Reimers 2006 Chap 11
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Transcript of Reimers 2006 Chap 11
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THE STMT OF CASH FLOWS (1of 2)
Learning objectives
Categories of cash flows
Accrual-basis accounting vs. cash-basis accounting
Overview of statement of cash flowsStatement of cash flowsindirect
method
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THE STMT OF CASH FLOWS (2of 2)
Cash flows from operating activitiesdirect method
Cash flows from investing and financingactivities
Preparing the statement of cash flowsFinancial statement analysis
Business risk, control, and ethics
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Learning Objectives(1 of 4)
Categorize cash flows as operating,investing, or financing cash flows
Explain the difference betweenaccrual-basis and cash-basis
accountingExplain the difference between the
two methods of preparing and
presenting the statement of cash
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Learning Objectives(2 of 4)
Compute cash from operating activitiesusing the indirect method
Compute cash from operating activitiesusing the direct method
Compute cash from investing activitiesand cash from financing activities
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Learning Objectives(3 of 4)
Prepare a complete statement ofcash flows and know the requiredsupplemental disclosures
Use the statement of cash flows to
help evaluate a firms past andfuture performance
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Learning Objectives(4 of 4)
Identify the risk of investing in agiven firm by using the statement ofcash flows and the related controls
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Categories of Cash Flows(1 of 3)
Cash flow
Inflows and outflows that result fromtransactions
Cash account must increase ordecrease
Operating activities
Cash receipts and cash
disbursements from revenues andex enses
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Categories of Cash Flows(2 of 3)
Investing activities
Cash receipts and disbursements thatresult from purchasing or selling long-term assets or investments in otherfirms
Financing activities
Cash receipts and disbursements fromlong-term debt and equity transactions
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Categories of Cash Flows(3 of 3)
Financing activities (continued)Debt
Issuing debtRepaying debt
Interest expense results from financingactivities because it arises from debt financing.
Why is it reported in the operating section?EquityReceiving contributions from owners
Paying dividends to owners
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Accrual-basis Accounting vs.Cash-basis Accounting (1 of 2)
Must convert from accrual-basisaccounting (GAAP) to cash-basisaccounting to prepare statement ofcash flows
Accrual-basis accountingRevenues recorded when earned and
expenses recorded when incurred
Timing of cash receipt is irrelevant
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Accrual-basis Accounting vs.Cash-basis Accounting (2 of 2)
Cash-basis accountingRevenues recorded when cash received
and expenses recorded cash paidTiming of revenue and expense recognition is
irrelevant
Convert from accrual basis to cashbasisAccounts payable (assume for inventory)Beg bal $1,200; End bal $400; purch $36,300Compute cash paid
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Overview of theStatement of Cash Flows (1 of 3)
Operating activities
Direct method
Cash inflows and outflows explicitlyidentified
Analyzes every item on income statement
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Overview of theStatement of Cash Flows (2 of 3)
Operating activities (continued)Indirect methodReconciles net income and cash flow
Starts with net income
Makes adjustments for income statement
items that do not affect cashAdjust for changes in current assets and
current liabilities
Ends with net cash flow
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Overview of theStatement of Cash Flows (3 of 3)
Investing and financing activities
Same presentation for both direct andindirect methods
Cash flows for each activity directlyidentified
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Statement of Cash FlowsIndirect Method
Used by 90% of companies. Why?
Financial statements needed
Current year income statement
Beginning and ending balance sheet
Steps to calculate operating cashflows
Cash flow indirect method example
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Steps to Calcu late Operat ing
Cash Flows(1 of 2)
1. Start with net income
2. Add back non-cash expenses suchas depreciation Undo the effect of non-cash expenses
3.Adjust for changes in current assets Increase (decrease) in account should
be subtracted from (added to) netincome to arrive at cash balance.Why?
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Steps to Calcu late Operat ing
Cash Flows(2 of 2)
4. Adjust for changes in currentliabilities Increase (decrease) in account should
be added to (subtracted from) netincome to arrive at cash balance. Why?
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Cash Flow Ind irec t Method
Example(1 of 4)
Sales Revenues 500,000$
Cost of Goods Sold 284,000
Gross M argin 216,000Depreciation Expense 50,000$
Interest Expense 5,000
Salary Expense 105,000 160,000N et Income 56,000$
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Cash Flow Ind irec t Method
Example(2 of 4)
Beginning Ending
Cash 37,500$ 75,000$
Accounts Receivable, net 17,000 13,000
Inventory 27,000 20,000Prepaid Insurance - 12,000
Prepaid Rent 28,000 4,000
Total Current Assets 109,500 124,000
Equip, net of $75K & $125K Accum Depr 175,000 193,000
Total Assets 284,500$ 317,000$
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Cash Flow Ind irec t Method
Example(3 of 4)
Beginning Ending
Accounts Payable 9,000$ 4,250$
Unearned Revenue 4,375 3,125Interest Payable 1,500 4,000
Total Current Liabilities 14,875 11,375
Long-term Notes Payable 40,000 15,000
Common Stock 40,000 45,000Retained Earnings 189,625 245,625
Total Liabilities and Equity 284,500$ 317,000$
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Cash Flow Ind irec t Method
Example(4 of 4)
+ / -
N et income
Depreciation expense
Decrease in accounts receivableDecrease in inventory
Increase in prepaid insurance
Decrease in prepaid rent
Decrease in accounts payable
Decrease in unearned revenue
Increase in interest payable
N et cash from operating activities
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Cash Flows from OperatingActivitiesDirect Method (1 of 6)
Changing revenues from accrualbasis to cash basis
Accounts receivable
Beginning balance (balance sheet)
+ Sales (income statement)
- Cash collected from customers(compute)
Ending balance (balance sheet)
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Cash Flows from OperatingActivitiesDirect Method (2 of 6)
Changing expenses from accrualbasis to cash basis
Cost of goods sold
Inventory account
Beginning inventory (balance sheet)
+ Purchases (compute)
- Cost of goods sold (income statement)
Ending balance (balance sheet)
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Cash Flows from OperatingActivitiesDirect Method (3 of 6)
Cost of goods sold (continued)
Accounts payable
Beginning balance (balance sheet)+ Purchases (from inventory computation)
- Cash paid to vendors (compute)
Ending balance (balance sheet)
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Cash Flows from OperatingActivitiesDirect Method (4 of 6)
Changing expenses from accrualbasis to cash basis (continued)
Rent expense
Prepaid rent
Beginning balance (balance sheet)
+ Cash paid for rent (compute)
- Rent expense (income statement)
Ending balance (balance sheet)
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Cash Flows from OperatingActivitiesDirect Method (5 of 6)
Changing expenses from accrualbasis to cash basis (continued)
Interest expense
Interest payable
Beginning balance (balance sheet)
+ Interest expense (income statement)
- Cash paid for interest (compute)
Ending balance (balance sheet)
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Cash Flows from OperatingActivitiesDirect Method (6 of 6)
Use the information provided earlier
Cash collected from customers
Cash paid to vendors
Cash paid to employees
Cash paid for insurance
Cash paid for rent
Cash paid for interest
N et cash from operating activities
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Cash Flows from Investingand Financing Activities (1 of 3)
Investing cash flows
Equipment purchases/disposals
require the following accountsAsset account (beg & end)
Accumulated depreciation (beg & end)
Depreciation expense (current)
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Cash Flows from Investingand Financing Activities (2 of 3)
Financing cash flowsDebt financingNeed to analyze changes in long-term
liability accounts
Equity financing
Additional capital contributionsCommon and preferred stock accounts
DividendsRetained earnings and current net income
C f
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Cash Flows from Investingand Financing Activities (3 of 3)
Use the information provided earlier
Investing Activities
Purchase of equipment
N et cash used by investing activities
Financing Activities
Repayment of note payable
Proceeds from issue of new stock
N et cash used by financing activities
P i h S f
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Preparing the Statement ofCash Flows (1 of 3)
Prepare operating, investing, andfinancing sections
Supplementary disclosuresNoncash financing and investing
activities
Cash paid for interest expense andincome taxesBroken out in supplementary disclosures
because usually part of subtotals
P i th St t t f
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Preparing the Statement ofCash Flows (2 of 3)
Add beginning cash to sum ofoperating, investing, and financing
activities to get ending cash balanceReconciles cash account on balance
sheet
Which financial statement is easier tomanipulate, the statement of cash
flows or the income statement? Why?
P i th St t t f
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Preparing the Statement ofCash Flows (3 of 3)
Use the information provided earlier
N et cash provided by operations
N et cash used by investing activities
N et cash used by financing activities
Cash at beginning of year
Cash at end of year
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Financial Statement Analysis
Using cash flows to evaluateperformance
Free cash flow
Cash flow adequacy ratio
Cash needed to pay current liabilities
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Free Cash Flow
Net cash from operating activities
- Cash dividends
- Capital expenditures _
Free cash flow
Why does a company need positivefree-cash flow?
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Cash Flow Adequacy Rat io
Measures the firms ability to generate
enough cash from operating activities
to pay for its capital expendituresNet cash from operating activities _
Cash required for investing activities
Cash required for investing activities
Cash paid for capital expenditures andacquisitions minus cash proceeds from disposal
of capital assets
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Cash Needed to Pay Cur ren t
Liabi l i t ies(1 of 2)
Current cash debt coverage ratio
Measures a firms ability to generate the
cash it needs in the short-run
A liquidity measure
Net Cash Provided by OperationsAverage Current Liabilities
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Cash Needed to Pay Cur ren t
Liabi l i t ies(2 of 2)
How does current cash debt coverageratio differ from other liquidity
measures previously discussed?Current ratioQuick ratio
Working capital
B i Ri k C t l d
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Business Risk, Control, andEthics
Investors risks associated with
statement of cash flows
Investors look for positive cash flowsfrom operations
How could a company manipulate
operating cash flows?
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Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorados
Kenneth W. Monfort College of [email protected] 11-
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