Chapter 11 Reporting and Analyzing the Statement of Cash Flows

Statement of Cash Flows

provide relevant information to financial statement users about a companies cash receipts and cash payments during an accounting period. Fills the void as to where a company has aqired cash

Does net income always indicate the amount of cash generated by a business from its operations?

No

Cash Equivelents

Short Term highly liquid in vestments that are readily convertible to cash and have maturities of three months or less

Cash Flows from Operating Activities

cash inflows and outflows that relate to acquiring, selling and delivering goods or services. W

What does cash inflows from operating activities include:

cash sales, collection of accounts, cash dividends, interest received

What are some cash outflows from operating

suppliers for goods and services, employee wages, taxes

Quality of earnings ratio

used by analysts to calculate the amount of cash that is generated by each dollar of earnings.

Cash flows from investing activities

Cash inflows and outflows that relate to acquiring and disposing of capital assets and investments in other companies, lending money and collecting loans

Cash Flows from financing activities

include obtaining resources from creditors and owners

Examples of Cash inflow from financing activities

issuance of shares

issuance of debt

Non-cash investing and financing activities

acquire one asset by exchanging for another or acquiring a capital asset. Because these do not involve cash, they do not show up on the statement

Direct Method

cash inflows and cash outflows are listed for each type of operating activity. Cash under this method is collected from customers, cash paid to suppliers, cash paid to employees, cash paid for interest and cash paid for taxes

Indirect method

does not report individual cash inflows and outflows for each type of operating activity that a company performs. Instead it focuses on the differences between net income and then adjusts it for non-cash items.

what are the four adjustments under the indirect method

1. add to net income any non-cash expenses and subtract from net income any non-cash revenues

2. add to net income any accounting losses and subtract from net income any accounting gains

3. add to net income any decreases in current assets or increases in current liabilities that are related to operating activities

4. subtract from net income any increases in current assets or decreases in current liabilities

What do non-cash items do

Reduct net income, but do not reduce cash. under the indirect method non-cash expenses are added back to the net income

How does the sale of a long term asset or end of a long term liability effect the statement of earnings

it produces a gain or loss, but the gain or loss does not affect cash flow and is not included as an operating activity

Accounts Receivable

accounts receivable account increases when credit sale are recorded and decreases when cash is collected from customers

Prepaid Insurance

the prepaid insurance account increases when cash payments are made and decreases as insurance expense is incurred

Inventory

The inventory account increases when inventory is purchased and decreases as inventory is sold.

Accounts Payable

The accounts payable account increases when credit purchases are made and decreased when cash payments are made to suppliers

Wages Payable

the wages payable account increases when wages are accrued and decreases when wages are paid

interest payable

Interest payable increases when interest expense is recorded and decreases when interest is paid

Income Tax Payable

the income tax payable account increases when income tax expense is incurred and decreases when income taxes are paid

How do you get a complete picture of the equipment account?

you must examine the equipment and the related accumulated depreciation account

Free Cash Flow

represents the csh flow that a company is able to generate after considering the maintenance of expansion of its assets and the payment of dividends

What is the advantage of having free cash flow

the company can purchase profit-generating opportunities as they arise

Cash Flow Adequacy Ratio

Provides a measure of the companies ability to meet its maturing debt obligations. This is the indicator if the company is able to borrow additional debt.

What does variances in cash flows from similar companies indicate

potential fraud