Preparing and Analyzing the Statement of Cash Flows

1
Chapter 11

• Preparing and Analyzing the Statement of Cash
  Flows

2
In Chapter 10

• You learned how a company accounts for and
  reports
• Contributions from Stockholders
• Payments of Dividends
• Retained Earnings

3
In Chapter 11

• You will learn how to
• Prepare a Statement of Cash Flows.
• from an Income Statement,
• and a comparative Balance Sheet

4
Categories of Cash Flows

• Cash Flows are subdivided into three categories
• Operating Cash Receipts and Cash Disbursements
  from day to day transactions. These transactions
  are generally from the Income Statement and
  affect Current Assets and Current Liabilities
• Investing Cash Receipts and Cash Disbursements
  from the purchase and sale of Long-Term Assets
• Financing Cash Receipts and Cash Disbursements
  from Long-term Debt and Equity

5
Classification of Cash Flows
6
Accrual Basis versus Cash Basis of Accounting
Accrual Basis Recognizes Revenues at the time
the earnings process is complete, and expenses at
the time they are incurred, regardless of cash
flow. Cash Basis Recognizes Revenues when the
Cash is Received, and Expenses at the time the
Cash is Paid.
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Financial Statements are prepared using the
Accrual Basis of Accounting

• The Statement of Cash Flows Requires that the
  Accrual Basis be converted to the Cash Basis of
  Accounting.
• This Can be Done either
• Directly by examining each item on the Income
  Statement, or
• Indirectly By Adjusting Net Income for the
  changes in the Non-Cash Balance Sheet Accounts.

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Lets look at Some Simple Transactions
Sales 600 (500 Cash, 100 on Account) Cost of
Goods Sold was 250
500
Cash
Accounts Receivable
100
Sales
600
250
Cost of Goods Sold
Inventory
250
Statement of Cash Flows Direct Method
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Paid 30 for Supplies Used 20 of them 10
remain
20
Supplies Expense
Supplies
10
Cash
30
Statement of Cash Flows Direct Method
10
Purchased 250 of Inventory Paid 200 Cash, 50
on account.
250
Inventory
Accounts Payable
50
Cash
200
Statement of Cash Flows Direct Method
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Cash Provided by Operating Activities
Statement of Cash Flows Direct Method
Total
12
Statement of Cash Flows Indirect Method
If Any
If Any
Equals Net Operating Cash Flow
If Any
Changes in Current Liabilities Adjust in Same
Direction Add the Increase Subtract the Decrease
Changes in Current Assets Adjust in Opposite
Direction Subtract the Increase Add the Decrease
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Net Operating Cash Flow
Is the Same using both the Direct and Indirect
Methods
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Statement of Cash Flows Indirect Method
Uses information from the Income Statement and
the Comparative Balance Sheet
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Statement of Cash Flows Indirect Method
If Any
Changes in Current Assets Adjust in Opposite
Direction Subtract the Increase Add the Decrease
Changes in Current Liabilities Adjust in Same
Direction Add the Increase Subtract the Decrease
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Calculating Operating Cash Flows using the Direct
Method
Is Determined by Converting Each Line Item on the
Income Statement from the Accrual basis to the
Cash Basis. This involves establishing the links
between the Income Statement and the Related
Balance Sheet accounts, and Reconstructing the
Cash Flows.
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Operating Activities
Calculating Cash Receipts From Customers
Accounts Receivable 150
250
Sales
20,000
Accounts Receivable
Sales
Beginning
0
Beginning
150
Net Change
Net Change
20,000
100
CR
DR
20,000
Ending
Ending
250
To Operating Section of Statement of Cash Flows
Calculate the Cash Flow with a reconstructed
entry
Cash
To Balance
19,900
Accounts Receivable
100
Sales
20,000
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Operating Activities
Calculating Cash Paid for Inventory
Inventory
100 1,300 Accounts Payable
800 500
Cost of Goods Sold 6,000
Cost of Goods Sold
Accounts Payable
Inventory
Beginning
0
Beginning
Beginning
800
100
Net Change
6,000
Net Change
DR
Net Change
DR
300
1,200
DR
6,000
Ending
500
Ending
Ending
1,300
To Operating Section of Statement of Cash Flows
Calculate the Cash Flow with a reconstructed
entry
Cost of Goods Sold
6,000
Inventory
1,200
Accounts Payable
300
Cash
7,500
To Balance
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Operating Activities
Calculating Cash Paid to Employees
Salaries Payable 50
150
Salaries Expense 3,000
Salaries Expense
Salaries Payable
Beginning
0
Beginning
50
Net Change
3,000
DR
CR
Net Change
100
Ending
3,000
Ending
150
Calculate the Cash Flow with a reconstructed
entry
Salaries Expense
3,000
Salaries Payable
To Operating Section of Statement of Cash Flows
100
Cash
2,900
To Balance
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Operating Activities
Calculating Cash Paid for Rent
Prepaid Rent 200
400
Rent Expense 1,000
Rent Expense
Prepaid Rent
Beginning
0
Beginning
200
Net Change
1,000
DR
DR
Net Change
200
Ending
1,000
Ending
400
To Operating Section of Statement of Cash Flows
Calculate the Cash Flow with a reconstructed
entry
Rent Expense
1,000
Prepaid Rent
200
Cash
1,200
To Balance
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Operating Activities
Calculating Cash Paid for Insurance
Prepaid Insurance 125
75
Insurance Expense 500
Insurance Expense
Prepaid Insurance
Beginning
0
Beginning
125
Net Change
500
DR
50
CR
Net Change
Ending
500
Ending
75
Calculate the Cash Flow with a reconstructed
entry
Insurance Expense
500
Prepaid Insurance
50
To Operating Section of Statement of Cash Flows
Cash
450
To Balance
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Operating Activities
Calculating Cash Paid for Interest
Interest Payable 150
80
Interest Expense 200
Interest Expense
Interest Payable
Beginning
0
Beginning
150
Net Change
200
DR
DR
Net Change
70
Ending
200
Ending
80
To Operating Section of Statement of Cash Flows
Calculate the Cash Flow with a reconstructed
entry
Interest Expense
200
Interest Payable
70
Cash
270
To Balance
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Calculate Net Cash from Operating Activities
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Depreciation Expense is a non-cash Expenditure
Depreciation is not reported on a Direct Method
Statement of Cash Flows
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Okay, so were done with the Operating Section
of the Statement of Cash Flows
Cash Flow from the Purchase and Sale of Long-Term
Assets are Investing Activities
Are we done reviewing the Comparative Balance
Sheets?
No, weve only explained the changes in the
current assets and liabilities
You have identified all Cash Inflows and Outflows
from day-to-day Operations
Lets look at the Long-Term Assets
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Long-Term Accounts

• Unlike Current Accounts, where a single Net
  Change was calculated,
• The Changes in Long-Term Accounts will be
  analyzed in detail. It may take two or more
  transactions to explain the change in the account
  balances. For Example
• The change in Retained Earnings may be
  attributable to both net income and dividends.
• The change in Equipment may be attributable to
  both a purchase and a disposal of equipment.

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Calculating Cash Paid for Equipment
Operating Activities
Accounts Related to Depreciable Assets
Equipment
4,000 5,000 Accumulated Depreciation
(150) (225)
Depreciation Expense 75
Depreciation Expense
Accumulated Depreciation
Equipment
Beginning
150
0
Beginning
Beginning
4,000
Depr Exp
75
Depr Exp
- Disposals
75
No Disposals
1,000
- Disposals
Purchases
No Disposals
Ending
225
Ending
75
5,000
Ending
Journal Entry for Depreciation Expense
Journal Entry for Equipment Purchases
To Investing Section of Statement of Cash Flows
Depreciation Expense
Equipment
75
1,000
Accumulated Depreciation
1,000
Cash
75
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Were done with the Investing Section of the
Statement of Cash Flows
All we have left are the Long-Term Liability and
Equity Accounts
Cash Flows for these items are Financing
Activities
You have explained the changes in all of the
Long-Term Asset Accounts
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Operating Activities
Calculating Proceeds from Issuance of Note Payable
Long-Term Notes Payable
0 2,000
Long-Term Notes Payable
To Financing Section of Statement of Cash Flows
0
Beginning
Borrowing
2,000
- Repayments
2,000
Ending
Journal Entry for Issuance of Long-Term Notes
Payable
Cash
2,000
Long-Term Notes Payable
2,000
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Operating Activities
Calculating Proceeds from Issuance of Common Stock
Common Stock and Additional Paid-in-Capital
5,000 8,000
Common Stock and P-I-C
To Financing Section of Statement of Cash Flows
5,000
Beginning
3,000
Proceeds from Issuance
8,000
Ending
Journal Entry for Issuance of Common Stock
Cash
3,000
Common Stock and Additional Paid-in-Capital
3,000
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Operating Activities
Calculating Dividends Paid
Net Income 9,225
Retained Earnings
5,120 14,345
Retained Earnings
5,120

• Net Losses

Beginning

To Financing Section of Statement of Cash Flows

• Dividends

• 0 to balance

Net Income
9,225
Ending
14,345
Journal Entry to Close Income to Retained Earnings
Journal Entry for Dividends (if any)
Income Summary
Retained Earnings
9,225
To Balance
Retained Earnings
Cash
9,225
To Balance
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Although the detail of the Operating Activities
is different
Net Cash from Operating Activities is the same
under each method
Comparing the Direct and Indirect Methods
The Investing and Financing sections are
identical under each method

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Financial Statement Analysis Free Cash Flow
42
Financial Statement Analysis
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End Chapter 11