (primarily) long-term liabilities and contributed capital (equity).

 Examples of financing activity includes:

 cash received from issue of bonds, mortgages and other long-term debt,

 cash received from issue of common stock and preferred stock,

 cash paid for the retirement of long-term debt,

 cash paid for the repurchase of treasury stock,

 cash paid for dividends,

 cash received for issue of non-trade notes payable (both short-term and long-term), and

 cash paid for retirement or repayment on non-trade notes payable (both short-term and

long-term)

Cash Provided (Used) by Financing Activities

 Note that cash paid for dividends is classified as a financing activity, but cash paid for interest is classified as an operating activity

 Note that cash received for dividends and cash received for interest are both classified as operating activities

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The Importance of Cash from Operating Activities

 Cash from Operating Activities has special importance to a business and those outside the company:

 The sale of services and/or inventory is a prerequisite for a successful business

 Investing and Financing cash flows can vary greatly year to year

 Operating cash flows should be more consistent, and, expected to reoccur

making them essential for predicting future outcomes

The Importance of Significant Noncash Transactions

Deriving Cash Flow from Accrual Financial Statements Operating – Sales and Bad Debt Expense

 Cash inflow from sales can be determined by analyzing changes in accounts receivable and the allowance for doubtful accounts.

Figure 14-6 Determining

Deriving Cash Flow from Accrual Financial Statements Operating – Fees Earned

 Cash inflow related to fees earned can be determined by looking at changes in the advance account

 16

Figure 14-7 Determining cash inflow from fees earned

Deriving Cash Flow from Accrual Financial Statements Operating – Cost of Goods Sold

 Cash outflow associated with goods sold can be determined with changes in inventory and accounts payable

Figure 14-8 Determining

Deriving Cash Flow from Accrual Financial Statements Operating – Miscellaneous Expenses

 Cash outflow related to miscellaneous expense can be determined by analyzing changes in accrued payables

 18

Figure 14-8 Determining cash outflow from miscellaneous expenses

Deriving Cash Flow from Accrual Financial Statements Operating – Insurance Expense

 Cash outflow related to insurance expense can be determined by looking at changes to the prepaid insurance account

Figure 14-10 Determining cash outflow related to insurance expense

Deriving Cash Flow from Accrual Financial Statements Operating – Depreciation, Amortization, and Losses on Sales

statements of cash flows must be adjusted for these items under the indirect method of preparing the statements of cash flows

 20

Deriving Cash Flow from Accrual Financial Statements Operating – Interest Expense

 Cash outflow related to interest expense can be determined by looking at changes in the discounts

on note payable account

Figure 14-11 Determining cash outflow related to interest expense

Deriving Cash Flow from Accrual Financial Statements Operating – Income Tax Expense

 Cash outflow related to income tax expense can be determined by looking at changes in the income tax payable account

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Figure 14-12 Determining cash outflow related to income taxes

Deriving Cash Flow from Accrual Financial Statements Investing

 Cash inflows and outflows associated with investing activities are analyzed by looking at changes in the long-lived asset accounts

 Outflows occur when assets are acquired

Figure 14-13 Determining cash outflow for land purchases

Deriving Cash Flow from Accrual Financial Statements Investing (cont’d)

 Cash inflows and outflows associated with investing activities are analyzed by looking at changes in the long-lived asset accounts

 Inflows occur when assets are sold

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Figure 14-14 Determining cash inflow from sale of machinery

Deriving Cash Flow from Accrual Financial Statements Financing – Payment on Notes Payable

 A pay down on a note payable would be do to the payment of cash unless another transaction is indicated

Figure 14-15 Determining cash outflow

from payments on notes

Deriving Cash Flow from Accrual Financial Statements Financing – Issuance of Common Stock and

Treasury Stock

 Cash inflows from the issuance of common stock and treasury stock can be

determined by looking at changes in the common stock, additional paid-in capital and treasury stock accounts

(See Next Slide)

 26

Figure 14-16 Determining

Deriving Cash Flow from Accrual Financial Statements Financing – Cash Dividends

 The cash dividend payment can be determined by looking at changes in the dividend payable account

 28

Figure 14-15 Determining cash outflow

from dividend payments

The Direct Method Figure 14-18 Statement

of cash flows for ABC Enterprises: Direct Method

The Indirect Method

 To understand the adjustments to get from net income to Cash Flow from operations, we can classify the adjustments into various categories:

 Noncash Changes to non current accounts

 Changes in current noncash accounts

The Indirect Method

Figure 14-20 Explaining current adjustments to net income in the calculation of net cash provided (used) by operating activities

Analyzing the Statement of Cash Flows: An Application

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 Operating Activities may provide positive or negative cash flows regardless of net income (see ABC

Enterprises Inc in previous slides) Remember that Operating Activities and the cash in this section are considered more sustainable.

 Cash must be evaluated over some time as any one period may mislead investors about longer

term cash flow based on management’s decisions during that period – but manipulation of cash for long periods of time is very difficult

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