Chapter 12 - Cash Flow Statement

direct method

separately lists operating cash receipts and operating cash payments

cash payments are subtracted from cash receipts

indirect method

reports net income and then adjusts it for items that don’t affect cash

it does NOT report individual items of cash inflows and cash outflows from operating activities

is the net cash amount different between indirect and direct?

NO - it’s exactly the same - the difference is in computation and presentation

indirect method is arguably easier, apple, google and samsung use it

two types of adjustments for indirect

(1) adjustments to income statement items that don’t impact cash

(2) adjustments for changes in current assets and current liabilities (linked to operating activities)

adjustments for income statement items not affecting cash

some expenses and losses that are subtracted when computing net income are not cash outflows

ex: depreciation, amortization, depletion, bad debts expense, loss from an asset sale, and loss from retirement of notes or bonds payable

**indirect method requires that “expenses and losses with no cash outflows are added back to net income”

revenues and gains with no cash inflows are subtracted from net income

**it’s just reversing them

adjustments for changes in current assets and liabilities

decreases in current assets are added to net income

increases in current assets are subtracted from net income

decreases in current liabilities are subtracted from net income

increases in current liabilities are added to net income

ex: if accounts receivable increases, subtract from net income

to compute cash flows from investing, we analyze changes in

(1) all long-term asset accounts and

(2) any current accounts for notes receivable and investments in securities

**identical under direct and indirect methods

steps to compute changes in investing cash

(1) identify changes in investing related accounts

(2) determine the cash effects using t-accounts and reconstructed entries

(3) report the cash flow effects

investing activities (for cash flows from investing)

(1) purchasing and selling long-term assets

(2) lending and collecting on notes receivable

(3) purchasing and selling investments

**assets

**does NOT include interest received from investments

cash flow on total assets

used, along w/ income-based ratios, to assess company performance

cash flow on total assets = cash flows from operations / avg total assets

tells us how effective a company’s assets are at producing cash

analyzing cash sources and uses - why is it important to review cash flows?

• managers review cash flows to make business decisions

• creditors evaluate cash flows to decide whether they can loan a company money and the company will generate enough cash flow to pay them back

• investors access cash flows before buying and selling stock

spreadsheet preparation

a spreadhseet, also called work sheet or working paper

helps us organize info needed to prepare a statement of cash flows

direct method of reporting operating cash flows: operating activities

adjust income statement accounts related to operating activities for changes in their related balance sheet accounts

revenue or expense ± adjustments for changes in related balance sheet accounts = cash receipts or payments

operating cash receipts + operating cash payments = net cash provided by operating activities

how do direct and indirect methods differ?

they only differ in how they compute operating - other than that it’s the same

**also, either way, you get the same answer, it’s just a different methodology

common stock transactions

goes under financing

if increase in common stock, we have an increase in cash

retained earnings transactions

if retained earnings increase frmo 88000 to 112000, and 14,000 of dividend are reported, we subtract 14000 for cash

proving cash balances

report the beginning and ending cash balances and prove that the net change in cash is expained by operating, investing, and financing cash flows

net increase in cash

cash balance at prior year end

cash balance at current year end

purpose of the statement of cash flows

how does a company receive its cash

how do we explain the change in cash balance

how do we explain the difference between net income and cash

where does a company spend its cash

cash flows include…

cash and cash equivalents

cash equivalents must meet two criteria:

(1) be readily convertivle into cash
(2) be sufficiently close to maturity so that market value is unaffectd by interest rate change

things included in operating activities

cash sales to customers

collections on credit sales

recipet of interest revenue

receipt of dividend rev

pay salaries and wages

pay interest owed

pay taxes

pay operating expenses

pay suppliers for G+S

financing activities

contributions by owners / withdrawals by owners

pay dividends

pay off long-term debt

purchase treasury stock

issuing long-term debt

issuing common and preferred stock

cash flows and links to BS

operating = current A+L

investing = long term A

financing = long-term L and equity

examples of noncash investing and financing

retirement of debt by issuing equity stock

conversion of preferred stock to common stock

lease of assets in a long-term lease transaction

purchase of long-term assets by issuing a note or a bond

preparing statement of cash flows (steps

(1) compute net increase / decrease

(2) net cash from op

(3) net cash investing

(4) net cash financing

(5) compute from all sources then prove it

analyzing noncash accounts cash equation

cash = liabilities + equity - noncash assets

information to prepare the statement of cash flows comes from these sources:

(1) comparative balance sheets

(2) current income statement

(3) additional information