MGMT 200 Chapter 11: Statement of Cash Flows

Cash flow activities

operating, investing, and financing

Operating activities

cash receipts and cash payments for transactions relating to revenues and expense activities

Investing activities

cash transactions involving the purchase and sale of long-term assets and current investments

Financing activities

inflows and outflows of cash resulting from the external financing of a business (transactions with lenders and with stockholders)

Operating cash inflows

selling inventory, providing services, collecting interest, collecting income tax refund, collecting dividends

Operating cash outflows

purchasing inventory, paying for operating expenses, pay interest, paying income taxes

Investing cash inflows

selling debt or equity investments, selling property and equipment, selling intangible assets, collecting notes receivable

Investing cash outflows

purchasing debt or equity investments, purchasing property and equipment, purchasing intangible assets, lending with notes receivable

Financing cash inflows

issuing notes payable, issuing bonds, issuing own stock

Financing cash outflows

repaying principal on notes payable, repaying principal on bonds, purchasing own stock, paying dividends

Sources for preparing the statement of cash flows

income statements, balance sheet, detailed accounting records

Income statement role in statement of cash flows

revenue and expenses provide information in determining cash flows from operating expenses

Balance sheet role in statement of cash flows

changes in assets, liabilities, and stockholders’ equity account balances from the end of the last period to the end of this period help identify cash flows from operating, investing, and financing activities

Detailed accounting records role in statement of cash flows

sometimes additional information from the accounting records is needed to determine specific cash inflows or cash outflows for the period

Income statement and balance sheet role in operating activities

revenues and expenses from income statement, changes in other current assets and changes in current liabilities from balance sheet

Income statement and balance sheet role in investing activities

changes in long-term assets from balance sheet

Income statement and balance sheet role in financing activities

change in long-term liabilities, changes in common stock, changes in retained earnings (dividends paid) from balance sheet

Noncash activities

significant investing and financing activities that do not affect cash, reported after the cash flow statement or in a note to the financial statements

Examples of significant noncash investing and financing activities

purchase of long-term assets by issuing debt, purchase of long-term assets by issuing stock, conversion of bonds payable into common stock, exchange of long-term assets

Steps in preparing the statement of cash flows

1.  Calculate net cash flows from operating activities, using information from the income statement and changes in current assets (other than cash) and current liabilities from the balance sheet

2. Determine the net cash flows from investing activities, by analyzing changes in long-term asset accounts from the balance sheet

3. Determine the net cash flows from financing activities, by analyzing changes in long-term liabilities and stockholders’ equity accounts from the balance sheet

4. Combine the operating, investing, financing activities, and make sure the total from these three activities equals the amount of cash reported in the balance sheet this year versus last year (the change in cash)

Indirect versus direct methods of operating activities

differ in presentation format for operating activities, both methods report investing, financing, and noncash activities identically

Indirect method

begin with net income, remove noncash revenues and noncash expenses, remove nonoperating gains and nonoperating losses, adjust for changes in current assets and current liabilities, most popular method, easier and less costly

Direct method

adjust the items in the income statement to directly show the cash inflows and outflows from operations, company must also report the indirect method either with the statement of cash flows or in the notes

Two most common noncash income statement adjustments

noncash items, such as depreciation expense and amortization expense, and non-operating items, such as gains and losses on sale of land, equipment, and buildings

Most common noncash balance sheet adjustments

current assets other than investments and notes receivable, current liabilities other than various forms of borrowing

Reporting investing activities

companies list separately cash inflows and cash outflows from transactions such as borrowing and selling property, plant, and equipment, making and collecting loans, and buying and selling investments in other companies, can find a firm’s investing activities in long-term asset accounts from the balance sheet

Reporting financing activities

companies list separately cash inflows, such as borrowing money and issuing stock, and cash outflows, such as repaying amounts borrowed and paying dividends to shareholders, can find financing activities by examining changes in long-term liabilities and stockholders’ equity accounts from the balance sheet

Cash flow ratios

often used to supplement analysis of a company, substitute cash flow from operations in place of net income, positive cash flow from operations is important to a company’s survival in the long run

Cash return on assets

measures the operating cash flow generated per dollar of assets

Cash flow to sales

measures the operating cash flows generated for each dollar of sales

Asset turnover

measures the sales revenue generated per dollar of assets

Cash return on assets equation

Cash Return on Assets = Cash Flow To Sales * Asset Turnover

(Operating Cash Flows/Average Total Assets) = (Operating Cash Flows/Net Sales) * (Net Sales/Average Total Assets)