Ch 12- Statement of Cash Flows

Statement of cash flows

A basic financial statement that provides information about the cash receipts and cash payments of an entity during a period, classified as operating, investing, and financing activities, in a format that reconciles the beginning and ending cash balances.

Direct method

A method of determining net cash provided by operating activities by adjusting each item in the income statement from the aural basis to the cash basis. The direct method shows operating cash receipts and payments.

Indirect method

A method of preparing a statement of cash flows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities.

Product life cycle

A series of phases in a product's sales and cash flows over time. These phases, in order of occurrence, are introductory, growth, maturity, and decline.

Changes in Current Liabilities

Add to net income increases in current liability accounts, and deduct from net income decreases in current liability accounts, to arrive at net cash provided by operating activities.

Financing activities

Cash flow activities that include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

Investing activities

Cash flow activities that include (a) transactions that involved the purchase or disposal of investments and property, plant, and equipment using cash, and (b) lending money and collecting the loans.

Operating activities

Cash flow activités that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income.

Cash Payments to Suppliers

Cost of Goods Sold +/- Inventory +/- Accounts Payable + Increase in inventory or - Decrease in Inventory + Decrease in Accounts Payable or - Increase in Accounts Payable

Changes in Noncash Current Assets

Deduct from net income increases in current asset accounts, and add to net income decreases in current asset accounts, to arrive at net cash provided by operating activities.

Use the statement of cash flows to evaluate a company

During the introductory stage, net cash provided by operating activities and net cash provided by investing activities are negative, and net cash provided by financing activities are positive. During the growth stage, net cash provided by operating activities becomes positive but is still not sufficient to meet investing needs. During the maturity stage, net cash provided by operating activities exceeds investing needs, so the company beings to retire debt. During the decline stage, net cash provided by operating activities is reduced, net cash provided by investing activities becomes positive (from selling off assets), and net cash provided by financing activities becomes more negative. Free cash flow indicates the amount of cash a company generated during the current year that is available for the payment of dividends or for expansion.

Cash Payments for Income Taxes

Income Tax Expense +/- Income Taxes Payable + Decrease in Income Taxes Payable or - Increase in Income Taxes Payable

Free Cash Flow

Net Cash Provided by Operating Expenses - Capital Expenditures - Cash Dividends

Net Cash Provided/ Used by Operating Activities

Net Income +/- Adjustments Adjustments = Add back non cash expenses (such as depreciation expense and amortization expense), Deduct gains and add losses (that resulted from investing and financing activities), Analyze changes (to non cash current asset and current liability accounts)

Free cash flow

Net cash provided by operating activities after adjusting for capital expenditures and cash dividends paid.

Cash Payments for Operating Expenses

Operating Expenses +/- Prepaid Expense +/- Accrued Expenses Payable + Increase in Prepaid Expense or - Decrease in Prepaid Expense + Decrease in Accrued Expenses Payable or - Increase in Accrued Expenses Payable

Cash Receipts from Customers

Sales Revenue +/- Accounts Receivable + Decrease in Accounts Receivable or - Increase in Accounts Receivable

Prepare a statement of cash flows using the indirect method

The preparation of a statement of cash flows involves three major steps. (1) Determine net cash provided/ used by operating activities by converting net income from an accrual basis to a cash basis. (2)Analyze changes in non-current asset and liability accounts and record as investing and financing activities, or disclose as non-cash transactions. (3) Compare the net change in cash on the statement of cash flows with the change in the Cash account reported on the balance sheet to make sure the amounts agree.

Prepare a statement of cash flows using the direct method

The preparation of the statement of cash flows involves three major steps. (1) Determine net cash provided/ used by operating activities by converting net income form an accrual basis to a cash basis. (2) Analyze changes in non-current asset and liability accounts and record as investing and financing activities, or disclose as non cash transactions. (3) Compare the net change in cash on the statement of cash flows with the change in the Cash account reported on the balance sheet to make sure the amounts agree. The direct method reports cash receipts less cash payments to arrive at net cash provided by operating activities.

Discuss the usefulness and format of the statement of cash flows

The statement of cash flows provides information about the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during the period. Operating activities include the cash effects of transactions that enter into the determination of net income. Investing activities involve cash flows resulting from changes in investments and long-term asset items. Financing activities involve cash flows resulting from changes in long-term liability and stockholders' equity items.

Use the T-account approach to prepare a statement of cash flows

To use T-accounts to prepare the statement of cash flows: (1) prepare a large Cash T-account with sections for operating, investing, and financing activities; (2) prepare smaller T-accounts for all other non cash accounts; (3) insert beginning and ending balances for all accounts; and (4) follows the steps listed for -preparing a statement of cash flows using the direct method- for entering debit and credit amounts as needed.