accounting chapter 12 - statement of cash flows

statement of cash flows

cash flow statement

the cash flow statement explains how the amount of cash on the balance sheet at the beginning period became the amount of cash reported at the end of the period

cash & cash equivalents

short term 3 months or less, highly liquid investments that can be readily converted to cash

cash: currency and coins, balances in checking accounts, checks and money orders from customers for deposit

cash equivalents: money market funds, treasury bills, commercial paper

cash flows statement activities

operating activities, investing activities, financing activities

operating activities

directly related to earnings from normal operations (paying for inventory)

investing activities

related to the acquisition or sale of fixed assets and investments in other companies

financing activities

related to transactions with owners and creditors

cash flows with operating activities

inflows:

cash received from : customers, *dividends or interest on investments

outflows:

cash paid for:

-purchase of goods for resale and services (electricity, etc).

-salaries and wages

-income taxes

-INTEREST on liabilities

investing activities

inflows:

cash received from :

-sale or disposal of property, plant and equipment

-sale of investments in securities

outflows:

cash paid for:

-purchase of property, plant and equipment

-purchase of investments in securities (*of another company)

note: outflows become before inflows

financing activities

inflows:

cash received from :

-borrowing on notes, mortgages, bounds, etc, from creditors

-issuing stock to owners

outflows:

cash paid for:

-repayment of principle to creditors (excluding interest, which is an operating activity)

-repurchasing stock from owners

-dividends to owners

two formats for reporting operating activities

1. direct method

2. indirect method

direct method (better method to use)

reports the cash effects of each operating activity

indirect method (more common)

starts with accrual net income and converts to cash basis

same total operating cashflow under both methods **

the direct method

+operating cash receipts (customers, renters, interest, dividends)

-(suppliers, employees, operations, interest, taxes)

=net cash provided (used) by operating activities

the indirect method

1. start with net income: accrual base income

2. + non cash expenses such as depreciation and amortization

3. + / - changes in current operating assets and liabilities

4. + losses and - gains

   5. cash flows from operating activities

converting indirect method statement to direct statement

-replace accrual basis net income with individual income statement line terms

-add or subtract each item reconciling net income to operating cash flow

the investing and financing sections are the same regardless of whether the direct or indirect method is used to calculate operating cash flow

additional disclosures

commonly reported following the statement of cash flows or in a note

non cash financing & investing activities

-commonly reported in a footnote

examples:

-purchasing fixed assets by issuing debt or common stock

-converting debt into common stock

-exchanging assets with another company

free cash flow

the amount of cash flow generated beyond what is needed to operate the business at its current productive capacity

-available for expansion, paying dividends, repaying debt, or other purposes

free cash flow= cash flow from operating activities - capital expenditures

operating cash flow to current liabilities ratio

measures a company’s ability to pay its current liabilities using operating cash flows -similar in nature to the current ratio and the quick ratio

operating cash flow to current liabilities ratio= cash flow from operating activities / average current liabilities

operating cash flow to capital expenditure ratio

-measures a company’s ability to finance its capital expenditures from operating cash flow

a ratio > 1.0 indicates that current operating activities are generating sufficient cash to fund capital investment

firms in a growth phase of their life cycle will likely have a lower ratio than firms in a mature phase

operating cash flow to capital expenditure ratio= cash flow from operating activities / annual net capital expenditure (means purchases-sales)

receipts from customers

net sales + decrease in AR

payments for merchandise

cost of sales - decrease in inventory + decrease in AP