Name of ChapterMcGraw-Hill/Irwin Slide 2 Understanding the Business Positive cash flows permit a...

Chapter 13

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Slide 2

Understanding the Business Positive cash flows permit a company to . . .

Expand its

operations.

Replace

needed assets.

Take advantage

of market

opportunities.

Pay

dividends to

owners.

Wall Street analysts consider cash flow an

important indicator of a company’s

financial health.


Cash Currency

Cash

Equivalents

Short-term, highly liquid investments.

Readily convertible into cash.

So near maturity that market value is unaffected by

interest rate changes (i.e., less than 3 months to

maturity).

Classifications of the Statement of Cash Flows


Classifications of the Statement of Cash Flows

Operating

Activities

Cash inflows and outflows

directly related to earnings

from normal operations.

Investing

Activities

Cash inflows and outflows related to

the acquisition or sale of productive

facilities and investments in the

securities of other companies.

Financing

Activities

Cash inflows and outflows related to

external sources of financing

(owners and creditors) for the

enterprise.

Investing Activities Operating Activities Financing Activities

Sale of operational assets

Sale of investments

Collections of loans

Cash received

from revenues

Issuance of stock

Issuance of bonds and notes

CASH INFLOWS

Business

CASH OUTFLOWS

Purchase of operational assets

Purchase of investments

Loans to others

Cash paid for

expenses

Payment of dividends

Repurchase of stock

Repayment of debt


Cash Flows from Operating Activities

Cash

Flows

from

Operating

Activities

Inflows

Cash received from:

Customers

Dividends and interest on investments

+

Outflows

Cash paid for:

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

Salaries and wages

Income taxes

Interest on liabilities

_


Direct Method vs. Indirect Method

Two Formats for Reporting Operating Activities

Reports the

cash effects of

each operating

activity

Direct Method

Starts with

accrual net

income and

converts to

cash basis

Indirect Method

Note that no matter which format is used, the same amount of

net cash flows from operating activities is generated.


Cash

Flows

from

Investing

Activities

+

Cash Flows from Investing Activities

Inflows

Cash received from:

Sale or disposal of property, plant and equipment

Sale or maturity of investments in securities

_

Outflows

Cash paid for:

Purchase of property, plant and equipment

Purchase of investments in securities


Cash

Flows

from

Financing

Activities

+

_

Cash Flows from Financing Activities

Inflows

Cash received from:

Borrowings on notes, mortgages, bonds, etc. from creditors

Issuing stock to owners

Outflows

Cash paid for:

Repayment of principal to creditors (excluding interest, which is an operating activity)

Repurchasing stock from owners

Dividends to owners

(in thousands) Three months ended

(unaudited) March 31, 2007

Cash flows from operating activities:

Net income 5,768$

Adjustments to reconcile net income to net cash

provided by operating activities:

Depreciation 1,726

Changes in assets and liabilities:

Accounts receivable (1,967)

Inventory (1,917)

Prepaid expense (1,677)

Accounts payable (3,320)

Accrued expenses (744)

Net cash provided by operating activities (2,131)

Cash flows for investing activities:

Purchases of property, plant and equipment (1,736)

2

Purchase of short-term investments (802)

Net cash provided by investing activities (2,536)

Cash flows from financing activities:

Purchase of treasury stock (2,729)

Proceeds from issuance of stock 5,698

Net cash used in financing activities 2,969

Net increase (decrease) in cash & cash equivalents (1,698)

Cash & cash equivalents at beginning of period 63,147

Cash & cash equivalents at end of period 61,449$

CONSOLIDATED STATEMENT OF CASH FLOWS

THE BOSTON BEER COMPANY, INC.

Proceeds from disposal of property,

plant & equipment

Boston

Beer uses

the indirect

method.

The indirect

method is

used by

98.3% of

companies.

This ending cash

balance should

agree with the

balance sheet.

Relationships to the Balance Sheet and the Income Statement

Information needed to prepare a

statement of cash flows:

Comparative Balance Sheets.

Income Statement.

Additional details concerning

selected accounts.



Cash = Liabilities Stockholders’

Equity Noncash Assets

Derives from . . .

Assets = Liabilities Stockholders’ Equity


Category Transactions Cash Effect Other Account Affected

Operating Collect accounts receivable +Cash -Accounts Receivable (A)

Pay accounts payable -Cash -Accounts Payable (L)

Prepay rent -Cash +Prepaid Rent (A)

Pay interest -Cash -Retained Earnings (SE)

Sale for cash +Cash +Retained Earnings (SE)

Investing Purchase equipment for cash -Cash +Equipment (A)

Sell investment securities for cash +Cash -Investments (A)

Financing Pay back debt to bank -Cash -Notes Payable-Bank (L)

Issue stock for cash +Cash +Common Stock and

Paid-in-Capital (SE)

Selected Cash Transactions and Their Effect on Other Balance Sheet Accounts


Reporting Cash Flows from Operating Activities—Indirect Method

Net

Income

Cash Flows

from Operating

Activities -

Indirect Method

+/- Changes in current

assets and current

liabilities.

+ Losses and

- Gains

+ Noncash

expenses such as

depreciation and

amortization.

The indirect method adjusts net income by eliminating

noncash items.


Use this table when adjusting Net Income

to Operating Cash Flows using the

indirect method.

Change in Account Balance During Year

Increase Decrease

Current Subtract from net Add to net income.

Assets income.

Current Add to net income. Subtract from net

Liabilities income.



Adjustment for Gains and Losses

Gains Gains must be subtracted from net

income to avoid double counting the

gain.

Losses Losses must be added to net income

to avoid double counting the loss.

Transactions that cause gains and losses should be

classified on the cash flow statement as operating,

investing, or financing activities, depending on their

dominate characteristics. For example, if the sale of

equipment produced a gain, it would be classified as an

investing activity.



Use the following

financial statements

for The Boston Beer

Company and prepare

the Statement of Cash

Flows for the quarter

ended on

March 31, 2007


(Unaudited) March 31, Dec. 30,

In Thousands 2007 2006 Changes

ASSETS

Current assets:

Cash & cash equivalents 61,449$ 63,147$ (1,698)

Short-term investments 20,025 19,223 802

Accounts Receivable 19,737 17,770 1,967

Inventories 18,951 17,034 1,917

Prepaid expenses 4,398 2,721 1,677

Total current assets 124,560 119,895

Equipment, net 31,887 31,879 8

Total assets 156,447$ 151,774$

LIABILITIES & STOCKHOLDERS' EQUITY

Current liabilities:

Accounts payable 14,622$ 17,942$ (3,320)

Accrued expenses 22,184 22,928 (744)

Total current liabilities 36,806 40,870

Stockholders' Equity:

Contributed capital 84,206 81,237 2,969

Retained earnings 35,435 29,667 5,768

Total stockholders' equity 119,641 110,904

Total liabs & stockholders' equity 156,447$ 151,774$


CONSOLIDATED BALANCE SHEET

(Unaudited) Three months ended

In Thousands March 30, 2007

Net sales 72,448$

Cost of sales 32,126

Gross profit 40,322

Operating expenses:

Selling, general and administrative 30,078

Depreciation and amortization 1,726

Total operating expenses 31,804

Operating income 8,518

Interest income 1,132

Income before provision for income taxes 9,650

Provision for income taxes 3,882

Net income $5,768

THE BOSTON BEER COMPANY, INC.CONSOLIDATED STATEMENT OF INCOME

The Statement of Cash Flows will begin

with Boston Beer’s Net income from the

Income Statement.

Step 1

Adjust net income for depreciation

and amortization expense.

(Remember, we showed the comparative balance sheets a

few slides earlier.)

Step 2

Adjust net income for changes in

current assets and

current liabilities.

Change in Account Balance During Year

Increase Decrease

Current Subtract from net Add to net income.

Assets income.

Current Add to net income. Subtract from net

Liabilities income.


Interpreting Cash Flows from Operating Activities

Accounts

Receivable

Changes

Managers sometimes attempt to

boost declining sales by extending

credit terms or by lowering credit

standards. The resulting increase in

accounts receivable can cause net

income to outpace cash flows from

operations.

Inventory

Changes

Inventory growth can be a sign that

planned sales growth did not

materialize. A decline in inventory

can be a sign that the company is

anticipating lower sales in the next

quarter.


Quality of Income Ratio

In general, this ratio measures the portion of income that was generated in cash. All other things equal, a higher quality of income ratio indicates greater ability to finance operating

and other cash needs from operating cash inflows.

Cash Flow from Operating Activities

Net Income

Quality of

Income Ratio =




ASSETS

Current assets:




Inventories 18,951 17,034 1,917




Total assets 156,447$ 151,774$













Let’s focus

on the

investing

accounts.

The balance sheet

indicates that

Equipment increased

by $8 during the

quarter.

If you had access to

additional company

information, you

would discover that

the company

purchased $1,736 of

new equipment and

sold old equipment at

its book value of $2.

This is offset by $1,726

in depreciation

expense (see the Cash

Flows from Operating

Activities).




Net income 5,768$



Depreciation 1,726



Inventory (1,917)







2













plant & equipment

Short-term

investments

increased by

$802 during the

quarter.

Although

short-term

investments is

a current asset,

it is reported in

the investing

section on the

statement of

cash flows.




Net income 5,768$



Depreciation 1,726



Inventory (1,917)







2













plant & equipment


Capital Acquisitions Ratio

In general, this ratio reflects the portion of purchases of property, plant and equipment financed from operating

activities. A high ratio indicates less need for outside financing for current

and future expansions.

Cash Flow from Operating Activities

Cash Paid for Property, Plant,

and Equipment

Capital

Acquisitions

Ratio

=


Free Cash Flow

In general, this measures a firm’s ability to pursue long-term investment opportunities.

Cash Flow from Operating Activities – Dividends –

Capital Expenditures




ASSETS

Current assets:




Inventories 18,951 17,034 1,917




Total assets 156,447$ 151,774$













Let’s focus

on the

financing

account.

The net increase in

Contributed Capital of

$2,969 was caused by

two transactions.

First, Boston Beer

repurchased $2,729 of

outstanding stock,

which is a cash

outflow.

Second, the company

issued common stock

to employees for

$5,698, which is a cash

inflow.




Net income 5,768$



Depreciation 1,726



Inventory (1,917)







2













plant & equipment


Interpreting Cash Flows from Financing Activities

The long-term growth of a company is normally

financed from three sources: internally

generated funds, the issuance of stock, and

money borrowed on a long-term basis.

The statement of cash flows 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.


Required Supplemental Information

1. Reconciliation of net income to cash flow

from operations.

2. Cash paid for income taxes and interest.

3. Significant noncash investing and

financing activities.

Additional Cash Flow Disclosures

Significant noncash investing and financing

transactions do not involve cash. Example: Purchase of a building with a mortgage.

Supplement A: Reporting Cash Flows from Operating Activities—Direct Method

Sales revenue

+ Decrease in accounts receivable

- Increase in accounts receivable

= Cash collected from customers

Interest/Dividend revenue

+ Decrease in interest/dividends

receivable

- Increase in interest/dividends

receivable

= Collections of interest/dividends

on investments

Cost of goods sold

+ Increase in inventory

- Decrease in inventory

- Increase in accounts payable

+ Decrease in accounts payable

= Cash payments to suppliers

Other expenses

+ Increase in prepaid expenses

- Decrease in prepaid expenses

- Increase in accrued expenses

+ Decrease in accrued expenses

= Cash paid for expenses

Income tax expense

+ Increase in prepaid income taxes

- Decrease in prepaid income taxes

- Increase in income taxes payable

+ Decrease in income taxes payable

= Payments of income taxes

(Unaudited) Three months ended

In thousands March 31, 2007


Cash collected from customers 70,481$

Cash collected from interest 1,132

Cash payments to suppliers (37,363)

Cash payments for expenses (32,499)

Cash payments for income taxes (3,882)

Net cash provided by operating activities (2,131)$



Remember that when we prepared the operating section using the indirect method, we also arrived at net cash inflow of $2,131.


Supplement B: Spreadsheet Approach

The spreadsheet approach offers a

systematic way to keep track of data. A

spreadsheet is organized as follows:

1. Four columns to record dollar amounts are

established (beginning balance, debit changes, credit

changes, and ending balance).

2. On the far left of the top half of the spreadsheet,

each account name from the balance sheet is

entered.

3. On the far left of the bottom half of the spreadsheet,

the name of each item that will be reported on the

statement of cash flows is entered.

After entering

all the

transactions

illustrated in

the textbook,

this is what the

spreadsheet

looks like.

Dec. 30, 2006 Debits Credits Mar. 31, 2007

Balance Sheet

Assets:

Cash and equivalents 63,147 (n) 1,698 61,449

Short-term investments 19,223 (k) 802 20,025

Accounts receivable 17,770 (d) 1,967 19,737

Inventories 17,034 (e) 1,917 18,951

Prepaid expenses 2,721 (f) 1,677 4,398

Equipment, net 31,879 (i) 1,736 (b) 1,726 31,887

(c) 2

Accounts payable 17,942 (g) 3,320 14,622

Accrued expenses 22,928 (h) 744 22,184

Contributed capital 81,237 (l) 2,729 (m) 5,698 84,206

Retained earnings 29,667 (a) 5,768 35,435

Statement of Cash Flows Subtotals


Net income (a) 5,768

Adj. to reconcile net income to net cash


Depreciation and amortization (b) 1,726


Accounts receivable (d) 1,967

Inventory (e) 1,917

Prepaid expense (f) 1,677

Accounts payable (g) 3,320

Accrued expenses (h) 744



Proceeds from sale of equipment (c) 2

Purchases of property, plant and equipment (i) 1,736

Purchase of short-term investments (k) 802



Purchase of treasury stock (l) 2,729

Proceeds from issuance of stock (m) 5,698


Net decrease in cash & cash equivalents (n) 1,698

Totals

29,784 29,784 (1,698)

BOSTON BEER COMPANY

Changes

Inflows Outflows

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