11-1

2006 Prentice Hall, Inc.

PREPARING & ANALYZING THE STMT OF CASH FLOWS (1

of 2)

Learning

objectives Categories of cash flows Accrual-basis accounting vs. cashbasis accounting Overview of statement of cash flows Statement of cash flowsindirect method
11-2
2006 Prentice Hall, Inc.

PREPARING & ANALYZING THE STMT OF CASH FLOWS (2

of 2)

flows from operating activities direct method Cash flows from investing and financing activities Preparing the statement of cash flows Financial statement analysis Business risk, control, and ethics 11-3
Cash
2006 Prentice Hall, Inc.

Learning Objectives
(1 of 4)

Categorize

cash flows as operating, investing, or financing cash flows Explain the difference between accrual-basis and cash-basis accounting Explain the difference between the two methods of preparing and 11-4 presenting the statement of cash
2006 Prentice Hall, Inc.

Learning Objectives
(2 of 4)

Compute

cash from operating activities using the indirect method Compute cash from operating activities using the direct method Compute cash from investing activities and cash from financing activities
11-5
2006 Prentice Hall, Inc.

Learning Objectives
(3 of 4)

Prepare

a complete statement of cash flows and know the required supplemental disclosures Use the statement of cash flows to help evaluate a firms past and future performance
11-6
2006 Prentice Hall, Inc.

Learning Objectives
(4 of 4)

Identify

the risk of investing in a given firm by using the statement of cash flows and the related controls

11-7
2006 Prentice Hall, Inc.

Categories of Cash Flows

(1 of 3)

Cash

flow

Inflows

and outflows that result from transactions Cash account must increase or decrease
Operating
Cash
2006 Prentice Hall, Inc.

activities
11-8

receipts and cash disbursements from revenues and expenses

Categories of Cash Flows

(2 of 3)

Investing
Cash

activities

receipts and disbursements that result from purchasing or selling longterm assets or investments in other firms

Financing
Cash
2006 Prentice Hall, Inc.

activities

receipts and disbursements from long-term debt and equity transactions 11-9

Categories of Cash Flows

(3 of 3)

Financing Debt

activities (continued)

Issuing

debt Repaying debt Interest expense results from financing activities because it arises from debt financing. Why is it reported in the operating section?
Equity
Receiving

contributions from owners Paying dividends to owners

2006 Prentice Hall, Inc.

11-10

Accrual-basis Accounting vs. Cash-basis Accounting (1 of 2)

Must

convert from accrual-basis accounting (GAAP) to cash-basis accounting to prepare statement of cash flows Accrual-basis accounting
Revenues
Timing
2006 Prentice Hall, Inc.

recorded when earned and expenses recorded when incurred

of cash receipt is irrelevant
11-11

Accrual-basis Accounting vs. Cash-basis Accounting (2 of 2)

Cash-basis
Revenues
Timing

accounting

recorded when cash received and expenses recorded cash paid

of revenue and expense recognition is irrelevant

Convert

from accrual basis to cash

payable (assume for inventory)
bal $400; purch $36,300 11-12

basis
Accounts
Beg bal $1,200; End 2006 Prentice Hall, Inc. Compute cash paid

Overview of the Statement of Cash Flows (1 of 3)

Operating
Direct
Cash

activities

method

inflows and outflows explicitly identified Analyzes every item on income statement

11-13
2006 Prentice Hall, Inc.

Overview of the Statement of Cash Flows (2 of 3)

Operating
Indirect

activities (continued)

method

Reconciles

net income and cash flow Starts with net income Makes adjustments for income statement items that do not affect cash Adjust for changes in current assets and current liabilities Ends with net cash flow 11-14
2006 Prentice Hall, Inc.

Overview of the Statement of Cash Flows (3 of 3)

Investing
Same

and financing activities

presentation for both direct and indirect methods Cash flows for each activity directly identified

11-15
2006 Prentice Hall, Inc.

Statement of Cash Flows Indirect Method

Used

by 90% of companies. Why? Financial statements needed

Current

year income statement Beginning and ending balance sheet

Steps

to calculate operating cash

11-16

flows Cash flow indirect method example

2006 Prentice Hall, Inc.

Steps to Calculate Operating Cash Flows (1 of 2)

1.
2.

Start with net income Add back non-cash expenses such as depreciation

Undo the effect of non-cash expenses

Increase (decrease) in account should be subtracted from (added to) net income to arrive at cash balance. 11-17 Why?

3.

Adjust for changes in current assets

2006 Prentice Hall, Inc.

Steps to Calculate Operating Cash Flows (2 of 2)

4.

Adjust for changes in current liabilities

Increase (decrease) in account should be added to (subtracted from) net income to arrive at cash balance. Why?

11-18
2006 Prentice Hall, Inc.

Cash Flow Indirect Method Example (1 of 4)

Sales Revenues Cost of Goods Sold Gross M argin Depreciation Expense Interest Expense Salary Expense N et Income $ 500,000 284,000 216,000 $ 50,000 5,000 105,000

160,000 $ 56,000
11-19

2006 Prentice Hall, Inc.

Cash Flow Indirect Method Example (2 of 4)

Cash Accounts Receivable, net Inventory Prepaid Insurance Prepaid Rent Total Current Assets Equip, net of $75K & $125K Accum Depr Total Assets Beginning $ 37,500 17,000 27,000 28,000 109,500 175,000 $ 284,500 Ending $ 75,000 13,000 20,000 12,000 4,000 124,000 193,000 $ 317,000

11-20
2006 Prentice Hall, Inc.

Cash Flow Indirect Method Example (3 of 4)

Accounts Payable Unearned Revenue Interest Payable Total Current Liabilities Long-term N otes Payable Common Stock Retained Earnings Total Liabilities and Equity Beginning $ 9,000 4,375 1,500 14,875 40,000 40,000 189,625 $ 284,500 Ending $ 4,250 3,125 4,000 11,375 15,000 45,000 245,625 $ 317,000

11-21
2006 Prentice Hall, Inc.

Cash Flow Indirect Method Example (4 of 4)

+/N et income Depreciation expens e Decreas e in accounts receivable Decreas e in inventory I ncreas e in prepaid ins urance Decreas e in prepaid rent Decreas e in accounts payable Decreas e in unearned revenue I ncreas e in interes t payable N et cas h from operating activities

11-22
2006 Prentice Hall, Inc.

Cash Flows from Operating ActivitiesDirect Method (1 of 6)

Changing

revenues from accrual basis to cash basis

Accounts

receivable

Beginning balance (balance sheet) + Sales (income statement) - Cash collected from customers (compute) Ending balance (balance sheet)
2006 Prentice Hall, Inc.

11-23

Cash Flows from Operating ActivitiesDirect Method (2 of 6)

Changing
Cost

expenses from accrual basis to cash basis

of goods sold
Inventory

account Beginning inventory (balance sheet) + Purchases (compute) - Cost of goods sold (income statement) Ending balance (balance sheet) 11-24
2006 Prentice Hall, Inc.

Cash Flows from Operating ActivitiesDirect Method (3 of 6)

Cost

of goods sold (continued)

Accounts

payable Beginning balance (balance sheet) + Purchases (from inventory computation) - Cash paid to vendors (compute) Ending balance (balance sheet)

11-25
2006 Prentice Hall, Inc.

Cash Flows from Operating ActivitiesDirect Method (4 of 6)

Changing
Rent

expenses from accrual basis to cash basis (continued)

expense
Prepaid

rent Beginning balance (balance sheet) + Cash paid for rent (compute) - Rent expense (income statement) Ending balance (balance sheet)
2006 Prentice Hall, Inc.

11-26

Cash Flows from Operating ActivitiesDirect Method (5 of 6)

Changing
Interest

expenses from accrual basis to cash basis (continued)

expense
Interest

payable Beginning balance (balance sheet) + Interest expense (income statement) - Cash paid for interest (compute) Ending balance (balance sheet)
2006 Prentice Hall, Inc.

11-27

Cash Flows from Operating ActivitiesDirect Method (6 of 6)

Use the information provided earlier Cash collected from customers Cash paid to vendors Cash paid to employees Cash paid for insurance Cash paid for rent Cash paid for interest N et cash from operating activities
11-28
2006 Prentice Hall, Inc.

Cash Flows from Investing and Financing Activities (1 of 3)

Investing

cash flows

Equipment
Asset

purchases/disposals require the following accounts

account (beg & end) Accumulated depreciation (beg & end) Depreciation expense (current)

11-29
2006 Prentice Hall, Inc.

Cash Flows from Investing and Financing Activities (2 of 3)

Financing
Debt
Need

cash flows

financing

to analyze changes in long-term liability accounts

Equity

financing
capital contributions
and preferred stock accounts
earnings and current net income

Additional Dividends
Retained
2006 Prentice Hall, Inc.

Common

11-30

Cash Flows from Investing and Financing Activities (3 of 3)

Use the information provided earlier Investing Activities Purchase of equipment N et cash used by investing activities Financing Activities Repayment of note payable Proceeds from issue of new stock N et cash used by financing activities

11-31
2006 Prentice Hall, Inc.

Preparing the Statement of Cash Flows (1 of 3)

Prepare

operating, investing, and financing sections Supplementary disclosures

Noncash

financing and investing

activities Cash paid for interest expense and income taxes

out in supplementary disclosures 11-32 because usually part of subtotals 2006 Prentice Hall, Inc.
Broken

Preparing the Statement of Cash Flows (2 of 3)

Add

beginning cash to sum of operating, investing, and financing activities to get ending cash balance
Reconciles

cash account on balance

sheet
Which

financial statement is easier to manipulate, the statement of cash 11-33 flows or the income statement? Why?

2006 Prentice Hall, Inc.

Preparing the Statement of Cash Flows (3 of 3)

Use the information provided earlier N et cash provided by operations N et cash used by investing activities N et cash used by financing activities Cash at beginning of year Cash at end of year

11-34
2006 Prentice Hall, Inc.

Financial Statement Analysis

Using

cash flows to evaluate performance

Free

cash flow Cash flow adequacy ratio Cash needed to pay current liabilities

11-35
2006 Prentice Hall, Inc.

Free Cash Flow

Net cash from operating activities - Cash dividends - Capital expenditures _ Free cash flow Why does a company need positive free-cash flow?
11-36
2006 Prentice Hall, Inc.

Cash Flow Adequacy Ratio

Measures

the firms ability to generate enough cash from operating activities to pay for its capital expenditures
Net cash from operating activities _ Cash required for investing activities
Cash

required for investing activities

Cash

paid for capital expenditures and acquisitions minus cash proceeds from disposal 11-37 of capital assets

2006 Prentice Hall, Inc.

Cash Needed to Pay Current Liabilities (1 of 2)

Current

cash debt coverage ratio

Measures

a firms ability to generate the cash it needs in the short-run A liquidity measure Net Cash Provided by Operations Average Current Liabilities
11-38
2006 Prentice Hall, Inc.

Cash Needed to Pay Current Liabilities (2 of 2)

How

does current cash debt coverage ratio differ from other liquidity measures previously discussed?
Current

ratio Quick ratio Working capital

11-39
2006 Prentice Hall, Inc.

Business Risk, Control, and Ethics

Investors

risks associated with statement of cash flows

Investors

look for positive cash flows from operations How could a company manipulate operating cash flows?
11-40
2006 Prentice Hall, Inc.

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorados Kenneth W. Monfort College of Business richard.newmark@PhDuh.com
2006 Prentice Hall, Inc.

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