Reporting Cash Flows

1. Chapter F5 Reporting Cash Flows Electronic Presentationby Douglas Cloud Pepperdine University

2. Objectives 1.Explain information reported on a statement of cash flows using the direct format. 2.Explain information reported on a statement of cash flows using the indirect format. 3.Interpret cash flow information as a basis for analyzing financial performance. Once you have completed this chapter, you should be able to:

3. The Statement of Cash Flows The statement of cash flows explains the changes in a company’s cash balance during the fiscal period.

4. The Statement of Cash Flows GAAP permit the statement to be presented in either of two formats: direct or indirect.

5. Objective 1 Explain information reported on a statement of cash flows using the direct format.

6. Cash Flow from Operating Activities Cash Received from Operating Activities – Cash Paid for Operating Activities = Net Cash from (for) Operating Activities The Direct Format 

7. Cash Flow from Investing Activities Cash Received from Investing Activities – Cash Paid for Investing Activities = Net Cash from (for) Investing Activities The Direct Format 

8. Cash Flow from Financing Activities Cash Received from Financing Activities – Cash Paid for Financing Activities = Net Cash from (for) Financing Activities The Direct Format 

9. The Direct Format Operating cash flows are the cash equivalent of the accrual results reported on the income statement. The direct format answers the question, “Where did cash come from and where did cash go?”

10. Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Exhibit 1 Operating Activities Receipts: Collections from customers $682,080 Payments: For inventory (471,590) To employees (70,800) For rent (24,000) For utilities (4,500) For supplies (15,990) For insurance (3,700) For advertising (6,500) For interest (4,150) For income tax (22,710) Net cash flow from operating activities 58,140 Continued

11. Statement of Cash Flows, Direct Format Exhibit 1 Carried forward $ 58,140 Investing Activities Payments for purchase of equipment (216,000) Receipts from sale of equipment 340 Net cash flow for investing activities (215,660) Financing Activities Receipts from sale of common stock 100,000 Payment of dividends (10,000) Receipts from borrowing 80,000 Repayment of debt (1,800) Net cash flow from financing activities 168,200 Net increase in cash 10,680 Cash balance, December 31, 2003 0 Cash balance, December 31, 2004 $ 10,680

12. Operating Activities Operating activities are transactions involving the acquisition or production of goods and services and the sale and distribution of these goods and services to customers.

13. Income Statement and Balance Sheet for Mom’s Cookie Company Exhibit 2 Continued

15. Calculation of Operating Cash Flows Exhibit 3

16. Investing Activities Investing activities involve acquisition or sale of long-term term assets and financial investments during a fiscal period.

17. Financing Activities Financing activities are transactions between a company and its owners or between a company and its creditors.

18. GAAP require a schedule reconciling cash flows from operating activities with net income when the direct format is used.

19. Objective 2 Explain information reported on a statement of cash flows using the indirect format.

20. The Indirect Format The differences between the direct and indirect formats are in the operating activities section only.

21. From the income statement Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Exhibit 4 Operating Activities Net income $ 52,990 Depreciation expense 25,500 Increase in accounts receivable (8,570) Increase in merchandise inventory (23,600) Increase in supplies (690) Increase in prepaid rent (2,000) Increase in accounts payable 9,610 Increase in unearned revenue 4,250 Increase in interest payable 650 Net cash flow from operating activities 58,140 Continued

22. The investing and financing sections are identical for the direct and indirect formats. Indirect Format of Statement of Cash Flows Exhibit 4 Carried forward $ 58,140 Investing Activities Payments for purchase of equipment (216,000) Receipts from sale of equipment 340 Net cash flow for investing activities (215,660) Financing Activities Receipts from sale of common stock 80,000 Payment of dividends (1,800) Receipts from borrowing 100,000 Repayment of debt (10,000) Net cash flow from financing activities 168,200 Net increase in cash 10,680 Cash balance, December 31, 2003 0 Cash balance, December 31, 2004 $ 10,680

23. The Indirect Format Increases in current assets are subtracted from net income to calculate operating cash flows.

24. 2004 2003 Change $8,570 $0 $8,570 Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Operating Activities Net income $ 52,990 Depreciation expense 25,500 Increase in accounts receivable (8,570) Increase in merchandise inventory (23,600) Increase in supplies (690) Increase in prepaid rent (2,000) Increase in accounts payable 9,610 Increase in unearned revenue 4,250 Increase in interest payable 650 Net cash flow from operating activities 58,140 Exhibit 4

25. 2004 2003 Change $23,600 $0 $23,600 Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Operating Activities Net income $ 52,990 Depreciation expense 25,500 Increase in accounts receivable (8,570) Increase in merchandise inventory (23,600) Increase in supplies (690) Increase in prepaid rent (2,000) Increase in accounts payable 9,610 Increase in unearned revenue 4,250 Increase in interest payable 650 Net cash flow from operating activities 58,140 Exhibit 4

26. The Indirect Format Because this is the first year of operations for Mom’s Cookie Company, there are no decreases in current assets. Decreases in current assets are added to net income to calculate operating cash flows.

27. The Indirect Format Increases in current liabilities are added to net income to calculate operating cash flows.

28. 2004 2003 Change $9,610 $0 $9,610 Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Operating Activities Net income $ 52,990 Depreciation expense 25,500 Increase in accounts receivable (8,570) Increase in merchandise inventory (23,600) Increase in supplies (690) Increase in prepaid rent (2,000) Increase in accounts payable 9,610 Increase in unearned revenue 4,250 Increase in interest payable 650 Net cash flow from operating activities 58,140 Exhibit 4

29. The Indirect Format As with current assets, there were no decreases in current liabilities because this is the firm’s first year of operation. Decreases in current liabilities are subtracted from net income to calculate operating cash flows.

30. Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Operating Activities Net income $ 52,990 Depreciation expense 25,500 Increase in accounts receivable (8,570) Increase in merchandise inventory (23,600) Increase in supplies (690) Increase in prepaid rent (2,000) Increase in accounts payable 9,610 Increase in unearned revenue 4,250 Increase in interest payable 650 Net cash flow from operating activities 58,140 Depreciation Expense is added to net income because it is an expense that does not require a cash outlay. Exhibit 4

31. Mom’s Cookie Company Statement of Cash Flows For the Year Ended December 31, 2004 Operating Activities Net income $ 52,990 Depreciation expense 25,500 Increase in accounts receivable (8,570) Increase in merchandise inventory (23,600) Increase in supplies (690) Increase in prepaid rent (2,000) Increase in accounts payable 9,610 Increase in unearned revenue 4,250 Increase in interest payable 650 Net cash flow from operating activities 58,140 The same treatment is used for Amortization Expense and Depletion Expense. Exhibit 4

32. Exhibit 6 Indirect Format of Statement of Cash Flows

33. The Indirect Format Review of Rules for Adjusting Net Income to Calculated Operating Cash Flow • When a current asset account increases, the increase is subtracted from net income. • When a current asset decreases, the amount of the decrease is added to net income. • An increase in a current liability is added to net income to calculate operating cash flow. • A decrease in a current liability is subtracted from net income to calculate operating cash flow.

34. Summary of Adjustments for the Indirect Format Net income + Depreciation and Amortization Expense – Increases in Current Asset Accounts + Decreases in Current Asset Accounts + Increases in Current Liability Accounts –Decreases in Current Liability Accounts = Cash Flow from Operating Activities

35. Objective 3 Interpret cash flow information as a basis for analyzing financial performance.

36. The amount of cash flow from operating activities normally is approximately equal to the amount of cash flow from or for investing activities plus the amount of cash flow from or for financing activities.

37. These normally are a sign of a prosperous and growing company. Cash Flow Patterns and the Financial Health of a Company Operating cash flows are positive Investing cash flows are negative Financing cash flows are positive

38. The company is facing serious financial problems. It is selling assets and using financing activities to meet current cash needs. Cash Flow Patterns and the Financial Health of a Company Operating cash flows are negative Investing cash flows are positive Financing cash flows are positive

39. The company is prosperous but may not have a lot of good growth opportunities. It is using operating cash to pay off debt and pay stockholders. Cash Flow Patterns and the Financial Health of a Company Operating cash flows are positive Investing cash flows are positive or negative Financing cash flows are negative

40. The company may be facing a current cash flow problem. It is selling assets to supplement current cash flows to cover its financing needs. Cash Flow Patterns and the Financial Health of a Company Operating cash flows are positive or negative Investing cash flows are positive Financing cash flows are negative

41. CHAPTER F5 THE END