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7/26/2019 Ch05_The Statement of Cash Flows
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1
TheStatement ofCash Flows
chapter5
An electronic presentation
by Douglas Cloud
Pepperdine University
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1. Describe the circumstances in which thecash flow statement is a particularly
important companion to the income
statement.
2.Outline the structure of and information
reported in the three main categories of
the cash flow statement: operating,
investing, and financing.
Learning Objectives
Continued
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3.Compute cash flow from operationsusing either the direct or indirect method.
4.Prepare a complete statement of cash
flows and provide the requiredsupplemental disclosures.
5.Understand the differences among cash
flow statements prepared according to
U.S. GAAP, U.K. GAAP, and
international accounting standards.
Learning Objectives
Continued
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Learning Objectives
6.Assess a firms financial strength byanalyzing the relationships among cashflows from operating, investing, and
financing activities and by computingfinancial ratios based on cash flow data.
7.Use knowledge of how the three
primary financial statements tie togetherin order to prepare a forecasted statementof cash flows.
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5What Good Is a Cash FlowStatement?
Does a statement of cashflows tell us anything we
dont already know from
other statements?
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6What Good Is a Cash FlowStatement?
Yes, because there aresituations where net
income does not give us an
accurate picture.
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7What Good Is a Cash FlowStatement?
Also, everything you wantto know about a company
is summarized in this one
statement.
Finally, a statement of cashflows is an excellent
forecasting tool.
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8Structure of the Cash FlowStatement
What is a cash
equivalent?
It is a short-term,
highly liquid
investment.
It must be readily convertible to cash
and it must be so near to maturity that
there is insignificant risks of changes in
value due to changes in interest rate.
f h h l
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CASH
INFLOWS
Cash Inflows
Operating
Activities
Investing
Activities
Financing
Activities
Structure of the Cash FlowStatement
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Operating ActivitiesTransactions andevents that enter into the determination of netincome.
Investing ActivitiesTransactions and
events that involve the purchase and sale ofsecurities, property, plant, equipment, andother assets not generally held for resale, andthe making and collecting of loans.
Financing ActivitiesTransactions andevents whereby resources are obtained fromor repaid to owners and creditors.
Cash Flow Patterns
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Cash Flow Patterns
Over the Life of a Company
Start-up, High-Growth Company
Financing
Investing
Operating
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Cash Flow Patterns
Over the Life of a Company
Steady-State Company
Operating
Investing
Financing
Dividends
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Cash Flow Patterns
Over the Life of a Company
Cash Cow
Operating
Investing
FinancingDividends
Share Repurchases
Loan Repayment
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Noncash Transactions
Investing and financing activities thatdo not affect cash.
Significant transactions should be
disclosed separately.
These transactions do not affect the
statement of cash flows.
R ti C h F l f
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15Reporting Cash F lows fromOperations
Direct MethodA method of reporting netcash flows from operations that shows cash
receipts and payments for a period of time.
This method is more straight forward.
Indirect MethodA method of reporting net
cash flow from operations that involves
reconciling net income to a cash basis. It
shows how noncash flows affect net income.
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The Direct Method
This method reports directly the majorclasses of operating cash receipts andpayments of an entity during a period.
Accrual-basis revenues and expensesmust be converted to equivalent cashreceipts and payments.
The amount of cash actually collectedor paid is determined.
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Indirect Method
Adjustments for receivables and other
current operating assets. Adjustments for payables and other
current liabilities.
Adjustments for depreciation and othernoncash items.
Adjustments for gains and losses.
The indirect method makes thefollowing adjustments:
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Operating Activi ties
Cash Inflow
Cash receipt of
sales Collection of
receivables
Interest revenue
Dividend revenue
Cash Outflow
Inventory payments Interest payments
Wages
Utilities
Rent
19R l ti hi B t N t
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19Relationship Between NetIncome and Operating Cash Flow
Business engages inoperating activities
Net income
Apply accrualaccounting rules
Undo accrualaccounting to get
back to cash flow
Cash is received and
disbursed
Operating cash flow
20E l f O ti A ti iti
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Sales and Cash Collected from Customers:
Beginning accounts receivable $ 40
+ Sales 150
= Cash available for collection $190 Ending accounts receivable 60
= Cash Collected from Customers $130
Example of Operating ActivitiesSection for the Direct Method
21E l f O ti A ti iti
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Cost of Goods Sold and Cash Paid for Inventory:
Ending inventory $ 75
+ Cost of goods sold 80
= Required inventory $155 Beginning inventory 100
= Cash paid for inventory this year $ 55
Example of Operating ActivitiesSection for the Direct Method
22E l f O ti A ti iti
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Wages Expense and Cash Paid for Wages:
Beginning wages payable $ 7
+ Wages expense 25
= Total obligation to employee $32 Ending wages payable 10
= Cash paid for wages $22
Example of Operating ActivitiesSection for the Direct Method
23Adj t t f G i
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23Adjustments for Gainsand Losses
Gains or losses do not represent the casheffect of the transaction.
Adjustment toAccount Net Income
Losses
Gains
These adjustments are made to net income
since the sale of an investment is an investing
activity, not an operating activity.
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Adjustments for Receivables
Changes in accounts directly affectrevenues recorded on an accrual basis.
Account Adjustment toAccount Change Net Income
Accounts Receivable
Accounts Receivable
Inventory
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Adjustments for Payables
Changes in liabilities mean the reverse of
changes in current operating asset accounts.
Account Adjustment toAccount Change Net Income
Accounts Payable
Wages Payable
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Noncash Adjustments
Depreciation and similar noncash items donot affect cash and are not reported on thestatement of cash flows.
Any noncash item that reducesnet incomeshould be added back to net income in theindirect method.
Any noncash item that increases net income
should be subtracted from net income in theindirect method.
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I nvesting Activities
Cash Inflow
Sale of plant assets
Sale of securities,other than trading
securities
Collection ofprincipal on loans
Cash Outflow
Purchase of plant assets
Purchase of securities,
other than trading
securities
Making of loans with
other entities
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F inancing Activi ties
Cash Inflow
Issuance of own
stock Borrowings
Cash Outflow
Dividend payments Repaying principal
on borrowing
Treasury Stockpurchase
29Differences between I ncome and
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29Differences between I ncome and
Cash from Operations
Cash from Net
Company Name Operations Income Difference
General Motors $19,750 $ 4,452 $(15,298 )
Lehman Brothers (14,733 ) 1,775 16,508
Ford Motors 33,764 3,467 (30,297 )
Citigroup 2,673 13,519 10,846
SOURCE: Standard and Poor COMPUTSTAT
Year 2000
(All amounts are in
millions)
30General Format of a
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30General Format of aStatement of Cash F lows
Cash Provided by (Used for):
Operating Activities $XXX
Investing Activities XXX
Financing Activities XXX
Net Increase (Decrease) in Cash $XXX
CashBeginning of Year XXXCashEnd of Year $XXX
31Preparing a
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31Preparing aCash Flow Statement
1. Compute how much the cash balance changedduring the year.2. Convert the income statement from an
accrual-basis to a cash-basis summary of
operations.a.Eliminate expenses that do not involve the
outflow of cash, such as depreciation.
b.Eliminate gains and losses associated withinvesting or financing activities.
c. Adjust for changes in the balances of
current assets and current liabilities.
32Preparing a
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3. Analyze the long-term assets to identify thecash flow effects of investing activities.4. Analyze the long-term debt and stockholders
equity account to determine the cash flow
effects of any financing transactions.5. Make sure that the total new cash flow from
operating, investing, and financing activitiesis equal to the net increase or decrease in cash
as computed in Step 1, then prepare a formalstatement.
6. Prepare supplement disclosure of significant
noncash transactions.
Preparing aCash Flow Statement
33Example: Comparative
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33Example: ComparativeBalance Sheet
Accounts PayableLong-term Notes Payable
Common Stock
Retained Earnings
Total Liabilities and Equity
2005 2004Assets
Cash and Cash EquivalentsAccounts Receivable
Inventory
Equipment
Accumulated Depreciation
Total Assets
Liabilities and Equity
$ 82180
170
200
(72)
$560
$100100
250
110
$560
$ 40150
200
140
(60)
$470
$ 8050
250
90
$470
34
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Income Statement, 2005
SalesExpenses:
Cost of goods sold
Selling and general expense
DepreciationInterest expense
Operating income
Gain from sale of equipmentIncome before income taxes
Income tax expense
Net income
$345
$120
58
202 (200 )
$145
5$140
30
$110
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Cash 2004........................... $ 40Cash 2005........................... 82
Change in Cash................... $ 42
Determine change in cash and cash
equivalents:
Step 1
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Convert from an accrual-basis to a cash-
basis summary of operations:
Step 2
EXAMPLE: Eliminate depreciation
expense, $44, because it does
not require the use of cash.
Cash provided by operations 44Accumulated Depreciation 44
(t-account or work sheet entry)
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Convert from an accrual-basis to a cash-
basis summary of operations:
Step 2
EXAMPLE: Eliminate the $5 gain fromselling equipment.
Cash 33
Accumulated Depreciation 32Equipment 60
Gain on Sale of Equipment 5
Add back $5 to cash
provided by operations.
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Analyze the long-term assets to identify the
ash flow effects of investing activities.
Step 3
Expenditures for Property, Plant, and Equipment:
Beginning equipment $140 Equipment sold during the year 60
= 80
Ending equipment 200= Expenditures for equipment during
year $ 120
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Analyze the long-term debt andstockholders equity accounts to determine
the cash flow effects of any financing
transactions:
Step 4
Expenditures for Long-Term Debt:
Beginning L-T Notes Payable balance $ 50
Notes reacquired during the year 0
= 50
Ending L-T Notes Payable balance 100
= L-T Notes Payable issued during year 50
40
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Analyze the long-term debt andstockholders equity accounts to determine
the cash flow effects of any financing
transactions:
Step 4
Payment of Dividends:
Beginning Retained Earnings balance $ 90
+ Net income 110
= 200
Ending Retained Earnings balance 110
= Dividends paid 90
41
S d 6
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Steps 5 and 6
Steps 5 and 6 relateto actually preparing
the formal and
supplementarystatements.
42Operating Activities Section:
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Cash Flows from Operating Activities:Net income $110
Adjustments:
Depreciation expense 44Gain on sale of equipment (5 )
Increase in accounts receivable (30 )
Decrease in inventory 30
Increase in accounts payable 20Net Cash Provided by Operating
Activities $169
Operating Activities Section:Indirect Method
Continued
Operating Activities Section:
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Cash Flows from Operating Activities:Cash Collected from Customers $414
Cash Payments for:
Inventory (155 )Selling & General Expenses (58 )
Interest (2 )
Income Taxes (30 )
(245 )Net Cash Provided by Operating
Activities $169
Operating Activities Section:Direct Method
Continued
44Operating Activities Section:
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The investing and
financing sections are the
same whether the direct or
indirect approach is used.
Operating Activities Section:Direct Method
45Investing and Financing
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Investing and FinancingActivities Sections
Cash Flows from Investing Activities:
Proceeds from sale of equipment $ 33
Purchase of equipment (120 )
Net cash provided by investing
activities (87 )Cash Flows from Financing Activities:
Issuance of long-term notes payable 50
Payment of cash dividends (90 )
Net cash used for financing activities (40 )Net increase in cash 42
Cash, January 1, 2005 40
Cash, December 31, 2005 82
46Investing and Financing
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Investing and FinancingActivities Sections
Cash Flows from Investing Activities:
Proceeds from sale of equipment $ 33
Purchase of equipment (120 )
Net cash provided by investing
activities (87 )Cash Flows from Financing Activities:
Issuance of long-term notes payable 50
Payment of cash dividends (90 )
Net cash used for financing activities (40 )Net increase in cash 42
Cash, January 1, 2005 40
Cash, December 31, 2005 82
47
Q i k R i
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Which of the following items would be listedunder Cash Provided by Investing Activities?
Paid cash dividend
Issued preferred stock
Sold merchandise for
cash
Sold equipment at
book value
Quick Review
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48
Q i k R i
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Which of the following items would be shown
under Cash Provided by Operating Activities?
Issued bonds to finance
new construction
Purchased treasury stock
Paid the weekly payroll
Declared and paid a cash
dividend
Quick Review
49
Q i k R i
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Which of the following items would be shown
under Cash Provided by Financing Activities?
Payment of a cash dividend
Recorded depreciation for theperiod
Received cash on account
from a customerPayment of cash to acquireland
Quick Review
50
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Which of the following statement is true
concerning preparing the statement of cash
flows using the indirect method?A loss from the sale of equipment is added
to net income under the cash provided by
operating activities category.
A gain on sale of land is an investing activity
because a noncurrent asset is involved.
Issuing common stock to purchase land is
both a financing activity and an investingactivity.
An increase inAccounts Payable results in a
decrease in the adjusted cash-basis net income.
51I nternational Cash
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I nternational Cash
F low Statements
In 1987, the United States
led the world concerning
the statement of cash flows
by issuing SFAS No. 95.
52I nternational Cash
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I nternational Cash
F low Statements
Interest and dividends received can be classified as
either operating or investing.
Interest and dividends paid can be classified as
operating or investing.
Income taxes will be classified as operating unless
specifically related to financing or investing
transactions.
In 1992, the IASC issued I AS 7which closelymatched the provisions of SAFS No. 7. The
international standard was more flexible in
classification of certain transactions.
53I nternational Cash
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In 1991, the United
Kingdom issued
FRS 1. It specified
eight categories forclassifying cash
flows.
I nternational Cash
F low Statements
Operating activities Returns on investments and
servicing of finance
Taxation
Capital expenditures andfinancial investment
Acquisition and disposal
Equity dividend paid
Management of liquid
resources
Financing
54
A i F i i l St th
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Assessing F inancial Strength
Financial strength isa function of
Liquidity
ProfitabilityGrowth potential
Risk
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A i F i i l St th
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Assessing F inancial Strength
Cash flow-to-net income
Cash from operations
Net income
o Measure of earnings quality
o Tends to be greater than 1
o Should remain fairly stablefor the years for a specific
company
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A i F i i l St th
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Assessing F inancial Strength
Cash flow adequacy
Cash from operations
Net income
o Measures relationship between investment spending
and cash generated by operations
o Indicate a companys attitude towards reinvestment
in long-lived production assetso When ratio is small it indicates that cash flows from
operations fall short of funding growth
57
A i F i i l St th
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Assessing F inancial Strength
Cash times interest earned
Cash from operations + Interest paid + Taxes paid
Interest expense
o Measures ability to service
debt
o Generally, a higher ratio
indicates more solvency
58Forecasted Statement of
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o ecasted State e t oCash F lows
Six Steps1. Compute the change in cash.
2. Convert the income statement
from an accrual to cash basis.3. Analyze the long-term asset
accounts.
4. Analyze the long-term debt and
stockholders equity.5. Prepare the forecasted
statement of cash flows.
6. Disclose noncash activities.
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The End
chapter 5
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