11-1 categories of cash flows cash flow inflows and outflows that result from transactions cash...
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11-1
Categories of Cash FlowsCategories of Cash Flows Cash flow
Inflows and outflows that result from transactions Cash account must increase or decrease
Operating activities Cash receipts and cash disbursements from
revenues and expenses Involve current assets and current liabilities
Investing activities Cash receipts and disbursements that result from
purchasing or selling long-term assets or investments in other firms
Financing activities Cash receipts and disbursements from long-term
debt and equity transactions
11-2
Categories of Cash FlowsCategories of Cash FlowsFinancing activities
DebtIssuing debtRepaying debt
Interest expense results from financing activities because it arises from debt financing. Why is it reported in the operating section?
EquityReceiving contributions from ownersPaying dividends to owners
11-3
Accrual-basis vs. Cash-basisAccrual-basis vs. Cash-basis Must convert from accrual-basis accounting
(GAAP) to cash-basis accounting to prepare statement of cash flows
Accrual-basis accountingRevenues recorded when earned and expenses
recorded when incurredTiming of cash receipt is irrelevant
Cash-basis accountingRevenues recorded when cash received and
expenses recorded cash paidTiming of revenue and expense recognition is
irrelevant Convert from accrual basis to cash basis
Accounts payable (assume for inventory) Beg bal $1,200; End bal $400; purch $36,300 Compute cash paid
11-4
Operating activitiesDirect method
Cash inflows and outflows explicitly identified
Analyzes every item on income statementIndirect method
Reconciles net income and cash flowStarts with net incomeMakes adjustments for income statement
items that do not affect cashAdjust for changes in current assets and
current liabilitiesEnds with net cash flow
11-5
Investing and financing activitiesSame presentation for both direct and
indirect methodsCash flows for each activity directly
identifiedUsed by 90% of companies.Financial statements needed
Current year income statementBeginning and ending balance sheet
11-6
Steps to Calculate Operating Cash Flows
1. Start with net income2. Add back non-cash expenses such as
depreciation Undo the effect of non-cash expenses
3. Adjust for changes in current assets Increase (decrease) in account should
be subtracted from (added to) net income to arrive at cash balance.
4. Adjust for changes in current liabilities
Increase (decrease) in account should be added to (subtracted from) net income to arrive at cash balance.
11-7
Cash Flow Indirect Method
Sales Revenues 500,000$ Cost of Goods Sold 284,000 Gross Margin 216,000 Depreciation Expense 50,000$ Interest Expense 5,000 Salary Expense 105,000 160,000 Net Income 56,000$
11-8
Cash Flow Indirect Method
Beginning EndingCash 37,500$ 75,000$ Accounts Receivable, net 17,000 13,000 Inventory 27,000 20,000 Prepaid Insurance - 12,000 Prepaid Rent 28,000 4,000 Total Current Assets 109,500 124,000 Equip, net of $75K & $125K Accum Depr 175,000 193,000 Total Assets 284,500$ 317,000$
11-9
Cash Flow Indirect Method
Beginning EndingAccounts Payable 9,000$ 4,250$ Unearned Revenue 4,375 3,125 Interest Payable 1,500 4,000 Total Current Liabilities 14,875 11,375 Long-term Notes Payable 40,000 15,000
Common Stock 40,000 45,000 Retained Earnings 189,625 245,625 Total Liabilities and Equity 284,500$ 317,000$
11-10
Cash Flow Indirect Method
+/-Net incomeDepreciation expenseDecrease in accounts receivableDecrease in inventoryIncrease in prepaid insuranceDecrease in prepaid rentDecrease in accounts payableDecrease in unearned revenueIncrease in interest payable Net cash from operating activities
11-11
Operating Activities—Direct Operating Activities—Direct MethodMethod
Changing revenues from accrual basis to cash basisAccounts receivable
Beginning balance (balance sheet)+ Sales (income statement)- Cash collected from customers (compute)
Ending balance (balance sheet)
11-12
Changing expenses from accrual basis to cash basisCost of goods sold
Inventory account Beginning inventory (balance sheet)
+ Purchases (compute)- Cost of goods sold (income statement)
Ending balance (balance sheet) Accounts payable
Beginning balance (balance sheet)+ Purchases (from inventory computation)- Cash paid to vendors (compute)
Ending balance (balance sheet)
11-13
Changing expenses from accrual basis to cash basisRent expense
Prepaid rent Beginning balance (balance sheet)
+ Cash paid for rent (compute)- Rent expense (income statement)
Ending balance (balance sheet)Interest expense
Interest payable Beginning balance (balance sheet)
+ Interest expense (income statement)- Cash paid for interest (compute)
Ending balance (balance sheet)
11-14
Use the information provided earlier
Cash collected from customersCash paid to vendorsCash paid to employeesCash paid for insuranceCash paid for rentCash paid for interest Net cash from operating activities
11-15
Investing and Financing Investing and Financing ActivitiesActivities
Investing cash flowsEquipment purchases/disposals require the
following accountsAsset account (beg & end)Accumulated depreciation (beg & end)Depreciation expense (current)
Financing cash flowsDebt financing
Need to analyze changes in long-term liability accounts
Equity financingAdditional capital contributions
Common and preferred stock accountsDividends
Retained earnings and current net income
11-16
Use the information provided earlier
Investing ActivitiesPurchase of equipment Net cash used by investing activities
Financing ActivitiesRepayment of note payableProceeds from issue of new stock Net cash used by financing activities
11-17
Preparing the Statement of Cash Preparing the Statement of Cash FlowsFlows
Prepare operating, investing, and financing sections
Supplementary disclosuresNoncash financing and investing
activitiesCash paid for interest expense and
income taxesBroken out in supplementary disclosures
because usually part of subtotals
11-18
Preparing the Statement of Cash Preparing the Statement of Cash FlowsFlows
Use the information provided earlier
Net cash provided by operations
Net cash used by investing activities
Net cash used by financing activities
Cash at beginning of yearCash at end of year
11-19
Free Cash FlowNet cash from operating activities- Cash dividends- Capital expenditures _
Free cash flow
11-20
Cash Flow Adequacy Ratio
Measures the firm’s 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 of capital assets
11-21
Cash Needed to Pay Current Liabilities
Current cash debt coverage ratioMeasures a firm’s ability to generate
the cash it needs in the short-runA liquidity measure
Net Cash Provided by OperationsAverage Current Liabilities
11-22
Business Risk, Control, and Business Risk, Control, and EthicsEthics
Investors’ risks associated with statement of cash flowsInvestors look for positive cash flows
from operationsHow could a company manipulate
operating cash flows?