Chapter 12 Statement of Cash Flows

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Chapter 12
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Chapter 12 Statement of Cash Flows

• After studying Chapter 12, you should be able
  to
• Indicate the primary purpose of the statement of
  cash flows.
• Distinguish among operating, investing, and
  financing activities.
• Explain the impact of the product life cycle on a
  company's cash flows.
• Prepare a statement of cash flows using one of
  two approaches
• (a) the indirect method, or
• (b) the direct method.
• Use the statement of cash flows to evaluate a
  company.

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The Primary Purpose of the Statement of Cash
Flows Is...

• To provide information about
• cash receipts,
• cash payments, and
• the net change in cash resulting from
• operating,
• investing, and
• financing activities of a company during a period.

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Operating Activities...

• Include
• The cash effects of transactions that create
  revenues and expenses and
• Enter into determination of net income.

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Investing Activities...

• Include
• Purchasing and disposing of investments and
  productive long-lived assets using cash and
• Lending money and collecting the loans.

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Financing Activities...

• Include
• Obtaining cash from issuing debt and repaying the
  amounts borrowed and
• Obtaining cash from stockholders and paying
  dividends.

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Types of Cash Flows -Operating Activities

• Cash inflows
• From sale of goods or services
• From interest on loans (interest received) and
  dividends on equity security investments
• Cash outflows
• To suppliers for inventory
• To employees for services
• To government for taxes
• To lenders for interest
• To others for expenses

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Types of Cash Flows -Investing Activities

• Cash inflows
• From sale of property, plant, and equipment
• From sale of debt or equity securities of other
  entities
• From collection of principal on loans to other
  entities
• Cash outflows
• To purchase property, plant, and equipment
• To purchase debt or equity securities of other
  entities
• To make loans to other entities

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Types of Cash Flows -Financing Activities

• Cash inflows
• From sale of equity securities (company's own
  stock)
• From issuance of debt (bonds and notes)
• Cash outflows
• To stockholders as dividends
• To redeem long-term debt or reacquire capital
  stock

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Operating Activities - ALERT

• Some cash flows relating to investing or
  financing activities are classified as operating
  activities. For example...
• Receipts of investment revenue (interest and
  dividends) and
• Payments of interest to lenders are classified as
  operating activities because these items are
  reported in the income statement.

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Format of the Statement of Cash Flows

• Three activities
• operating
• investing
• financing
• PLUS
• noncash investing and financing activities

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Statement of Cash Flows Helps Users Evaluate

• 1. The entity's ability to generate future cash
  flows
• 2. The entity's ability to pay dividends and meet
  obligations
• 3. The reasons for the difference between net
  income and net cash provided (used) by operating
  activities
• 4. The investing and financing transactions
  during the period

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COMPUTER SERVICES COMPANY Comparative Balance
Sheet December 31, 2003
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Income Statement and Additional Information

• COMPUTER SERVICES COMPANY
• Income Statement
• For the Year Ended December 31, 2003
• Revenues 85,000
• Operating expenses 40,000
• Income before income taxes 45,000
• Income tax expense 10,000
• Net income 35,000
• Additional Information
• (a) Examination of selected data indicates that a
  dividend of 15,000 was declared and paid during
  the year.
• (b) The equipment was purchased at the end of
  2003. No depreciation was taken in 2003.

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Indirect and Direct Methods

• Convert net income from an accrual basis to a
  cash basis.
• This conversion may be done by two
  methods
• indirect
• direct

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Indirect and Direct Methods

• Both methods arrive at the same total amount for
  Net cash provided by operating activities.
• The methods differ in disclosing the items that
  make up the total amount.
• The choice of methods affects only the operating
  activities section the investing and financing
  activities sections are the same.

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Indirect Method

• The indirect method is used extensively in
  practice.
• Most companies favor the indirect method for the
  following reasons
• it is easier to prepare
• it focuses on the differences between net income
  and net cash flow from operating activities
• it tends to reveal less company information to
  competitors.

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Direct Method

• The FASB prefers the direct method but allows the
  use of either method.
• When the direct method is used, the net cash flow
  from operating activities as computed using the
  indirect method must also be reported in a
  separate schedule.

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Statement Of Cash Flows - Indirect Method

• The transactions of Computer Services Company for
  the year ended 2003 are used to illustrate the
  preparation of a statement of cash flows .
• Computer services Company started in January 1,
  2003, when it issued 50,000 shares of 1 par
  value common stock for 50,000 cash.
• The company rented its office space and furniture
  and performed consulting services throughout the
  first year.

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Determine Net Cash Provided/Used By Operating
Activities

• Adjust net income for items that did not affect
  cash.
• Net income must be converted because earned
  revenues may include credit sales that have not
  been collected in cash and expenses incurred that
  may not have been paid in cash.

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Determine Net Cash Provided/Used By Operating
Activities

• Receivables, payables, prepayments, and
  inventories must be analyzed for their effects on
  cash.

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Determine Net Cash Provided/Used By Operating
Activities

• Computer Services Company had revenues of 85,000
  in its first year of operations.
• However, CSC collected only 55,000 in cash.
  Accrual basis revenue was 85,000, cash basis
  revenue would be 55,000.
• The increase in accounts receivable of 30,000
  must be deducted from net income.
• If accounts receivable decrease, the decrease
  must be added to net income.

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• COMPUTER SERVICES COMPANY
• Statement of Cash Flows--Indirect Method
  (Partial)
• For the Year Ended December 31, 2003
• Cash flows from operating activities
• Net income 35,000
• Adjustments to reconcile net income to
• net cash provided by operating activities
• Increase in accounts receivable (30,000)
  

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Determine Net Cash Provided/Used By Operating
Activities

• Accounts payable - When accounts payable increase
  during a year, operating expenses on an accrual
  basis are higher than they are on a cash basis.
• For CSC, operating expenses reported in the
  income statement were 40,000.
• Since Accounts Payable increased 4,000, 36,000
  (40,000 4,000) of the expenses were paid in
  cash.
• To convert net income to net cash provided by
  operating activities, an increase in accounts
  payable must be added to net income, a decrease
  subtracted.

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• COMPUTER SERVICES COMPANY
• Statement of Cash Flows--Indirect Method
  (Partial)
• For the Year Ended December 31, 2003
• Cash flows from operating activities
• Net income 35,000
• Adjustments to reconcile net income to
• net cash provided by operating activities
• Increase in accounts receivable (30,000)
• Increase in accounts payable
  4,000 (26,000)
• Net cash provided by operating activities
  9,000

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Determine Net Cash Provided/Used By Investing
and Financing Activities

• No data are given for the increases in Equipment
  of 10,000 and Common Stock of 50,000. Assume
  any differences involve cash.
• The increase in equipment is from a purchase of
  equipment for 10,000 cash. This purchase is
  reported as a cash outflow in the investing
  activities section.
• The increase of common stock results from the
  issuance of common stock for 50,000 cash. It is
  reported as an inflow of cash in the financing
  activities section of the statement of cash flows.

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COMPUTER SERVICES COMPANY Comparative Balance
Sheet December 31, 2003
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Determine Net Cash Provided/Used By Investing
and Financing Activities

• Reasons for the increase of 20,000 in the
  Retained Earnings.
• Net income increased retained earnings by
  35,000. REPORTED IN THE OPERATING ACTIVITIES
  SECTION.
• The additional information indicates that a cash
  dividend of 15,000 was declared and paid.
  REPORTED IN THE FINANCING ACTIVITIES SECTION.

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• COMPUTER SERVICES COMPANY
• Statement of Cash Flows--Indirect Method
  (Partial)
• For the Year Ended December 31, 2003
• Cash flows from operating activities
• Net income 35,000
• Adjustments to reconcile net income to
• net cash provided by operating activities
• Increase in accounts receivable (30,000)
• Increase in accounts payable
  4,000 (26,000)
• Net cash provided by operating activities
  9,000
• Cash flows from investing activities
• Purchase of equipment (10,000)
• Cash flows from financing activities
• Issuance of Common Stock 50,000
• Payment of cash dividends (15,000)
• Net cash provided by financing activities
  35,000
• Net increase in cash 34,000

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• COMPUTER SERVICES COMPANY
• Statement of Cash Flows--Direct Method
  (Partial)
• For the Year Ended December 31, 2003
• Cash flows from operating activities
• Cash receipts from customers
  765,000
• Cash payments
• To supplier 550,000
• For operating expenses
  158,000
• For income taxes 48,000 756,000
• Net cash provided by operating activities
  9,000

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Free Cash Flow

• Cash Provided By Operations
• Capital Expenditures
• Dividends Paid
  
• Free Cash Flow

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Assessing Liquidity, Solvency, and Profitability
Using Cash Flows

• Rather than using numbers from the income
  statement for assessment purposes, we use numbers
  from the statement of cash flows.