Statement of Cash Flows THE CONTENT AND VALUE OF THE STATEMENT OF CASH FLOWS The cash flow statement reconciles beginning and ending cash by presenting the cash receipts and cash disbursements of an enterprise for an accounting period. The receipts and disbursements are segregated into three classes of activities. Cash receipts and disbursements from operating activities report on the cash flows of the enterprise related to its business operations. Cash receipts and disbursements from investing activities report on the cash flows of the enterprise related to the acquisition and disposition of noncurrent assets. Cash receipts and disbursements from financing activities report on the cash flows of the enterprise related to the acquisition and repayment of debt and equity. The information contained in the statement is useful to creditors and investors for the following reasons: 1 To assess the entity’s ability to generate cash flows in the future 2 The ability of the entity to pay dividends and meet its obligations 3 Reconciliation between net income in the income statement as net cash flow from operating activities in the statement of cash flows. 4 To assess cash and noncash investing and financing activities of the entity during the accounting period. Classification of Cash Flows There are three classifications of cash flows: 1 Operating activities Cash receipts and disbursements are transactions that relate to net income. More specifically these transactions relate to operating income. They include cash receipts from the sale of products or services, the payment to vendors for inventory and the payment of salaries and wages to employees. 2 Investing activities Cash receipts and disbursements are transactions that relate to noncurrent assets. They include the purchase and disposition of investments and long-lived assets and loans and collection of loans to outside parties. 3 Financing activities Cash receipts and disbursements are transactions that relate to long-term debt and stockholders’ equity. They include borrowing cash from creditors and repayment of such loans and the sale of capital stock and the payment of dividends and return of capital to equity investors. Format of the Statement of Cash Flows The following format is for a statement of cash flows using the indirect method of reporting cash flows from operating activities. F:\Teaching\3322\web\post\module5\c21\tnotes\c21a.doc 3/14/2007 1Statement of Cash Flows Cash flows from operating activities Net income $ Amortization + Depreciation + Changes in current assets: Increases - Decreases + Changes in current liabilites: Increases + Decreases -Gains from investing or financing -Losses from investing or financing + $ Net cash flow from operating activities $Cash flows from investing activities Sale of long-term assets + Sales of investments + Collection of loans + Purchase of long-term assets - Purchase of investments - Loan of funds to outside entities - Net cash flow from investing activities $Cash flows from financing activities Sale of equity securities + Issuance of long-term debt + Dividends to stockholders - Repayment of long-term debt - Reacquisition of capital stock - Net cash flow from financing activities $Net increase (decrease) in cash $Cash at beginning of period $Cash at ending of period $Spencer CompanyStatement of Cash FlowsFor the Period Ended December 31, 20001 Steps in Preparation The statement of cash flows is prepared using the following information: 1 Comparative balance sheets F:\Teaching\3322\web\post\module5\c21\tnotes\c21a.doc 3/14/2007 2Statement of Cash Flows The changes between the beginning and ending balance sheets are analyzed to determine the sources of changes in cash flows. 2 Current income statement The current income statement provides the information required to determine the sources and uses of cash during the accounting period. 3 T-account analysis of selected general ledger accounts A T-account analysis must be conducted on each account that resulted in a gain or loss from investing or financing activities during the accounting period. There are five steps involved in preparing the statement of cash flows: 1 Determine the change in cash Using the work sheet approach (which will be discussed in lesson 2) we compare the beginning and ending cash balances to determine the change in cash during the accounting period. 2 Determine the net cash flows from operating activities a) Direct Method The direct method reports cash receipts from sales, cash disbursements as a result of the cost of goods sold, operating expenses and income taxes. It is essentially a cash flow statement using the income statement format. To determine the cash receipts from sales a T-account analysis is conducted of the changes in accounts receivable. Any increase in the accounts receivable during the accounting period is subtracted from sales to derive the cash collected from sales activities for the period. Likewise, to determine the cost of goods sold a T-account analysis of accounts payable and inventory must be conducted to calculate the cash paid for inventory sold. The cash disbursements are segregated so that cash payments to suppliers (vendors for inventory items), operating expenses and income taxes are presented separately. Although the FASB recommends this approach in practice few companies actually report using this method. Not only is this more complicated and time consuming but entities reporting under this approach must still provide the reconciliation that is presented using the indirect method as well. Exercise: Spencer Company had the following 2003 income statement: Sales $200,000Cost of goods sold 120,000Gross profit 80,000Operating expenses 29,000Deprecation 21,000Net income $ 30,000 The following accounts increased during 2003: Accounts receivable $17,000Inventory 11,000Accounts payable 13,000Prepare the cash flows from operating activities section of Azure’s 2002 statement of cash flows using the direct method. F:\Teaching\3322\web\post\module5\c21\tnotes\c21a.doc 3/14/2007 3Statement of Cash Flows Cash flows from operating activities: Cash received from customers $ Cash payments: Vendors $ Operating expenses $ Net cash provided by operating activities $ Solution: Cash flows from operating activities: Cash received from customers 183,000 ($200,000 - $17,000)