Chapter 12 Reporting and Analyzing Cash Flows Mc

Chapter 12 Reporting and Analyzing Cash Flows Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -2 Conceptual Learning Objectives C 1: Explain the purpose and importance of cash flow information C 2: Distinguish between operating, investing, and financing activities C 3: Identify and disclose noncash investing and financing activities C 4: Describe the format of the statement of cash flows Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -3 Analytical Learning Objectives A 1: Analyze the statement of cash flows A 2: Compute and apply the cash flow on total assets ratio Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -4 Procedural Learning Objectives P 1: Prepare a statement of cash flows P 2: Compute cash flows from operating activities using the indirect method P 3: Determine cash flows from both investing and financing activities P 4: Appendix 16 A: Illustrate use of a spreadsheet to prepare a statement of cash flows P 5: Appendix 16 B: Compute cash flows from operating activities using the direct method Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

C 1 Purpose of the Statement of Cash Flows How does a company obtain its cash? 12 -5 Where does a company spend its cash? What explains the change in the cash balance? Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -6 Importance of Cash Flows C 1 How did the business fund its operations? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? Did the business borrow any funds or repay any loans? Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -7 C 1 Measurement of Cash Flows Cash Equivalents l l l Cash Currency Short-term, highly liquid investments. Readily convertible into cash. Sufficiently close to maturity so that market value is unaffected by interest rate changes. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -8 Classifying Cash Flows C 2 • • • Mc. Graw-Hill/Irwin The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities © The Mc. Graw-Hill Companies, Inc. , 2008

12 -9 C 2 Operating Activities • • • Mc. Graw-Hill/Irwin Inflows Receipts from customers Cash dividends received Interest from borrowers Other. Outflows Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Other © The Mc. Graw-Hill Companies, Inc. , 2008

12 -10 Investing Activities C 2 • • Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans Other Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Other Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -11 Financing Activities C 2 • • Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Outflows Pay dividends Purchasing treasury stock Repaying cash loans Paying owners’ withdrawals Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

Noncash Investing and Financing C 3 • • • Mc. Graw-Hill/Irwin 12 -12 Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred stock to common stock. Leasing of assets in a capital lease transaction. © The Mc. Graw-Hill Companies, Inc. , 2008

C 4 Mc. Graw-Hill/Irwin Format of the Statement of Cash Flows 12 -13 © The Mc. Graw-Hill Companies, Inc. , 2008

C 4 Format of the Statement of Cash Flows 12 -14 There are two acceptable methods to determine Cash Flows from Operating Activities: • Direct Method • Indirect Method Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

P 2 Preparing the Statement of Cash Flows 12 -15 Let’s look at the Indirect Method for preparing the Cash Flows from Operating Activities section. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -16 Indirect Method P 2 Changes in current assets and current liabilities. Cash Flows from Operating Activities Net Income + Losses and - Gains + Noncash expenses such as depreciation and amortization. 97. 5% of all companies use the indirect method. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -17 P 2 Indirect Method Use this table when adjusting Net Income to Operating Cash Flows. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -18 Indirect Method Example P 2 Ø Ø Ø East, Inc. reports $125, 000 net income for the year ended December 31, 2008. Accounts Receivable increased by $7, 500 during the year and Accounts Payable increased by $10, 000. During 2008, East reported $12, 500 of Depreciation Expense. What is East, Inc. ’s Operating Cash Flow for 2008? Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -19 P 2 Indirect Method Example Netincome $$ 125, 000 Deduct: Increasein inaccounts For the indirect receivable method, start with Cash provided byoperating net income. activities Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -20 P 2 Indirect Method Example Netincome Add: Depreciationexpense Deduct: Increasein inaccounts receivable Add noncash expenses such receivable $$ 125, 000 12, 500 as depreciation, depletion, amortization, orby bad debt Cash provided byoperating expense. activities Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -21 P 2 Indirect Method Example Netincome Add: Depreciationexpense Deduct: Increasein inaccounts receivable $$ 125, 000 12, 500 (7, 500) Cashprovidedby byoperating activities Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -22 P 2 Indirect Method Example Net $$ 125, 000 Netincome 125, 000 Add: 12, 500 Add: Depreciationexpense 12, 500 Deduct: Increasein inaccounts receivable (7, 500) Add: 10, 000 Add: Increasein inaccountspayable 10, 000 Cashprovidedby byoperating activities Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -23 P 2 Indirect Method Example Net $$ 125, 000 Netincome 125, 000 Add: 12, 500 Add: Depreciationexpense 12, 500 Deduct: Increasein inaccounts receivable (7, 500) Add: 10, 000 Add: Increasein inaccountspayable 10, 000 Cashprovidedby byoperating activities $$ 140, 000 activities 140, 000 If we used the Direct Method, we would get the same $140, 000 for Cash Provided by Operating Activities. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -24 Indirect Method P 2 Let’s prepare a Statement of Cash Flows for B&G Company using the Indirect Method. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -25 P 2 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -26 P 2 Additional Information for 2008: • Net income was $105, 000. • Cash dividends declared and paid were $40, 000. • Bonds payable of $50, 000 were redeemed for $50, 000 cash. • Common stock was issued for $35, 000 cash. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -27 P 1 Add noncash expenses and losses. Subtract noncash revenues and gains. Start with accrual-basis net income. Then, analyze the changes in current assets and current liabilities. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -28 P 2 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -29 P 3 Now, let’s complete the investing section. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -30 P 3 Now, let’s complete the financing section. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -31 P 1 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -32 A 1 Mc. Graw-Hill/Irwin Analyzing Cash Sources and Uses © The Mc. Graw-Hill Companies, Inc. , 2008

12 -33 A 2 Cash Flow on Total Assets Used, along with income-based ratios, to assess company performance. Cash flow on total assets Mc. Graw-Hill/Irwin = Operating cash flows Average total assets © The Mc. Graw-Hill Companies, Inc. , 2008

Preparing the Statement of Cash Flows P 5 12 -34 Let’s look at the Direct Method for preparing the Cash Flows from Operating Activities section. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -35 P 5 Analyzing the Cash Account Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows under the Direct Method. Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -36 P 5 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008

12 -37 End of Chapter 12 Mc. Graw-Hill/Irwin © The Mc. Graw-Hill Companies, Inc. , 2008