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Chapter 13

• How Well Am I Doing? Statement of Cash Flows

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Purpose of the Statement of Cash Flows
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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
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Classify changes in noncash balance sheet
accounts as sources or uses of cash.
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Definition of Cash
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• The term cash on the statement of cash flows
  refers broadly to both currency and cash
  equivalents.

Currency and Bank Accounts
Treasury Bills
Cash
Commercial Paper
Money Market Funds
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Constructing the Statement of Cash Flows Using
Changes in Noncash Balance Sheet Accounts
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Net Cash Flows for a Period
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Constructing the Statement of Cash Flows Using
Changes in Noncash Balance Sheet Accounts
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Constructing the Statement of Cash Flows Using
Changes in Noncash Balance Sheet Accounts
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Increases in noncash asset accounts 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
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Increases in liability accounts imply sources of
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
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Decreases in noncash assets accounts imply
sources of cash.
Example Accounts receivable decreases when a
company pays its bill.
The companys cash increases accordingly.
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Constructing the Statement of Cash Flows Using
Changes in Noncash Balance Sheet Accounts
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Decreases in liability accounts imply uses of
cash.
Example If a company makes a payment on a note
payable.
The companys cash balance decreases accordingly.
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A Simplified Statement of Cash Flows
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A Simplified Statement of Cash Flows
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• 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
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Here is a summary of the sources of cash for Eds
Pizza Hut.
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A Simplified Statement of Cash Flows
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Here is a summary of the uses of cash.
The net cash flow for Eds Pizza Hut is
(19,000) 66,000 in sources minus 85,000 in
uses.
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A Simplified Statement of Cash Flows
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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
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Classify transactions as operating, investing, or
financing activities.
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The Three Sections of the Statement of Cash Flows
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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 Three Sections of the Statement of Cash Flows
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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 held for
long-term investments
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The Three Sections of the Statement of Cash Flows
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Financing activities relate to transactions
involving borrowing from creditors or repaying
creditors and engaging in transactions with the
companys 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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Format of the Statement of Cash Flows (Indirect
Method)
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Format of the Statement of Cash Flows (Indirect
Method)
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Operating Activities
Reconciliation of the beginning cash balance with
the ending cash balance
Investing Activities
Financing Activities
Noncash Investing and Financing Activities
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Operating Activities
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Net Income or Loss Net Income or Loss XXX
Add Decrease in current noncash assets XXX
Increase in current liabilities XXX
Depreciation charges XXX
Losses XXX
Less Increase in current noncash assets (XXX)
Decrease in current liabilities (XXX)
Gains (XXX)
Cash Flows from Operating Activities Cash Flows from Operating Activities XXX
Includes those activities that affect current
assets, current liabilities, or net income.
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Operating Activities
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• Sources of cash are added to and uses of cash are
  subtracted from net cash provided by operating
  activities.

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Operating Activities
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Net Income or Loss Net Income or Loss XXX
Add Decrease in current noncash assets XXX
Increase in current liabilities XXX
Depreciation charges XXX
Losses XXX
Less Increase in current noncash assets (XXX)
Decrease in current liabilities (XXX)
Gains (XXX)
Cash Flows from Operating Activities Cash Flows from Operating Activities XXX
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Operating Activities
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Net Income or Loss Net Income or Loss XXX
Add Decrease in current noncash assets XXX
Increase in current liabilities XXX
Depreciation charges XXX
Losses XXX
Less Increase in current noncash assets (XXX)
Decrease in current liabilities (XXX)
Gains (XXX)
Cash Flows from Operating Activities Cash Flows from Operating Activities XXX
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Operating Activities
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Net Income or Loss Net Income or Loss XXX
Add Decrease in current noncash assets XXX
Increase in current liabilities XXX
Depreciation charges XXX
Losses XXX
Less Increase in current noncash assets (XXX)
Decrease in current liabilities (XXX)
Gains (XXX)
Cash Flows from Operating Activities Cash Flows from Operating Activities XXX
Depreciation and Amortization charges are added
back because they are decreases in noncash assets.
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Operating Activities
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Net Income or Loss Net Income or Loss XXX
Add Decrease in current noncash assets XXX
Increase in current liabilities XXX
Depreciation charges XXX
Losses XXX
Less Increase in current noncash assets (XXX)
Decrease in current liabilities (XXX)
Gains (XXX)
Cash Flows from Operating Activities Cash Flows from Operating Activities XXX
Gains are subtracted.
Losses are added.
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Investing Activities
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Includes transactions that involve the
acquisition or disposal of noncurrent assets.
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Financing Activities
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Includes transactions involving receipts from or
payments to creditors and owners.
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Cash Flows Gross or Net?
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• For investing and financing activities, items on
  the statement of cash flows should be presented
  in gross amounts rather than in net amounts.

• Example
• Assume Macys 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.

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Operating Activities Direct or Indirect Method?
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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
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Prepare a statement of cash flows using the
indirect method to determine the net cash
provided by operating activities.
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Statement of Cash Flows Indirect Method
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Lets revisit the comparative balance sheet
account balances for Eds Pizza Hut.
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Statement of Cash Flows Indirect Method
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Refresh your 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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Step 1 of 8
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List each account appearing on the comparative
balance sheets except for cash and cash
equivalents and retained earnings.
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Step 2 of 8
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Compute the change from the beginning balance to
the ending balance for each account.
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Step 3 of 8
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Code each entry on the worksheet as a source or
use of cash.
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Step 4 of 8
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Code sources of cash as positive numbers and uses
of cash as negative numbers.
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Step 5 of 8
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Make any necessary adjustments, including
adjustments for gains and losses. The net effect
of these should equal zero.
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Step 6 of 8
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Classify each entry as operating, investing, or
financing activity.
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Step 7 of 8
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Copy the data from the worksheet into the
Statement of Cash Flows section by section.
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Step 8 of 8
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Prepare a cash reconciliation at the bottom of
the statement.
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Statement of Cash Flows Indirect Method
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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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Interpretation of the Statement of Cash Flows
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• Examine the operating activities section
  carefully.
• Eds 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.

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Learning Objective 4
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Compute free cash flow.
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Free Cash Flow
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Free cash flow measures a companys ability to
fund its capital expenditures and dividends from
its net cash provided by operating activities.
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Free Cash Flow
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Using the equation shown on the prior slide, the
free cash flow for Eds Pizza Hut of (51,000) is
computed like this . . .
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Appendix 13A

• The Direct Method of Determining the Net Cash
  Provided by Operating Activities.

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Learning Objective 5
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Use the direct method to determine the net cash
provided by operating activities.
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Computing Net Cash Provided by Operating
Activities
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The direct method computes net cash provided by
operating activities by reconstructing the income
statement on the cash basis from top to bottom.
However
The amount of 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 Differencesin Handling Data
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Adjustments for accounts that affect revenue are
the same in the direct method 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
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Regarding gains and losses on sale of assets, no
adjustments are needed at all under the direct
method.
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The Direct Method
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Lets revisit the comparative balance sheet
account balances for Eds Pizza Hut.
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The Direct Method
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Lets assume that Eds Pizza Hut prepared this
income statement.
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The Direct Method
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Step 1 Translate sales revenue into cash
collected from customers.
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The Direct Method
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Step 2 Translate cost of goods sold into
cash disbursements for purchases.
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The Direct Method
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Step 3 Translate operating expenses into cash
paid for operating expenses.
There is not an adjustment needed for income
taxes because Eds Pizza Hut has a net loss of
27,000.
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The Direct Method
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Notice that the net cash provided by operating
activities agrees with that computed using the
indirect method.
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Appendix 13B

• The T-Account Approach to Preparing the Statement
  of Cash Flows

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T-Account Approach Statement of Cash Flows
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T-Account Approach Statement of Cash Flows
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• 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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T-Account Approach
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Here is a summary of the sources of cash for Eds
Pizza Hut.
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T-Account Approach
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Here is a summary of the uses of cash for Eds
Pizza Hut.
The net cash flow for Eds Pizza Hut is
(19,000) 66,000 in sources minus 85,000 in
uses.
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T- Account Approach
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T-Account Approach
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T-Account Approach
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T-Account Approach
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T-Account Approach
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T-Account Approach
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What about the 50,000 issuance of common stock
to settle the note payable to Joe Doe?
However, this transactions would be disclosed in
a supplemental schedule that accompanies the
statement of cash flows.
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T-Account Approach
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The net effect of these transactions on the cash
account is as shown. Notice, the net decrease in
cash is 19,000.
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The Statement of Cash Flows
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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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End of Chapter 13
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