Untitled Flashcards Set

Classification of the Statement of Cash Flows:

§  Cash Equivalents – short-term investments with original maturities of three months or less that are readily convertible to cash and whose value is unlikely to change (i.e. Treasury Bills, Money Market Funds)

§  Classifications of the Statement of Cash Flows

§  Operating

§  Investing

§  Financing

Direct Method vs. Indirect Method:

Cash Flow Classifications:

§  Operating Activities – cash inflows and outflows directly related to earnings from normal operations

Dividends:

Receive = Operating

Pay = Financing

Principal = Financing

Interest = Operating

§  Investing Activities – cash inflows and outflows related to the acquisition or sale of productive facilities and investments in the securities or other companies

§  Financing Activities – cash inflows and outflows related to external sources of financing (owners and creditors) for the enterprise

Net Increase (Decrease) in Cash:

§  The combination of net cash flows from operating, investing, and financing activities must equal the net increase (decrease) in cash for the reporting period.

Net Cash Provided by Operating Activities $200,000
Net Cash Used in Investing Activities (50,000)
Net Cash Used in Financing Activities (25,000)

Net Increase in Cash and Cash Equivalents 125,000
Cash and Cash Equivalents at Beginning of Period 85,000

Cash and Cash Equivalents at End of Period $210,000

Relationships with the Balance Sheet and Income Statement:

§  Companies cannot prepare the statement of cash flows using the amounts recorded in the T-accounts because those amounts are based on accrual accounting. They must analyze the numbers recorded under the accrual method and adjust them on a cash basis.

§  To prepare a statement of cash flows, preparers need:

§  Comparative balance sheets

§  Complete income statement

§  Additional details concerning selected accounts

1.       Investing

2.       Operating

3.       Investing

4.       Operating

5.       Financing

6.       Financing

7.       Operating

8.       Operating

9.       Investing

10.  Financing

Reporting Cash Flows from Operating Activities – Indirect Method

-            Completing the Operating Section using the indirect method involves 2 steps

1.       Adjust net income for depreciation and amortization expense and gains and loses on sale of investing assets such as property, plant and equipment (PPE) and investments

§  Depreciation and amortization are subtracted by calculating net income, but does not affect cash, therefore we need to add it back

§  Gains on sale of PPE need to be subtracted and losses on sale of PPE need to be added to net income

2.       Adjust net income for changes in assets and liabilities marked as operating

§  Add the change when an operating asset decreases, or an operating liability increases

§  Subtract the change when an operating asset increases, or an operating liability decreases

ASSETS:

Change in Accounts Receivable:

-            Balance sheet indicates an increase/decrease in accounts receivable

§  If A/R increases, that means less cash is collected from customers and therefore the change must be subtracted from net income

§  If A/R decreases, that means  more cash is collected from customers and therefore the change must be added to net income

*** If accounts receivable increases ($ is lower (-)

*** If accounts receivable decreases ($ is higher (+)

Change in Inventory:

-            Balance sheet indicates an increase/decrease in inventory

§  If inventory increases, that means the amount of purchases is more than the amount of merchandise sold, and the increase must be subtracted from net income

§  If inventory decreases, that means the amount of cost of goods sold is more than purchases, and the decrease must be added to net income

*** If inventory increases ($ is lower (-)

*** If inventory decreases ($ is higher (+)

Change in Prepaid Expenses:

-            Balance sheet indicates an increase/decrease in prepaid expenses

§  If prepaid increases, that means the new cash prepayments are more than the amount of expenses and therefore must be subtracted from net income

§  If prepaid decreases, that means that the amount of expenses is more than the prepayments and therefore must be added back to net income

*** If prepaid expenses increase ($ is lower (-)

*** If prepaid expenses decrease ($ is higher (+)

LIABILTIES:

Change in Accounts Payable:

-            Balance sheet indicates an increase/decrease in accounts payable

§  If accounts payable increases, that means the cash payments were less than the purchases on accounts and therefore must be added to net income

§  If accounts payable decrease, that means the cash payments were more than the purchases on account and therefore must be subtracted from net income

*** If accounts payable decrease ($ is lower (-)

***If accounts payable increase ($ is higher (+)

Change in Accrued Expenses:

-            Balance sheet indicates an increase/decrease in accrued expenses

§  If accrued expenses increase, that means the cash paid for expenses is less than accrual basis expenses, therefore it must be added to net income

§  If accrued expenses decrease, that means the cash paid for expenses is more than the accrual basis expenses, therefore it must be subtracted from net income

*** If accrued expenses decrease ($ is lower) (-)

*** If accrued expenses increase ($ is higher) (+)

Quality of Income Ratio:

Quality of Income Ratio – How much cash does each dollar of net income generate

Cash Inflow from Operating Activities

Net Income

-            Measures the portion of income that was generated in cash

-            Higher quality of income ratio indicates greater ability to finance operating and other cash needs from operating cash inflows

-            Higher ratio indicates that it is less likely that the company is using aggressive revenue recognition polices are therefore less likely to experience a decline in the future

4 Potential Causes of Differences

1.       The corporate life cycle

2.       Seasonality

3.       Changes in revenue and expense recognition

4.       Changes in management of operating assets and liabilities

Interpreting Cash Flows from Investing Activities:

-            Capital Acquisitions Ratio

Cash flow from Operating Activities

Cash Paid for Property, Plant, and Equipment

-            Reflects the portion of purchases of property, plant, and equipment financed from operating activities (without the need for outside debt or equity financing or the sale of other investments or fixed assets)

-            A high ratio indicates less need for outside financing for current and future expansion

-            Free Cash flow = Cash Flow from Operating Activities – Dividends – Capital Expenditures

-            Managers and analysts calculate free cash flow as a measure of a firm’s ability to pursue long-term-investments opportunities

-            Any positive free cash flow is available for additional capital expenditures investments in other companies, and mergers and acquisitions with the need for external financing or reductions in dividends to shareholders

Interpreting Cash Flows from Financing Activities:

-            The long-term growth of a company is normally financed from 3 sources

1.       Internally generated funds (cash from operating activities)

2.       The issuance of stock

3.       Money borrowed on a long-term basis

-            The statement of cash flow shows how management has elected to fund its growth. This information is used by analysts who wish to evaluate the capital structure and growth potential of a business

Review Question:

Cash paid for interest, $20,000; Cash paid for dividends, $6,000; Cash dividends
received, $4,000; Cash proceeds from bank loan, $29,000; Cash purchase of treasury
stock, $11,000; Cash paid for equipment purchase, $27,000; Cash received from
issuance of common stock, $37,000; Cash received from sale of land with a $32,000
book value, $25,000; Acquisition of land costing $51,000 in exchange for preferred stock issuance; Payment of a $100,000 note payable by exchanging used machinery with a $77,000 book value and $100,000 fair value.

How much was net cash flow from financing activities?
A. A net outflow of $51,000.
B. A net inflow of $29,000.
C. A net outflow of $53,000.
D. A net inflow of $49,000.

Cash paid for dividends (6,000)

Cash Received from bank loans 29,000

Cash Received from Sale of Stock 37,000

Cash Paid for treasury stock [YT1] (11,000)

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Net Cash inflow from financing activities 49,000

Completing the Statement and Additional Disclosures:

-            Net increase or decrease in cash and cash equivalents added to the cash and cash equivalents taken from the beginning of the period amount on the balance sheet equals end of period cash reported on the balance sheet.

-            Companies must also provide two other disclosures

1.       Noncash Investing and Financing Activities

2.       Cash Paid for Interest and Income Taxes

 [YT1]Outflow and financing because you’re buying and financing because it’s related to your own stock