CASH FLOWS
to find out how a company is able to buy assets we look mainly at:
Financing section
STEPS TO PREPARE THE CASH FLOW STATEMENT (4)
STEP ONE: OPERATING STEP TWO: INVESTING STEP THREE: FINANCING STEP FOUR: NET INCREASE/DECREASE IN CASH
why is CF statement important? to whom does CF provide info to? how is it structured?
Since cash flows are vital to a company's financial health, the statement of cash flows provides useful information to management, investors, creditors, and other interested parties. The statement of cash flows classifies cash receipts and disbursements as operating, investing, and financing cash flows. Both inflows and outflows are included within each category
A short term notes payable from a bank..... which activity is it?
a financing activity
CF RELATIONSHIP WITH CURRENT LIABILITIES increase in ____ causes decrease in ___ ?? - accounts payable - accrued liability
accounts payable increases = cost of goods sold (cash basis) decreases (instead of paying cash, the purchase was made on credit) accrued liability (such as salaries payable) increases = related operating expense (salaries expense) on a cash basis decreases
What does "CASH" include?
both cash and cash equivalents EXAMPLES of cash equivalents: short-term investments in Treasury bills commercial paper money market funds
What has to be added back to "Net Income"? Why? Why is it deducted in the first place?
depreciation expense because "net income" is a starting point in gauging CFs in the indirect method (so dep. expense has to be added back to net income) (accountants remove depreciation when calculating net income- so in here it understates cash from operations) because the journal entry to record depreciation debits an expense account and credits an accumulated depreciation account -The transaction has no effect on cash and, therefore, should not be included when measuring cash from operations
FINANCING ACTIVITIES
generally include the cash effects (inflows and outflows) of transactions and other events involving creditors and owners. Cash inflows from financing activities include cash received from issuing capital stock and bonds, mortgages, and notes, and from other short- or long-term borrowing. Cash outflows for financing activities include payments of cash dividends or other distributions to owners (including cash paid to purchase treasury stock) and repayments of amounts borrowed.
INVESTING ACTIVITIES
generally include transactions involving the acquisition or disposal of noncurrent assets cash inflows include cash received from: (1) the sale of property, plant, and equipment (2) the sale of available-for-sale and held-to-maturity securities (3) the collection of long-term loans made to others Cash outflows: (1) to purchase property, plant, and equipment; (2) to purchase available-for-sale and held-to-maturity securities; (3) to make long-term loans to others
why & where does "payment of interest" appear on CF?
operating activities because interest expense appears on the income statement
WHAT'S the main purpose of the "Statement of Cash Flows"?
to report on the cash receipts and cash disbursements of an entity during an accounting period (reports the effects on cash during a period of a company's operating, investing, and financing activities)
How to do STEP TWO: INVESTING
use the balance sheet and any additional info provided. negative cash flow for investing, is that good or bad? if the company e.g. sold old equipment and purchased new equipment with CASH not with a loan (!) it is a good thing When analyzing this section, you really want to see the asset sold because you are purchasing new ones — it is not a good sign to sell assets without replacing them
Where do the 3 below accounts appear on CF (why?) ? Cash payments to settle: accounts payable wages payable income taxes payable
in the operating activities section because they are NOT financing activities
WHAT'S the difference between "direct" & "indirect" method?
The direct method converts each item on the income statement to a cash basis The indirect method adjusts net income for: changes in current assets (other than cash) current liabilities items that were included in net income but did not affect cash
CF RELATIONSHIP WITH CURRENT ASSETS when following increase... what decreases? - accounts receivable - inventory - prepaid expense
accounts receivable increases = sales revenue (cash basis) decreases inventory increases = cost of goods sold (cash basis) increases (increasing cash outflow) prepaid expense increases = related operating expense (cash basis) increases. (For example, a company not only paid for insurance expense but also paid cash to increase prepaid insurance.)
What effect does an increase in a current liability have on cash inflow & respectively cash outflow??
increases cash inflow or decreases cash outflow
What effect does an INCREASE in a current asset (other than cash) have on cash inflow or likewise cash outflow??
it DECREASES cash inflow or INCREASES cash outflow
OPERATING ACTIVITIES
generally include the cash effects (inflows and outflows) of transactions and other events that enter into the determination of net income Cash inflows from operating activities affect items that appear on the income statement and include: (1) cash receipts from sales of goods or services; (2) interest received from making loans; (3) dividends received from investments in equity securities; (4) cash received from the sale of trading securities; (5) other cash receipts that do not arise from transactions defined as investing or financing activities, such as amounts received to settle lawsuits, proceeds of certain insurance settlements, and cash refunds from suppliers.
How to do STEP THREE: FINANCING
For the financing section, we will use the balance sheet and the statement of retained earnings. On the balance sheet, we are looking at the notes payable - bank from the current liability section and any other long term liabilities. If these balances increased, we can assume we received cash and if the balances decreased, we can assume we paid on the debt unless we are given additional information on the subject. Notes Payable is the only liability we haven't already accounted for on the balance sheet. Next we look at the Equity section of the balance sheet. We have common stock, paid in capital and retained earnings. Common stock and paid in capital both increased — why does this account increase? It increases when we issue shares of common stock. We will assume Dells issued the stock for cash unless we are given additional information to the contrary. In our case, we are given no additional information so we will assume all increases or decreases involve cash. Lastly, we have retained earnings. What is involved in retained earnings? Let's look at the statement of retained earnings to find out. Retained earnings includes the beginning retained earnings + net income - dividends to get the ending retained earnings balance. What do we need for the statement of cash flows? We already accounted for net income in the operating section but we need to know dividends. We will assume cash dividends unless the information given tells us otherwise. In this case, it shows we paid cash dividends Now we know how Dells was able to purchase new equipment with cash, by issuing stock. This helped Dells in the current year but what about next year when they owe $90,000? We need to put all 3 sections together to finish the picture
CF FROM OPERATING ACTIVITIES (indirect method) * Net Income (plus of minus??) Depreciation Expense (from income statement) Losses (from income statement) Gains (from income statement) Amortization, depletion (from income statement) DECREASE in Current Assets (other than cash) INCREASE in Current Assets (other than cash) Increase in Current Liabilities Decrease in Current Liabilities (no plus or minus on account below) Net cash provided by Operating Activities
Net Income + Depreciation Expense (from income statement) + Losses (from income statement) - Gains (from income statement) + Amortization, depletion (from income statement) + DECREASE in Current Assets (other than cash) - INCREASE in Current Assets (other than cash) + Increase in Current Liabilities - Decrease in Current Liabilities Net cash provided by Operating Activities
How to do STEP ONE: OPERATING
STEP ONE: OPERATING We need net income, depreciation expense and any gains or losses (do not make this harder than it is — you must see the words "gain" or "loss" or do not consider it a gain or loss): Now we move on to the balance sheet for the CURRENT assets and liabilities. Notice the increase (or decrease) has already been calculated for you but if not you would take the current year amount - previous year amount. If the current year is more, there is an increase and if the current year is less that is a decrease. We will use the current assets (other than cash) and the current liabilities (other than the notes payable - bank which we will report in financing). Remember, we ADD decreases and SUBTRACT increases in current assets but in current liabilities we will ADD increases and SUBTRACT decreases. last: add the "net cash provided by operating activities" which tells us the company's ability (in $$$) to generate cash from its day to day business operations
How to do STEP FOUR: NET INCREASE/DECREASE IN CASH
The final part of the statement of cash flows is to calculate a Net Increase (or Decrease if negative) in Cash by adding the net cash from operating, investing and financing. Cash flows from Operating is $7,000 + Investing $(217,000) + Financing $160,000 which gives a net decrease in cash of $(50,000). We then take this increase (or decrease) and add it to the beginning cash balance (which is the previous year cash balance from the balance sheet) to get a calculate Ending Cash Balance which should agree to the cash balance reported on the balance sheet for the current year. We can always check our work with a built in check figure of ending cash! This last section would look like this: Net Increase (or Decrease) in Cash $ (50,000.00) Cash Balance, 2014 $ 80,000.00 ----------------- Cash Balance, 2015 $ 30,000.00
