Chapter 13 Statement of Cash Flows 1 Usefulness of the Statement of Cash Flows a Statement of Cash Flows Reports the cash receipts cash payments and net changes in cash resulting from operating investing and financing activities during a period b Helps investors creditors and others asses i Entity s ability to generate future cash flows ii Entity s ability to pay dividends and meet obligations iii The reasons for the difference between net income and net cash provided used by operating activities iv The cash investing and financing transactions during the period 2 Classification of Cash Flows a Operating Activities Cash effects of transactions that create revenue and expenses determines net income Best measure of a company s ability to generate sufficient cash to continue as a going concern Involve income statement items i Cash Inflows ii Cash Outflows 1 From sale of goods or services 2 From interest received and dividends received 1 To suppliers for inventory 2 To employees for services 3 To government for taxes 4 To lenders for interest 5 To others for expenses b Investing Activities Acquiring and disposing of investments and property plant and equipment as well as lending money and collecting loans Involve cash flows resulting from changes in investments and long term asset items i Cash Inflows ii Cash Outflows 1 From sale of property plant and equipment 2 From sale of investments in debt or equity securities and other entities 3 From collection of principal on loans to other entities 1 To purchase property plant and equipment 2 To purchase investments in debt or equity securities of other entities 3 To make loans to other entities c Financing Activities Obtaining cash from issuing debt and repaying the amounts borrowed as well as obtaining cash from stockholders repurchasing shares and paying dividends Involve cash flows resulting in changes in long term liability and stockholder s equity items i Cash Inflows ii Cash Outflows 1 From sale of common stock 2 From issuance of long term debt bonds notes 1 To stockholders as dividends 2 To redeem long term debt or reacquire capital stock treasury stock 3 Significant Noncash Activities If an activity does not involve cash company s do not report the activity in the body of the statement of cash flows a Direct issuance of common stock to purchase assets b Conversion of bonds into common stock c Direct Issuance of debt to purchase assets d Exchange of plant assets e To satisfy Full Disclosure Principle company s report noncash activities in a separate schedule or in a supplementary schedule 4 Preparing Statement of Cash Flows a Operating activities appears first followed by investing activities and then financing activities b Not prepared from an adjusted trial balance because this statement requires detailed information concerning the changes in account balances that occurred between two points in time i Must adjust the effects of the use of accrual accounting to determine cash flows c Information to Prepare Statement comes from 3 Sources i Comparative Balance Sheets Indicates the amount of the changes in assets liabilities and stockholder s equities from the beginning to the end of the period ii Current Income Statement Determines amount of cash provided or used by operations during the period iii Additional Information 5 Indirect Direct Methods operating activities a Step 1 Convert net income from an accrual basis to a cash basis to get net cash provided by i Indirect Method Adjusts net income for items that do not affect cash 1 Easier and less costly to prepare 2 Focuses on the difference between net income and net cash flow from operating activities ii Direct Method Shows operating cash receipts and payments making it more consistent with the object of the statement of cash flows 6 Step 1 Operating Activities a DETERMINE NET CASH PROVIDED USED BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS i Adjust net income to convert certain items to the cash basis 1 Net Income or adjustments Net Cash Provided Used by Operating Activities a Noncash Expenses such as depreciation amortization or depletion b Gains and Losses that resulted from investing and financing activities c Analyze changes to noncash current asset and current liability accounts d Deduct from net income increases in current asset accounts and add to net income decreases in current asset accounts to arrive at net cash provided by operating activities e Add to net income increases in current liability accounts and deduct form net income decreases in current liability accounts to arrive at net cash provided by operating activities 7 Summary of Conversion to Net Cash Provided by Operating Activities Indirect Method a Indirect method starts with net income and then adds or deducts items to arrive at net cash provided by operating activities i Required Adjustments are 1 Noncash charges such as depreciation amortization and depletion 2 Gains and Losses on the sale of plant assets Gains Losses 3 Changes in noncash current asset and current liability accounts do opposite of what happened for assets the same for what happened for liabilities 8 Step 2 Investing and Financing Activities a ANALYZE CHANGES IN NONCURRENT ASSET AND LIABILITY ACCOUNTS AND RECORD AS INVESTING AND FINANCING ACTIVITIES OR AS NONCASH INVESTING AND FINANCING ACTIVITIES 9 Step 3 Net Change in Cash a Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree 10 Free Cash Flow a Cash provided by operating activities fails to take into account that a company must invest in new fixed assets to maintain its current level of operations b Companies must also maintain dividends at current levels to satisfy investors c Free Cash Flow Cash remaining from operations after adjustment for capital expenditures and dividends i Cash Provided by Operating Activities Capital Expenditures Cash Dividends
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