ACCT 4A(14.1-14.2)

Cash Flows From Operating Activities

When using the indirect method, the statement of cash flows operating activities section begins with net income (or net loss) because revenues and expenses, which affect net income, produce cash receipts and cash payments. - income statement is accrual-based, and the cash flows (cash basis net income) do not always equal the accrual basis revenues and expenses. For example, sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. Accrued expenses decrease net income, but the company has not paid cash if the expenses are accrued. The Statement of Cash flow purely focuses on cash. On the cash that you have available to waste, and the cash that you simply do not have available to waste. To go from net income to net cash flow from operating activities, we must make some adjustments to net income on the statement of cash flows. These additions and subtractions follow net income and are labeled Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities.

Cash Flows from Investing Activities

When computing investing cash flows, it is helpful to evaluate the T-accounts for each long-term asset. The T-account will show if there was an acquisition or disposal that happened during the year. The beginning and ending balances for each account are taken directly from the comparative balance sheet. Depreciation expense has been included in the Accumulated Depreciation account, and this was taken from the income statement.

Net Change in Cash and Cash Balances 2

After this, we then take into account the cash balance at the beginning of the period. Analyze the image.

Cash Flows from Financing Activities 1

Financing activities affect the long-term liability and equity accounts, such as Long-term Notes Payable, Bonds Payable, Common Stock, and Retained Earnings. To determine the cash flows from financing activities, we need to review each of these account types.

Financing Activities

Financing activities include cash inflows and outflows involved in long-term liabilities and equity. This includes issuing stock, paying dividends, and buying and selling treasury stock. It also includes borrowing money and paying off long-term liabilities such as notes payable, bonds payable, and mortgages payable.

Evaluating Cash Flows from Operating Activities

Notice how when we are using the indirect method, we always begin by listing down what the Accrual Basis Net Income is. From there you are simply making all of the necessary adjustments.

Know These Adjustments(for test)

Look at image, and place this in your cheat sheet.

Cash Flows from Investing Activities 3

Notice in the image how all cash relating to the purchase and disposal of a Plant Asset is taken into consideration.

Two Formats For Operating Activities

- The indirect method starts with net income and adjusts it to net cash provided by operating activities. - The direct method restates the income statement in terms of cash. The direct method shows all the cash receipts and all the cash payments from operating activities. The indirect and direct methods use different computations but produce the same amount of net cash flow from operating activities. Both methods present investing activities and financing activities in exactly the same format. Only the operating activities section is presented differently between the two methods. here we focus on the indirect method.

Cash Flows from Financing Activities 3(Common Stock&Treasury Stock)

Cash flows for financing activities are also determined by analyzing the stock accounts. For example, the amount of new issuances of stock is determined by analyzing the stock accounts and reviewing the additional information provided: - this is because you can receive cash from issuing stock and you can lose cash when you as the company purchase your own stock.

Non-Cash Investing and Financing Activities

Companies do make investments that do not require cash. They also obtain financing that does not involve cash. Such transactions are called non-cash investing and financing activities. Examples of these activities include the purchase of equipment financed by a long-term note payable or the contribution of equipment by a stockholder in exchange for common stock. These activities are not included in the statement of cash flows. Instead, they appear either as a separate schedule at the bottom of the statement or in the notes to the financial statements.

Gains and Losses on the Disposal of Long-term Assets

Disposals of long-term assets such as land and buildings are investing activities, and these disposals usually create a gain or a loss. The gain or loss is included in net income, which is already in the operating activities section of the statement of cash flows. The gain or loss must be removed from net income on the statement of cash flows so the total cash receipts from the sale of the asset can be shown in the investing activities section. - in other words, you are taking this out from the net income because you'd want to list these gains under "Investing Activities," not "Operating Activities."

Each Section Affects the Balance Sheet Differently

Each section of the statement of cash flows affects a different part of the balance sheet. The operating activities section reports on how cash flows affect the current accounts—current assets and current liabilities. Investing activities affect the long-term assets. And the financing activities affect long-term liabilities and equity. Exhibit 14-1 shows the relationship between operating, investing, and financing cash flows and the various parts of the balance sheet.

Changes in Current Assets and Current Liabilities

Most current assets and current liabilities result from operating activities. For example: - Accounts receivable result from sales. - Merchandise inventory relates to cost of goods sold, and so on. Changes in the current asset and current liability accounts create adjustments to net income on the statement of cash flows, as follows: - An increase in a current asset other than cash causes a decrease adjustment to net income. For example, ShopMart's balance sheet in Exhibit 14-3 shows that Accounts Receivable increased by $17,000. Accounts Receivable is increased when the company makes sales on account and decreases when the company collects cash from customers. Therefore, there were more sales on account (revenue earned and reported on the income statement) than cash collections, the amount we want to reflect on the statement of cash flows. Because the indirect method of accounting for operating activities begins with net income, subtract the $17,000 increase in the current asset Accounts Receivable to adjust accrual-based net income to net cash flows provided by operating activities. - A decrease in a current asset other than cash causes an increase adjustment to net income. ShopMart's Merchandise Inventory decreased by $2,000. What caused the decrease? ShopMart must have sold more merchandise inventory than it purchased. Therefore, we add the decrease in Merchandise Inventory of $2,000 to net income on the statement of cash flows. - An increase in a current liability causes an increase adjustment to net income. ShopMart's Accounts Payable increased by $40,000. This means there were more purchases on account than cash paid for the purchases, resulting in an increase to the liability. Accordingly, even though net income was reduced by the expense, cash was not reduced as much. Therefore, an increase in a current liability is added to net income in the statement of cash flows. - A decrease in a current liability causes a decrease adjustment to net income. Decreases in current liabilities have the opposite effect of increases. The payments of the current liabilities were more than the accrual of the expenses. Therefore, we subtract decreases in current liabilities from net income to get net cash flow from operating activities. ShopMart's Accrued Liabilities decreased by $5,000. That change shows up as a $5,000 decrease adjustment to net income.

Cash Flow from Financing Activities 4(Dividend Payments)

The amount of dividend payments can be computed by analyzing the Retained Earnings account. The equation we use to calculate this, is the following: Ending Retained Earnings=(Beginning Retained Earnings)+(Net Income)-(Net Loss)-(Dividends) In order for the cash dividends to be reported on the statement of cash flows, the company must have paid the dividends. And this is cash outflow. So, if you know the balances of "Beginning Retained Earnings," "Ending Retained Earnings," and "Net Income/Loss," you can actually solve for the amount of cash that was used for Dividends.

Cash Flows from Financing Activities 2(Long Term Liabilities)

The beginning and ending balances of Notes Payable are taken from the comparative balance sheet. - take notice of the cash that is received by the company, and the payments of cash that the company makes. ONLY focus on cash. look at image. In the statement of cash flow, under "Financing Activities" you'll see cash being gained because of the notes payable, and cash outflow when the company is paying back because of the liability.

Non-cash Investing and Financing Activities

The last step in preparing the statement of cash flows is to prepare the non-cash investing and financing activities section. This section appears as a separate schedule of the statement of cash flows or in the notes to the financial statement. Examples of Non-Cash Transactions: Acquired $300,000 building by issuing common stock. Acquired $70,000 land by issuing notes payable. Retired $100,000 notes payable by issuing common stock. Because these did not include cash, they are reported separately, and NO cash account is affected by these transactions.

Purpose of The Statement Of Cash Flow

The statement of cash flows explains why net income as reported on the income statement does not equal the change in the cash balance. In essence, the statement of cash flows is the link between the accrual-based income statement and the cash reported on the balance sheet. It helps do the following: Predict future cash flows. Past cash receipts and payments help predict future cash flows. Evaluate management. Wise investment decisions help the business prosper, while unwise decisions cause the business to have problems. Investors and creditors use cash flow information to evaluate managers' decisions. Predict ability to pay debts and dividends. Lenders want to know whether they will collect on their loans. Stockholders want dividends on their investments. The statement of cash flows helps make these predictions.

Classification of Cash Flows

The three basic cash flow activities are the following: - Operating activities - Investing activities - Financing activities Each individual section reports cash inflows (cash receipts coming into the company) and cash outflows (cash payments going out of the company) based on these three divisions.

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities.

These adjustments include adding back non-cash expenses such as depreciation, depletion, and amortization expenses. These expenses are added back to net income to reconcile net income to net cash flow from operating activities. the thing is that these "expenses" are "fictionary" and do not require the paying of cash, therefore, these amounts are added back in order to show, that we still have THAT cash.

Statement of Cash Flow

This financial statement reports on a business's cash receipts and cash payments for a specific period. It does the following things: - Reports on the cash flows of a business—where cash came from (receipts) and how cash was spent (payments). - Reports why cash increased or decreased during the period. - Covers a span of time and is dated the same as the income statement—"Year Ended December 31, 2018," for example.

Operating Activities

This is the first and by far the most important section of the Statement of Cash Flow. The operating activities section reports on activities that create revenue or expense in the entity's business. It reflects the day-to-day operations of the business such as cash receipts (cash inflows) from customers for the sales of merchandise inventory and services and the cash payments (cash outflows) for purchases of merchandise inventory or payment of operating expenses. The operating activities section also includes cash receipts (cash inflows) for interest revenue and dividend income and cash payments (cash outflows) for interest expense and income tax expense. Deal with current assets and current liabilities.

Investing Activites

This section reports cash receipts and cash payments that increase or decrease long-term assets such as property, plant, equipment, notes receivable, and investments. It includes the cash inflow from selling and the cash outflow for the purchase of these long-term assets. In addition, it includes the lending (cash outflow) and collection (cash inflow) of long-term notes receivable. deals with long-term assets

Net Change in Cash and Cash Balances 1

To complete the statement of cash flows, the net change in cash and its effect on the beginning cash balance must be shown. This represents the total change in cash for the period and reconciles the statement of cash flows. First, the net increase or decrease in cash is computed by combining the cash provided by or used for operating, investing, and financing activities.(look at image)

Preparing the Statement of Cashflow(5 Steps)

To prepare the Statement of Cashflow, simply follow the following five steps: Step 1: Complete the cash flows from operating activities section using net income and adjusting for increases or decreases in current assets (other than cash) and current liabilities. Also adjust for gains or losses from long-term assets and non-cash expenses such as depreciation expense. Step 2: Complete the cash flows from investing activities section by reviewing the long-term assets section of the balance sheet. Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. Step 4: Compute the net increase or decrease in cash during the year. The change in cash is the key reconciling figure for the statement of cash flows and must match the change in cash reported on the comparative balance sheet. Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities. You use the Income Statement for Operating Activities The Balance Sheet is used for Investing Activities and Financing Activities.

What You Need To Prepare Statement of Cashflow

To prepare the statement of cash flows, you need the income statement for the current year, as well as the balance sheets from the current and prior years. In addition, you need to review the transactions for some additional information. Notice in the attached image, how the two Balance Sheets are compare.

Cash Flows from Investing Activities 2

We actually need to do some calculation in order to determine the inflow of cash when a Plant Asset is disposed of. The information you need, is the following: - Original Cost of Plant Asset - Accumulated Depreciation Up To Point of Sale - Gain/Loss