Chapter 11

The three primary categories of cash flow

1) cash flow from operating activities 2) cash flows from investing activities 3) cash flows from financing activities

Steps in preparing a statement of cash flows

1) determine the change in each balance sheet account 2) identify the cash flows category/categories to which each account relates 3) create schedules that summarize the operating, investing, and financing cash flows

The best measurement of a company's profitability

Accrual-based net income

The following financial statements provide useful information that helps financial statement users to forecast a company's cash generating potential:

Balance sheet and Income Statement

Cash flows: operating activities

Cash inflows: 1) sale of goods or services for cash 2) receipt of interest and dividends 3) payment of salaries Ex: collection on from customers, interest received on notes receivable, receipt of interest Cash outflows: 1) purchase of inventory 2) for operating expenses 3) for interest 4) for income taxes 5) collection/payment on account Ex: payment on salary, payment on account, purchase of supplies, interest paid on bonds

The two generally accepted forms for preparing the statement of cash flows for U.S. GAAP are:

Direct and indirect methods

Loss on sale of land

Gains on the sale of long-term assets increase net income, while losses on the sale of those assets decrease net income.

The statement of cash flows provides summary info about cash:

Inflows and outflows

Net cash flow from financing activities

Issue common stocks/borrow from bank-pay dividend-repay loan from bank

Cash flows to sales

Measures the operating cash flows generated for each dollar of sales

Asset turnover

Measures the sales revenue generated per dollar of assets

Cash basis

Revenues when we receive cash and expenses when we pay cash.

Detailed accounting records: Statement of Cash Flows

Sometimes we need additional information from the accounting records to determine specific cash inflows or cash outflows for the period.

Balance sheet

We look at the change an asset, liability, and stockholders equity accounts from the end of the last period to the end of this period to find cash flows from operating investing and financing activities. Ex: assets, liabilities, and stockholders' equity

Accrual basis

We report revenues when we earn them regardless of when cash is received and expenses when we incur them, regardless of when cash is paid.

Cash Flows: Financing Activities

Cash Inflows: 1) Issuance of bonds or notes payable 2) issuance of stock Ex: issuing stock to investors for cash, barring from bank Cash Outflows: 1) Repayment of bonds or notes payable 2) Reacquisition of stock ( treasury stock) 3) Payments of dividends. Ex: repayment of note payable, payments of dividends, repay borrowing from bank

Cash flows: Investing Activities

Cash Inflows: 1) sale of investments 2) sale of long term assets 3) collection of notes receivable Ex: sale of equipment, sale of building, and sale of held-to-maturity investments Cash Outflows: 1) purchase of investments 2) purchase of long term assets 3) lending with notes receivable Ex: purchase of available-for-sale securities, purchase of lands, purchase of long-term investments, purchase of buildings

Operating activities

Include cash receipts and cash payments for tramsactions relating to revenue amd expense activities These activities are reported on the income statement Cash flows from operating activities include the elements of net income but reported on a cash basis Decrease in accounts payable represents a cash outflow Increase in accounts payable represents a cash inflow Examples: collection of cash from customers or the payments of cash for inventory purchases, salaries, and rent

Financing activities

Include inflows and outflows of cash resulting from external financing of a business Major parts of companies come from external sources, specifically stockholders and lenders. Repayment of formal long term debt contracts Examples: borrowing and repaying debt, issuing and repurchasing stock, paying dividends, repayment of a long term loan, payment of cash dividends, sale of the company's common stock, issuance of bonds, repurchasing company's own common stock

Investing activities

Include transactions involving the purchase and sale of long-term assets and current investments. Companies periodically invest cash to replace or expand productive facilities such as buildings land and equipment Companies. Ay also invest in other assets such as stocks or bonds of other companies expecting a return on those investments. Examples: the purchases and sale of a long-term asset and investments

Return on assets formula

Net income divided by average total assets

Income Statements

The income statement provides important information in determining cash flows from operating activities. Ex: revenues and expenses

Direct method

We adjust the items on the income statement to directly show the cash inflows and outflows from operations such as cash received from customers and cash paid for inventory salaries rent interest and taxes. Reports cash received and cash paid from operating activities

Indirect method

We began with net income and then list adjustments to net income, in order to arrive at operating cash flows. The indirect method is more popular because it is generally easier and less costly to repair. All major companies in the US prepare the steam in cash flows using the indirect method.