Lecture Managerial Accounting for the hospitality industry: Chapter 5 - Dopson, Hayes

Chapter 7 - The statement of cash flows. In this chapter you will learn about the Statement of Cash Flows (SCF). The SCF is a report that tells its readers about increases (inflows) and decreases (outflows) of cash of a business during a specific accounting period.

Chapter 5

The Statement of Cash

Flows

 Understanding Cash Flows

 The Purpose of the Statement of Cash Flows

 Sources and Uses of Funds

 Creating the Statement of Cash Flows

 Statement of Cash Flows Analysis

Chapter Outline

Learning Outcomes

 State the reason cash flows are critical to the operation

of a successful business

 Identify sources and uses of funds to assist in the

creation of a statement of cash flows

 Create a statement of cash flows using an income

statement and two balance sheets

 Analyze a statement of cash flows to better manage the

cash flows of your own business

Understanding Cash Flows

 Assume, for example, that you have income from a

variety of sources

 These sources may include money paid to you from a

job, income from parents or other family members, and interest you may earn on savings accounts

 In addition, you have living and school expenses that

must be paid

 You know that you must have enough money on hand

to pay your bills as they become due

 Having access to cash at the right time (versus having

the right amount of cash) is important to individuals It is also critically important to businesses

The Purpose of the Statement of Cash Flows

 The statement of cash flow shows (SCF) shows all

sources and uses of funds from operating, investing,

and financing activities of a business

 The SCF is designed to report a business’s inflows and

outflows of money affecting the cash position as well as its beginning and ending cash and cash equivalents

balances for each accounting period

 The cash inflows and outflows of a business are of

significant importance to a business’s owners,

investors, lenders, creditors, and managers

The Purpose of the Statement of Cash Flows

 Cash on a balance sheet is considered to be a current

asset

 Cash, in this case, refers to currency, checks on hand,

and deposits in banks

 Cash is not synonymous with the term “revenue” or

“sales.”

 Cash equivalents are short-term, temporary

investments such as treasury bills, certificates of

deposit, or commercial paper that can be quickly and

easily converted to cash

Sources and Uses of Funds

 Sources represent inflows and uses represent outflows

of funds for the hospitality business

 When comparing assets from last period’s balance

sheet to this period’s balance sheet, decreases in

assets represent sources of funds and increases in

assets represent uses of funds

 Accumulated depreciation behaves in an opposite

manner to the other assets

 This is because depreciation is a contra asset account

Figure 5.1 Sources and Uses of Funds for Assets

Assets Increases Decreases

Current Assets

Property and Equipment

Sources and Uses of Funds

 Alternatively, increases in liabilities and owners’ equity

represent sources of funds and decreases in liabilities

and owners’ equity represent uses of funds

Figure 5.2 Sources and Uses of Funds for Liabilities and Owners’ Equity

Current Liabilities

Other Current Liabilities Source Use Long-Term Liabilities

Owners’ Equity

Sources and Uses of Funds

“decreases.”

 Assets in each column have opposite arrows from liabilities and

owners’ equity Also, arrows in the left column are opposite of

those in the right column.

Figure 5.3 Trick for Remembering Sources and Uses of Funds

Sources Uses

↓ Assets* ↑ Assets*

↑ Liabilities ↓ Liabilities

↑ Owners’ Equity ↓ Owners’ Equity

*Remember that depreciation is a contra asset account and behaves oppositely of all other assets,

so ↑ in depreciation is a source and ↓ of depreciation

is a use

Sources and Uses of Funds

 If you can remember only one, you can remember all

the rest Once you have that arrow correct, then you

can remember the directions of the other arrows Be

careful, though!

 If you get your one example backwards, then ALL of the

others are wrong! Memorize this “trick”; it will help you immensely!

 You can now put numbers to your sources and uses of

funds

 These numbers will show you increases and decreases

as shown in Figure 5.4

Steps to Calculate Sources and Uses

of Funds

1 Draw the chart shown in Figure 5.3 to help you identify sources

and uses of funds.

2 Draw up arrows ↑ and down arrows ↓ next to the balance sheets to

indicate increases and decreases in the accounts from 2009 to

2010.

3 Calculate the difference in each account from 2009 to 2010.

4 Place the difference in each account under the appropriate

Sources or Uses column Do not calculate subtotals and totals.

in the Uses column.

6 The totals in each column should equal each other If they do, you

have identified the correct sources and uses of funds, and you are finished!

7. If the totals in each column do not equal each other, calculate the

difference between the columns and divide by 2 This is the

amount of your mistake.

Figure 5.4 Sources and Uses of Funds for Blue Lagoon Water Park Resort

Blue Lagoon Water Park Resort Balance Sheets December 31, 2009 and 2010

2009 2010 Sources Uses

Current Assets Cash 2,370,800 2,314,750 ↓ 56,050 Marketable Securities 4,109,600 3,309,600 ↓ 800,000 Net Receivables 1,655,300 1,053,950 ↓ 601,350 Inventories 897,200 1,497,200 ↑ 600,000 Total Current Assets 9,032,900 8,175,500

Investments 4,223,500 5,023,500 ↑ 800,000 Property and Equipment

Land 7,712,550 7,712,550 - Building 22,290,500 22,290,500 - Furnishings and Equipment 5,063,655 7,289,000 ↑ 2,225,345 Less Accumulated Depreciation 3,408,900 4,668,900 ↑ 1,260,000

Net Property and Equipment 31,657,805 32,623,150

Other Assets 588,800 669,800 ↑ 81,000

Total Assets 45,503,005 46,491,950

Liabilities and Owners’ Equity

Current Liabilities Accounts Payable 2,038,100 1,438,100 ↓ 600,000 Notes Payable 2,104,255 1,319,900 ↓ 784,355 Other Current Liabilities 1,814,600 1,264,600 ↓ 550,000 Total Current Liabilities 5,956,955 4,022,600

Long-Term Liabilities Long-Term Debt 13,821,750 14,577,400 ↑ 755,650 Total Liabilities 19,778,705 18,600,000

Owners’ Equity Common Stock 2,925,000 3,000,000 ↑ 75,000 Paid in Capital 17,850,100 18,775,100 ↑ 925,000 Retained Earnings 4,949,200 6,116,850 ↑ 1,167,650

Total Owners’ Equity 25,724,300 27,891,950

Total Liabilities and Owners’ Equity 45,503,005 46,491,950 Total Sources and Uses of Funds 5,640,700 5,640,700

Creating the Statement of Cash

Flows

 The statement of cash flows should be prepared just as

often as you prepare your income statement and

balance sheet In order to build a statement of cash

flows, you will need the following:

 Income statement for this year, including a statement

of retained earnings

 Balance sheet from last year

 Balance sheet from this year

Creating the Statement of Cash Flows

 The format of a SCF consists of the following:

 Cash flow from operating activities

 Cash flow from investing activities

 Cash flow from financing activities

 Net changes in cash

 Supplementary schedules

 Figure 5.5 is an example of the standard format used to

prepare a statement of cash flows

Figure 5.5 Statement of Cash Flows Format

Cash Provided (inflow) or Used (outflow) by:

Operating activities $XXX Investing activities $XXX Financing activities $XXX

Net increase (decrease) in cash $XXX Cash at beginning of the accounting period $XXX Cash at the end of the accounting period $XXX

Supplementary Schedule of Noncash Investing and Financing Activities $XXX

Supplementary Disclosure of Cash Flow Information

Cash paid during the year for:

Interest $XXX Income taxes $XXX

Cash Flow from Operating

Activities

 Cash flow from operating activities is the result of all of

the transactions and events that normally make up a

business’s day to day activities

 These include cash generated from selling goods or

providing services, as well as income from items such

as interest and dividends

 Operating activities will also include cash payments for

items such as inventory, payroll, taxes, interest, utilities, and rent

Cash Flow from Operating Activities

 The net amount of cash provided (or used) by operating

activities is a key figure on a statement of cash flows

because it shows cash flows that managers can control the most

 The first step in creating a statement of cash flows is to

develop a summary of cash inflows and outflows

resulting from operating activities, using information

provided on the income statement including sales,

expenses, and thus, net income

Cash Flow from Operating Activities

 There are two methods that are used in calculating and

reporting the amount of cash flow from operating

activities on the statement of cash flows: the indirect

method and the direct method

 Although both produce identical results, the indirect

method is more popular because it more easily

reconciles the difference between net income and the

net cash flow provided by operations

Cash Flow from Operating Activities

 When using the indirect method, you start with the

figure for net income (taken from your income

statement) and then adjust this amount up or down to

account for any income statement entries that do not

actually provide or use cash

 The accrual income statement must be converted to a

cash basis in order to report cash flow from operating

activities

Cash Flow from Operating Activities

 The two most common items on the income statement

that may need to be adjusted from an accrual basis to a cash basis are

 Depreciation, and

 Gains/losses from a sale of investments/equipment

 Depreciation is a method of allocating the cost of a fixed

asset over the useful life of the asset

 More important, however, depreciation is subtracted

from the income statement primarily to lower income,

and thus lower taxes

Cash Flow from Operating Activities

 In order to adjust net income to reflect actual cash,

then, depreciation must be added back

 A gain on a sale of an investment/equipment occurs

when the original cost of the investment/equipment is

lower than the price at which it is sold at a later date

 Conversely, a loss on a sale of an

investment/equipment occurs when the original cost of

the investment/equipment is higher than the price at

which it is sold at a later date

Archie lost money on the deal Therefore, he can subtract the loss of $50,000 from his income statement to reduce his taxes However, just like depreciation,

he did not write a check for “loss” to anyone, and therefore, his cash is still there!

In order to adjust net income to reflect actual cash on his statement of cash flows, the $50,000 loss would be added back In addition, the $100,000 of land that he sold would be shown on the investing activity portion of the statement of cash flows Alternatively, a gain on the sale would result in an addition to his income statement A gain, then, would have to be subtracted from net income on the statement of cash flows

Cash Flow from Operating Activities

 The remaining adjustments to net income when

calculating cash flow from operating activities come from the sources and uses of funds calculated from the

balance sheets

 Sources of funds are shown as a positive number on the

statement of cash flows and uses of funds are shown as

a negative number of the statement of cash flows

 In general, the sources and uses of funds used for cash

flow from operating activities will come from current

assets and current liabilities

 The exceptions to this are marketable securities, which

belongs in investing activities, and notes payable

(short-term debt), which belongs in financing activities

Cash Flow from Investing Activities

 An investment can be understood simply as the

acquisition of an asset for the purpose of increasing

future financial return or benefits

 Cash flow from investing activities summarizes this part

of a business’s action

 A business’s investing activities include those

transactions and events involving the purchase and sale

of marketable securities, investments, land, buildings,

equipment, and other assets not generally purchased

for resale

Cash Flow from Investing Activities

 The cash flow from investing activities comes from the

sources and uses of funds that you calculated from your balance sheets

 Sources of funds are shown as a positive number on the

statement of cash flows and uses of funds are shown as

a negative number of the statement of cash flows

 In general, the sources and uses of funds used for cash

flow from investing activities will come from long-term

assets (investments, property and equipment, and other assets)

 The exception to this is marketable securities, which is a

current asset that belongs in investing activities

Cash Flow from Financing Activities

 The third and final of the three cash inflow and outflow

activity summaries that make up a complete SCF

relates to the financing activities of a business

 Cash flow from financing activities refers to a variety

Cash Flow from Financing Activities

 Although repayments of loans are considered a

financing activity, interest paid and interest received are classified as operating activities (as part of the income

statement)

 Cash payments made to reduce the principal (the

amount borrowed) of a loan would be considered cash

flow related to a financing activity, while any interest

paid to secure the loan would be considered an

operating expense

 Loans, notes, and mortgages are all examples of

financing activities that affect cash flows

Cash Flow from Financing Activities

 The cash flow from financing activities comes from the

sources and uses of funds calculated from the balance

sheets

 Sources of funds are shown as a positive number on the

statement of cash flows and uses of funds are shown as

a negative number of the statement of cash flows

 In general, the sources and uses of funds needed for

cash flow from financing activities come from long-term

debt and equity

 The exception to this is notes payable (short-term debt),

which is a current liability that belongs in financing

activities

Cash Flow from Financing Activities

 Also, dividends paid must be recorded in financing

activities because that is a cash outflow from net

income

 Additions and subtractions to the statement of cash

flows are shown in Figure 5.9

 With the exceptions noted, operating activities are

developed using current assets and current liabilities,

investing activities are developed using long-term

assets, and financing activities are developed using

long-term debt and owners’ equity

Figure 5.9 General Additions and Subtractions to the Statement of Cash Flows

Operating activities

Net income +/- Depreciation +/- Losses/gains from the sale of investments/equipment +/- Current assets (except marketable securities)

+/- Current liabilities (except notes payable)

Investing activities

+/- Marketable securities +/- Investments

+/- Property and equipment +/- Other assets

Financing activities

+/- Notes payable +/- Long-term debt +/- Common stocks and paid in capital +/- Dividends paid