Cash Flow Statement

Slide 2

 Definition

of cash, cash equivalents & cash

flows.  Roles of the cash flow statement (CFS)  Components in CFS  Preparing CFS

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Slide 3



Resources immediately available to pay obligations. Examples: cash on hand and cash in bank

 



Short-term, highly liquid investments. Readily convertible into known, fixed amounts of cash. So near maturity that there is insignificant risk of market value fluctuation from interest rate changes. Examples: short-term fixed deposits and investments in short-term treasury bills. 21-3

Slide 4

CASH INFLOWS Operating Activities Cash received from revenues

Investing Activities Sale of operational assets Sale of investments Collections of loans

Financing Activities Issuance of stock Issuance of bonds and notes

Business Cash paid for expenses

Purchase of operational assets Purchase of investments Loans to others

Payment of dividends Repurchase of stock Repayment of debt

CASH OUTFLOWS 21-4

Slide 5

The Statement helps users assess . . .   



a firm’s ability to generate cash. a firm’s ability to meet its obligations. the reasons for differences between income and associated cash flows. the effect of cash and noncash investing and financing activities on a firm’s financial position.

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Slide 6

Lists inflows and outflows of cash and cash equivalents by category Explains the change in cash during the period FRS 107 requires a CFS to be presented as an integral part of the FS for each period. 21-6

Slide 7

Operating Activities Investing Activities Financing Activities

Reconciliation of the Net Increase or Decrease in Cash with the Change in the Balance of the Cash Account

Noncash Investing and Financing Activities 21-7

Slide 8

Operating Activities

Reports the cash effects of the elements of net income.

Investing Activities

Reports the cash effects of the acquisition and disposition of assets (other than inventory and cash equivalents).

Financing Activities

Reports the cash effects of the sale or repurchase of shares, the issuance or repayment of debt securities, and the payment of cash dividends. 21-8

Slide 9

Inflows from:  

Sales to customers. Interest and dividends received.

+

Outflows to:    

Purchase of inventory. Salaries, wages, and other operating expenses. Interest on debt. Income taxes.

_

Cash Flows from Operating Activities

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Slide 10

Two Formats for Reporting Operating Activities Direct Method

Indirect Method

Reports the cash effects of each operating activity

Starts with accrual net income and converts to cash basis

Note that no matter which format is used, the same amount of net cash flows operating activities is generated.

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Slide 11

The cash effect of each operating activity is reported directly on the statement of cash flows.

Cash Flows from Operating Activities--Direct Method Cash Inflows: From customers $ 98 From investment revenue 3 Cash Outflows: To suppliers of goods (50) To employees (11) To bondholders (3) For insurance expense (4) Cash Flows from Operating Activities--Indirect Method For income taxes (11) Net Income $ 12 Net cash flows from operating activities $ 22 Adjustments for noncash effects:

The net cash increase or decrease from operating activities is derived indirectly by starting with reported net income on an accrual basis and working backwards to convert that amount to a cash basis.

Gain on sale of land Depreciation expense Loss on sale of equipment Changes in operating assets and liabilities: Increase in accounts receivable Decrease in inventory Increase in accounts payable Increase in salaries payable Discount on bonds payable Decrease in prepaid insurance Decrease in income tax payable Net cash flows from operating activities

(8) 3 2

$

(2) 4 6 2 2 3 (2) 22 21-11

Slide 12

So, which method? FRS 107 encourages the use of the direct method because the direct ,method provides information which may be useful in estimating future cash flows and which is not available under the indirect method.

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Slide 13

Inflows from:  Sale

of long-term assets used in the business.  Sale of investment securities (stocks and bonds).  Collection of nontrade receivables.

+

Outflows to:   

Purchase of long-term assets used in the business. Purchase of investment securities (stocks and bonds). Loans to other entities.

_

Cash Flows from Investing Activities

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Slide 14

Inflows from:  Sale

of shares to owners.  Borrowing from creditors through notes, loans, mortgages, and bonds.

+

Outflows to:   

Owners in the form of dividends or other distributions. Owners for the reacquisition of shares previously sold. Creditors as repayment of the principal amounts of debt.

_

Cash Flows from Financing Activities

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Slide 15

The net amount of cash inflows and outflows reconciles the change in the company’s beginning and ending cash balances. For example, assume the net increase in cash is $9 million and the Cash beginning balance is $20 million. The cash reconciliation would be as follows: Net increase in Cash Cash balance, January 1 Cash balance, December 31

$ 9,000,000 20,000,000 $ 29,000,000 21-15

Slide 16

1. Acquiring an asset by incurring a debt payable to the seller. 2. Acquiring an asset by entering into a capital lease. 3. Converting debt into common stock or other equity securities. 4. Exchanging noncash assets or liabilities for other noncash assets or liabilities. FRS 107 provides that significant investing and financing transactions not involving cash should be excluded from CFS. 21-16

Slide 17

 FRS

107 requires that:

 Interest

and dividends – disclose separately  Interest paid – may be classified as an operating CF or a financing CF  Dividend paid - may be classified as an operating CF or a financing CF  Interest received - may be classified as an operating CF or a investing CF  Dividend received - may be classified as an operating CF or a investing CF  Taxes paid – disclose separately and shd be classified as CF from operating activities.

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Slide 18

Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be reported.

A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked.

Let’s see how to use a spreadsheet to prepare a Cash Flow Statement on the next few slides. 21-18

UNITED BRANDS CORPORATION Spreadsheet for the Cash Flow Statement Changes Dec. 31, Dec. 31, 2008 Debits Credits 2009 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation

20 30 50 6 60 75 (20) 221

29 32 12 46 3 80 81 (16) 267

Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable

20 1 8 50 (3)

26 3 6 20 35 (1)

Shareholders' Equity: Common stock

100 130

Paid-in capital

20 29

Retained earnings

25 221

19 267

Slide 19

We begin by entering the beginning and ending balances for each account on the comparative balance sheet and income statement. The changes columns will be used later to explain the increase or decrease in each account balance. 21-19

Slide 20

Changes Dec. 31, 2008

Debits

Dec. 31, Credits 2009

Income Statement Revenues: Sales revenue Investment revenue Gain on sale of land

100 3 8

Expenses: Cost of good sold Salaries expense Depreciation expense Bond interest expense Insurance expense Loss on sale of equipment Income tax expense Net income

(60) (13) (3) (5) (7) (2) (9) 12

The beginning balances for income statement accounts are always zero.

21-20

Changes Dec. 31, 2008 Cash Flow Statement Operating Activities:

Debits

Slide 21

Dec. 31, Credits 2009

Next we allocate space on the spreadsheet for the statement of cash flows.

Investing Activities:

Financing Activities:

Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year. They are only entered on the spreadsheet and are not recorded in the accounting records.

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UNITED BRANDS CORPORATION Spreadsheet for the Cash Flow Statement Changes Dec. 31, Dec. 31, 2008 Debits Credits 2009 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation

20 30 50 6 60 75 (20) Dec. 31, 221 2008

Changes

Let’s start by analyzing Sales Revenue and its 29 related account 32 12 Accounts 46 3 Receivable by 80 81 looking at the (16) Dec. 31, 267 relationship in a T2009 account format. 26

Debits Credits Liabilities: Income Statement Accounts payable 20 Revenues: Salaries payable 1 Sales revenue Income tax payable 8 Investment revenue Accounts- Receivable Notes payable Gain on sale of land Bonds payable Beg. bal. 30 50 Less: Discount on bonds payable Expenses: Credit sales 100 (3) ? Cash received Cost of good sold End. bal. Shareholders' Salaries expenseEquity: Common stock Depreciation expense Bond interest expense Paid-in capital Insurance expense Loss on sale of equipment Retained earnings Income tax expense Net income

32 100 20 25 221

Slide 22

3 100 6 3 20 8 35 (1) (60) (13) (3) 130 (5) (7) (2)29 (9) 1219 267

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UNITED BRANDS CORPORATION Spreadsheet for the Cash Flow Statement Changes Dec. 31, Dec. 31, 2008 Debits Credits 2009 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation

20 30 50 6 60 75 (20) Dec. 31, 221 2008

We can see from this analysis that cash received from 29 32 customers must 12 have been $98 46 3 million. 80

Changes

Debits Liabilities: Income Statement Accounts payable 20 Revenues: Salaries payable 1 Sales revenue Income tax payable 8 Investment revenue Accounts- Receivable Notes payable Gain on sale of land Bonds payable Beg. bal. 30 50 Less: Discount on bonds payable Expenses: Credit sales 100 (3) 98 Cash Cost of good sold End. bal. Shareholders' Salaries expenseEquity: Common stock Depreciation expense Bond interest expense Paid-in capital Insurance expense Loss on sale of equipment Retained earnings Income tax expense Net income

32 100 20 25 221

Slide 23

81 (16) Dec. 31, 267 Credits 2009

received

26 3 100 6 3 20 8 35 (1) (60) (13) (3) 130 (5) (7) (2)29 (9) 1219 267

Let’s see how to post this entry to the spreadsheet.

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Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation

Slide 24

20 30 (1) 50 6 60 75 (20) 221

Liabilities: Accounts payable 20 Salaries payable 1 Income tax payable Dec. 31, 8 Notes payable 2008 Bonds payable 50 Income Statement Revenues: Less: Discount on bonds payable (3) Sales revenue Investment revenue Shareholders' Equity: Gain on sale of land Common stock

First, $2 million is debited to Accounts Receivable to account for the total change in the 26 account.

29 32 12 46 3 80 81 (16) 267

2

Changes Debits

3 Dec. 31, 6 Credits 2009 20 35 (1)

(1)

100

Accounts Receivable 100 Beg. bal. 30 Expenses: 100 20 98 Cash received Paid-in capital Credit sales Cost of good sold End. bal. 32 Salaries expense Retained earnings Depreciation expense Bond interest expense Insurance expense Loss on sale of equipment Income tax expense Net income

25 221

Changes Dec. 31,

Then, $100 million is credited to Sales 130 Revenue to (60) 29 account for the (13) (3) total change in the (5)19 267 (7) account. (2)

100 3 8

(9) 12

Dec. 31,

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Changes Dec. 31, 2008 Statement of Cash Flows Operating Activities: Cash Inflows: From customers

Debits

(1)

Dec. 31, Credits 2009

98

Investing Activities:

Accounts Receivable Beg. bal. 30 Credit sales 100 98 Cash received Financing Activities: End. bal. 32

Slide 25

The final part of this entry is a $98 million entry on the Statement of Cash Flows under Cash Inflows from Customers. Let’s skip ahead and look at the analysis of Short-term Investments.

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UNITED BRANDS CORPORATION Spreadsheet for the Cash Flow Statement Changes Dec. 31, Dec. 31, 2008 Debits Credits 2009 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable

20 30 (1) (12) 50 6 60 75 (20) 221 20 1 8 50 (3)

2 12

Short-term Investments Shareholders' Equity: Beg. bal. 0 Common stock Purchases 12 100 End. bal. 12 Paid-in capital

20

Retained earnings

25 221

Slide 26

The $12 million increase in the Short-term 29 32 Investments 12 46 account is due to 3 80 the purchase of 81 short-term (16) 267 investments 26 during the year. 3 6 20 35 (1)

In the textbook, entry number 12 illustrates the 29 analysis of the Short19 term Investment account.

130

267

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Changes Dec. 31, 2008 Statement of Cash Flows Operating Activities: Cash Inflows: From customers

Dec. 31, Credits 2009

Debits

(1)

The final part of this entry is a $12 million entry on the Statement of Cash Flows under Investing Activities.

98

Investing Activities:

Purchase of S-T investment

Slide 27

(12)

12

Financing Activities:

Short-term Investments Beg. bal. 0 Purchases 12 End. bal. 12

Now, let’s look at a noncash transaction.

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UNITED BRANDS CORPORATION Spreadsheet for the Cash Flow Statement Changes Dec. 31, Dec. 31, 2008 Debits Credits 2009 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation

20 30 (1) (12) 50 6 60 75 (14) (20) 221

Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable

20 1 8 50 (3)

Shareholders' Equity: Common stock

100

29 32 12 46 3 80 81 (16) 267

2 12

20x

(14)

20x

26 3 6 20 35 (1)

Slide 28

In entry number 14, we find that a note payable was issued as payment for a building. Investing in a new building is a significant investing activity and financing the acquisition with long-term debt is a significant financing activity.

130 Paid-in capital

20 29

Retained earnings

x denotes a noncash transaction

25 221

19 267

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UNITED BRANDS CORPORATION Spreadsheet for the Cash Flow Statement Changes Dec. 31, Dec. 31, 2008 Debits Credits 2009 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation

20 30 50 6 60 75 (20) 221

(19) (1) (12)

9 2 12

(13) (14) (9)

(4) (8) 30 (3) 20x (9) 7 (6)

4 3 10 14 3

(4) (5)

6 2

(14)

20x

(7)

2

(16) (17) (16) (17)

10 20 3 6

13 5 (11)

12

Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable

20 1 8 (10) 50 (15) (3)

Shareholders' Equity: Common stock

100

Paid-in capital Retained earnings

20 25 (16) (18) 221

2 15

29 32 12 46 3 80 81 (16) 267

Slide 29

After entering all the transactions, this is what the balance sheet portion of the spreadsheet looks like.

26 3 6 20 35 (1)

130 29 19 267

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Slide 30

Changes Dec. 31, 2008

Debits

Income Statement Revenues: Sales revenue Investment revenue Gain on sale of land Expenses: Cost of good sold Salaries expense Depreciation expense Bond interest expense Insurance expense Loss on sale of equipment Income tax expense Net income

Dec. 31, Credits 2009

(1) (2) (3)

(4) (5) (6) (7) (8) (9) (10) (11)

100 3 8

100 3 8

60 13 3 5 7 2 9 12

(60) (13) (3) (5) (7) (2) (9) 12

After entering all the transactions, this is what the income statement portion of the spreadsheet looks like. 21-30

Changes Dec. 31, 2008 Statement of Cash Flows Operating Activities: Cash Inflows: From customers From investment revenue Cash Outflows: To suppliers of goods To employees To bondholders For insurance expense For income taxes Net cash flows Investing Activities: Sale of land Sale of equipment Purchase of S-T investment Purchase of land Net cash flows Financing Activities: Retirement of bonds payable Sale of common stock Payment of cash dividends Net cash flows Net increase in cash Totals

Dec. 31, Credits 2009

Debits

(1) (2)

98 3 (4) (5) (7) (8) (10)

50 11 3 4 11 22

(3) (9)

18 5 (12) (13)

Slide 31

After entering all the transactions, this is what the statement of cash flows portion of the spreadsheet looks like.

12 30 (19)

(17)

(15)

15

(18)

5

26

(19) 376

9 376

6 9

21-31

Here is the Statement of Cash Flows prepared using the direct method.

UNITED BRANDS CORPORATION Slide 32 Cash Flow Statement For the Year Ended December 31, 2009 ($ in millions) Cash Flows from Operating Activities: Cash Inflows: From customers $ 98 From investment revenue 3 Cash Outflows: To suppliers of goods (50) To employees (11) To bondholders (3) For insurance expense (4) For income taxes (11) Net cash flows from operating activities $ 22 Cash Flows from Investing Activities: Sale of land (30) Sale of equipment (12) Purchase of S-T investment 18 Purchase of land 5 Net cash flows from investing activities (19) Cash Flows from Financing Activities: Retirement of bonds payable 26 Sale of common stock (15) Payment of cash dividends (5) Net cash flows from financing activities 6 Net increase in cash 9 Cash balance, January 1 20 Cash balance, December 31 $ 29 21-32

Slide 33

Cash Flows from Operating Activities--Indirect Method and Reconciliation of Net Income to Net Cash Flows from Operating Activities Net Income $ 12 Adjustments for noncash effects: Increase in accounts receivable (2) Gain on sale of land (8) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Depreciation expense 3 Discount on bonds payable 2 Decrease in prepaid insurance 3 Loss on sale of equipment 2 Decrease in income tax payable (2) Net cash flows from operating activities $ 22

The indirect method derives the net cash increases or decreases from operating activities indirectly by starting with reported net income and “working backwards” to convert that amount to a cash basis.

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Slide 34

Depreciation Expense

Loss on Sale of Equipment

Gain on Sale of Land

Adding these items back to net income restores net income to what it would have been had depreciation and the loss not been subtracted at all.

Subtracting the gain reverses the effect of the gain having been added to net income.

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Slide 35

For components of net income that increase or decrease cash, but by an amount different from that reported on the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the effects of those items to a cash basis.

Note: Cash and cash equivalents, short-term investments in securities available for sale, dividends payable, and short-term payables to financial institutions are excluded from this category. 21-35

Slide 36

Cash Flows fromOperating Activities Income Statement Indirect Method Direct Method Net income $ 12 Adjustments Sales $ 100 Increase in accounts receivable (2) Cash received fromcustomers $ 98 Investment revenue 3 (No adjustment--no investment Cash received from 3 revenue receivable or long-term investments investments) Gain on sale of land 8 Gain on sale of land (8) (Not reported--no cash effect) Cost of goods sold (60) Decrease in inventory 4 Increase in accounts payable 6 Cash paid to suppliers (50) Salaries expense (13) Increase in salaries payable 2 Cash paid to employees (11) Depreciation expense (3) Depreciation expense 3 (Not reported--no cash effect) Interest expense (5) Decrease n bond discount 2 Cash paid for interest (3) Insurance expense (7) Decrease in prepaid insurance 3 Cash paid for insurance (4) Loss on sale of equipment (2) Loss on sale of equipment 2 (Not reported--no cash effect) Income tax expense (9) Decrease in income tax payable (2) Cash paid for income taxes (11) Net cashflowfromoperating Net cashflowfromoperating Net income $ 12 activities $ 22 activities $ 22 21-36

Slide 37

A spreadsheet is equally useful in preparing a statement of cash flows whether we use the direct or the indirect method of determining cash flows from operating activities. 21-37

Slide 38

The T-Account method serves the same purpose as a spreadsheet in assisting in the preparation of a statement of Cash Flows.

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Slide 39

1. Draw a T-account for each income statement and balance sheet account. 2. The T-account for cash should be drawn considerably larger. 3. Enter each account’s net change on the appropriate side (debit or credit) of the uppermost portion of each Taccount. 4. Reconstruct the transactions that caused changes in each account balance during the year and record the entries for those transactions directly in the T-accounts. 5. After all account balances have been explained by Taccount entries, prepare the statement of cash flows from the cash T-account, being careful also to report noncash investing and financing activities.

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Slide 40

 E21-24  E21-25  E21-28  E21-29

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