Transcript Chapter 4, Statement of Cash Flows
Statement of Cash Flows- First Approach
Appendix 6- Introduction to preparation of the Statement of Cash Flows
Cash Flow Statement
Flow statement Periodic Provides information regarding the liquidity of a firm explains the reasons for increase or decrease in cash balance from one balance sheet date to the next classifies the reasons for the change as an operating, investing or financing activity.
amount of net income in a period is usually different than the amount of increase in cash in the same period reconciles net income with cash flow from operations.
Classification of Cash Flows
Operations -- cash flows related to selling goods and services; that is, the principle business of the firm.
Investing -- cash flows related to the acquisition or sale of noncurrent assets.
Financing -- long term and short term cash flows related to liabilities and owners’ equity; dividends are a financing cash outflow.
What is Cash?
Cash includes cash and cash equivalents
Cash equivalents:
treasury bills maturing in 90 days or less; investment funds; foreign currency on hand; checking account and free savings account
External Uses of CFS
To assess the ability of a firm to manage cash flows To assess the ability of a firm to generate cash through its operations To assess the company’s ability to meet its obligations and its dividend policy To provide information about the effectiveness of the firm to convert its revenues to cash To provide information to estimate or anticipate the company’s need for additional financing
Internal Uses of CFS
Along side with cash budget CFS is used: To assess liquidity Determine if short-term financing is necessary To determine dividend policy Decide to distribute; or increase or decrease To evaluate the investment and financing decisions
Cash flow from operating activities
Examples (IAS No.7): cash received from customers through sale of goods or services performed; cash received from non-operating activities such as dividends from investments, interest revenue, commissions, and fees; cash payments to suppliers or employees; cash payments for taxes and other expenses;
In effect, the income statement is changed from accrual basis to cash basis
Investing Activities
Examples of investing activities include: cash payments to acquire property, plant, and equipment (PPE), other tangible or intangible assets, and other long-term assets; and sale of such assets loans extended to other companies; and collection of such loans;
Financing Activities
Examples of financing activities are : cash received from issuing share capital; cash proceeds from issuing bonds, loans, notes, mortgages and other short or long-term borrowings; cash repayment of loans and other borrowings; and cash payments to shareholders as dividends.
Classification of Cash in-flows and outflows
From sales of goods and services to customers From receipt of customer advances From receipt of interest revenue or dividends or rent revenue or similar revenue items Operating Activities To wages salary payments To suppliers for purchases of inventories To other operating expenses To interest payments To tax payments To advance payments to suppliers From sale of PPE and other long-term assets From collection of loans Investing Activities To purchase PPE and other long-term assets To make loans and to collect such loans From sale of common or preferred stock From issuance of short or long term debt Financing Activities To repay debt To pay dividends
Format of the Cash Flow Statement
Name of the Company Cash Flow Statement For the period
…
Cash from operating activities Cash from investing activities A B Cash from financing activities Net Change in Cash C D = (A+B+C) increase or (decrease) + Beginning Cash balance Ending Cash balance CB, from the beginning balance sheet =CB + D should equal to ending cash balance in the ending balance sheet Non-cash Investing and Financing Activities
Determination of Cash Flows From Operating Activities
Direct Method Income Statement items are converted to cash flows individually Indirect Method Net income or loss is adjusted for accruals such as accounts receivable and payable, and for non-cash expenses such as depreciation reconciliation of the accrual based and cash based accounting
Comparison of Methods
Direct method of presentation calculates cash flow from operations by subtracting cash disbursements to supplies, employees, and others from cash receipts from customers.
The indirect method calculates cash flow from operations by adjusting net income for non-cash revenues and expenses.
Most firms present their cash flows using the indirect method.
Only operating activities section is different between the methods, investing and financing sections are the same .
How to prepare cash flow statement
Firms could prepare their own cash flow statement directly from the cash account.
however, we need two consecutive balance sheets and the income statement that covers the period between the two balance sheets
Algebraic Formulation*
Assets = Liabilities + Shareholders’ Equity
or
A = L + SHE
Assets are either cash (C) or not (Non-Cash) Thus reorganizing
C + Non Cash Assets (NCA) = L + SE
C +
NCA =
L +
SE
Where means the change in the balance of the item from the previous period.
Solving for change in cash:
C =
L +
SE -
NCA
Based on Stickney and Weil, 10 th ed. Financial Accounting Slides http://www.swlearning.com/accounting/stickney/tenth_edition/stickney.html
Algebraic Formulation (Cont.)
C =
L +
SE -
NCA
The change in cash,
C,
is the increase or decrease in the cash account.
This amount must equal changes in liabilities
plus
changes in shareholders’ equity
minus
changes in assets other than cash.
Thus, we can identify the causes in the change in the cash account by studying the changes in non-cash accounts.
Indirect Method – cash flow from operations Adjusting Net Income of the period (accrual) to cash basis income INCREASE DECREASE Assets Increase in non-cash assets shows that cash was spent, so cash outflow.
Decrease in non-cash assets shows that they provided cash so cash inflow.
Liabilities and Shareholders’ equity Increase in liabilities cash savings; increase in SHE cash received; so cash inflow Decrease in liabilities or SHE shows cash paid; so cash outflow
Indirect Method- operating activities Adjustments to net income
Net income
+ noncash expenses: depreciation, amortization, uncollectible account expense,etc + loss on sale of asset + increases in current liabilities + decreases in current assets - gain on sale of asset - decrease in current liabilities increase in current assets =
Cashflow from operating activities
Noncash Expenses
Noncash expenses, such as depreciation expense, are added back – because they were deducted to measure net income but did not require any cash payment in the current period They are not truly sources of cash, even though they are associated with cash inflows but reversal of an accrued expense
Portakal Company Prepare Cash Flow Statement Accounts with Debit Balances
Cash Notes Receivable (from loans to other companies) Accounts Receivable Merchandise Inventory Prepaid Operating Expenses Interest Receivable Land Property,Plant and Equipment-PPE-net
2008
37.500
69.000
53.700
158.000
2.100
1.400
110.000
377.000
808.700
2007
39.250
50.000
39.900
120.000
1.800
600 65.000
380.000
696.550
increase (decrease) (1.750) 19.000
13.800
38.000
300 800 45.000
(3.000) 112.150
Accounts with Credit Balances
Accounts Payable Accrued Wages Payable Income Taxes Payable Unearned Revenues Bank Notes Payable - long term Common Stock; TL 15 par value Additional Paid in Capital Retained Earnings 45.000
3.000
6.000
2.500
215.000
405.000
70.000
62.200
808.700
38.000
2.400
4.500
1.250
200.000
375.000
50.000
25.400
696.550
7.000
600 1.500
1.250
15.000
30.000
20.000
36.800
112.150
Portakal Company Income Statement
Sales Revenue Cost of Goods Sold Depreciation Expense Salary and Wages Expense Administrative Expenses Loss on Sale of Equipment Other Operating Expenses Interest Revenue Interest Expense Income Tax Expense Net Income 0
2008
750.000
(375.000) (43.000) (125.000) (80.000) (4.000) (5.000) 4.000
(20.000) (28.000) 74.000
The company paid TL 50.000 of Bank Notes and borrowed new bank loan. The company declared and paid cash dividends.
The company sold equipment with a cost of TL 12000 and accumulated depreciation of TL 6000 for TL 2000 receving a note in return to be collected in 2009. The company purchased equipment for TL 46.000; paid TL 44.000 in 2008 and gave a note for Jan. 2009.
The company issued common stock during the year .
Portakal Company Cash Flow Statement
Cashflow from Operating Activities Net Income Add back noncash: Depreciation Expense Loss on Sale of Equipment
2008
74000 43.000
4.000
121.000
adjustments that increase cash: increase in Acct.Payable
Increase in Acc.Wages Payable increase in Income Taxes payable increase in unearned revenued adjustments that decrease cash: increase in Accts Rec.
increase in Merch. Inv.
Increase in Prepaid Expense increase in interest recev.
Cashflow from operations
7.000
600 1.500
1.250
10.350
(13.800) (38.000) (300) (800) (52.900)
78.450
Cashflow from investing Sale of PPE (note will be received in 2009) Purchase of PPE Loans extended( to other companies) Purchase of land
Cashflow from investing
(44.000) (19.000) (45.000)
(108.000)
Cashflow from financing Bank Notes Payable - long term Common Stock; TL 15 par value Additional Paid in Capital Payment of Bank loan Payment of Dividends
Cashflow from financing
65.000
30.000
20.000
(50.000) (37.200)
27.800
Net Change in Cash (1.750)
Effects of a Sale of a Long-Term Assets on Cash Flows
A few transactions complicate the derivation of a cash flow statement from a comparative balance sheet, for example, the sale of a long-term (or fixed) asset.
Recall the journal entry for the sale of an asset: Cash
nnnn
Accumulated Depreciation
nnnn
Asset
nnnn
Gain (or loss) on sale
nnnn
Sale of an Asset
Each of the four parts of the above journal entry require an adjustment in the cash flow statement.
The first line, cash, adds a line to the investing section.
The second line, a debit to accumulated depreciation, increases the depreciation expense above the change in the change in the accumulated depreciation account.
The third line, a credit to the asset, increases the amount of cash invested in long-lived assets above the change in the fixed asset accounts.
The fourth line, a gain or loss, is reversed out in the operating sections since this is not a cash flow.
Comparison of Cash Flow to Net Income
Net income is an accrual based concept and purports to show the long-term.
Cash flows purport to show the short term.
Consider the outlook for both short-term and long-term and consider that each is either good or poor.
A strong growing firm would show both good long-term and good short-term outlooks.
A failing firm would show both poor long-term and poor short term outlooks.
What about a firm with good cash flows (short-term) but poor net income (long-term)?
What about a firm with poor cash flows (short-term) but good net income (long-term)?