Cash Flow AnalysisAbout The ExamStatement of Cash FlowsStatement of Cash FlowsWhy focus on a cash flow statement?Why focus on a cash flow statement?1. Joe’s Landscaping ServiceJoe contributes $10,000 in cash2. The company borrows $3,000 from the bank3. Company purchases equipment for $5,000 cash4. Company performs service for $12,000. The customer pays $8,000 in cash and promises to pay the balance at a later date.5. Company pays $9,000 for expenses (wages, interest, and maintenance)6. Company pays a dividend of $1,000Transactions and the Accounting EquationBalance Sheet as at December 31, 1997Income Statement For the year ended December 31, 1997Transactions and Accounting EquationStatement of Cash FlowsFor the year ended December 31, 1997Indirect versus Direct Cash Flow FormatsCash flow statementIndirect cash flow statement - depreciationQuick tutorial on depreciation – contd.To arrive at CFO from net incomeTo arrive at CFO from net incomeCash Flow Statement: Indirect-MethodCash Flow Statement: Indirect-MethodPreparing a cash flow statementPreparing a cash flow statement1Cash Flow Analysis15.501/516AccountingSpring 2004Professor S. RoychowdhurySloan School of ManagementMassachusetts Institute of TechnologyMar 1/3, 20042About The Examz March 10th– a week from today. z In classz Closed bookz TAs will hold a review session. Time and place to be announced shortly.z March 8thclass: in-class exam review.3Statement of Cash Flowsz Reports operating cash flow as well as other cash flow information.z Provides important information to investors and creditors. z In particular, information about differences in the timing of revenue and expense recognition under GAAP and the associated cash inflows and outflows.4Statement of Cash Flowsz The cash flow statement separates changes in cash into three categories: z operating cash flowz investing cash flowz financing cash flow. z The statement sums to the actual change in cash during the year z The change equals the difference between the beginning and ending cash balances reported on the balance sheet.5Why focus on a cash flow statement?z Net income reported on the income statement provides an important measure of performance. z However, in the absence of cash flow, income does not pay the bills. z Interest and dividend payments, required principal reductions on debt, and capital expenditures for plant and equipment and for expansion cannot be made without cash. z Cash provided by operating activities, also known as operating cash flow, is a primary source of cash to meet these needs.6Why focus on a cash flow statement?z In the absence of operating cash flow, cash from other sources can be used to cover cash requirements. z For example, cash can be obtained from on-hand balances or nonrecurring asset sales, new debt or equity financing.z These non-operating sources of cash flow can be relied upon only in the short run. z In the long run, operating cash flow is the only reliable source of cash available to meet recurring needs.71. Joe’s Landscaping ServiceJoe contributes $10,000 in cashz Assets = Liabilities + Owners’ Equityz Cash Contributed Capitalz +$10,000 +$10,000Journal EntryDr Cash 10,000Cr Contributed capital 10,00082. The company borrows $3,000 from the bankz Assets = Liabilities + Owners’ Equityz Cash Loans Payablez +$3,000 +$3,000Journal EntryDr Cash 3,000Cr Loans payable 3,00093. Company purchases equipment for $5,000 cashz Assets = L + OEz Cash Equipmentz -$5,000 +$5,000Journal EntryDr Equipment 5,000Cr Cash 5,000104. Company performs service for $12,000. The customer pays $8,000 in cash and promises to pay the balance at a later date.z Assets = L + Owners’ Equityz Cash Receivables Retained Earningsz +$8,000 +$4,000 +$12,000Journal EntryDr Cash 8,000Dr Accounts receivable 4,000Cr Retained earnings (Revenue) 12,000115. Company pays $9,000 for expenses (wages, interest, and maintenance)z Assets = Liabilities + Owners’ Equityz Cash Retained Earningsz -$9,000 -$9,000Journal EntryDr Retained Earnings (Expenses) 9,000Cr Cash 9,000126. Company pays a dividend of $1,000z Assets = Liabilities + Owners’ Equityz Cash Retained Earningsz -$1,000 -$1,000Journal EntryDr Retained Earnings (Dividends) 1,000Cr Cash 1,00013Transactions and the Accounting EquationCash A/R Equip. L/P C. Cap. R/E+10,000 +10,000+ 3,000 + 3,000- 5,000 + 5,000+ 8,000 + 4,000 +12,000- 9,000 - 9,000- 1,000 - 1,000 6,000 4,000 5,000 3,000 10,000 + 2,000++ =+ +14Balance Sheet as at December 31, 1997Assets Amount Liabilities andOwners’ EquityAmountCash 6,000 Loans Payable 3,000Receivables 4,000 ContributedCapital 10,000Equipment 5,000 RetainedEarnings 2,000TotalAssests $15,000Total Liabilitiesand Owners’Equity $15,00015Income Statement For the year ended December 31, 1997Revenues: Fees earned for service $12,000Expenses: Wages, interest, maintenance $ 9,000Net income $ 3,00016Transactions and Accounting EquationCash A/R Equip. L/P C. Cap. R/E +10,000 +10,000 + 3,000 + 3,000 - 5,000 + 5,000 + 8,000 + 4,000 +12,000 - 9,000 - 9,000 - 1,000 - 1,000 6,000 4,000 5,000 3,000 10,000 + 2,000 ++=++17Statement of Cash FlowsFor the year ended December 31, 1997Operating activities:Sale of a service (4) 8,000Payments for expenses (5) (9,000)Net cash from operating activities (1,000)Investing activities:Purchase of equipment (3) (5,000)Net cash from investing activities (5,000)Financing activities:Borrowings (2) 3,000Owner contributions (1) 10,000Payment of dividends (6) (1,000) 12,000Increase in cash balance 6,000Cash balance at