MGMT 200 Chapter 11

Cash Flows from Investing Activities

Cash Inflows: Sale of investments Sale of long-term assets Collection of notes receivable Outflows: Purchase of investments Purchase of long-term assets Lending with notes receivable

Steps in Preparing the Statement of Cash Flows

Step 1. Calculate net cash flows from operating activities, using information from the income statement and changes in current assets (other than cash) and current liabilities from the balance sheet. Step 2. Determine the net cash flows from investing activities, by analyzing changes in long-term asset accounts from the balance sheet. Step 3. Determine the net cash flows from financing activities, by analyzing changes in long-term liabilities and stockholders' equity accounts from the balance sheet. Step 4. Combine the operating, investing, and financing activities, and make sure the total change from these three activities equals the amount of cash reported in the balance sheet this year versus last year (the change in cash).

Operating Activities—Indirect and Direct Methods

Using the indirect method, we begin 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 prepare. Using the 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. •Both methods report investing, financing, and noncash activities identically

Key Point

Using the indirect method, we start with net income and adjust this number for (1) revenue and expense items that do not affect cash, (2) gains and losses that do not affect operating cash flows, and (3) changes in current assets and current liabilities.

Operating Activities—Indirect Method

Adjustments to net income in calculating operating cash flows include the following: •Noncash items -Depreciation expense •Non-operating items -Gains and losses on sale of assets •Changes in current assets and current liabilities -Increase in accounts receivable is the amount of revenue reported in the income statement but not yet collected in cash

Cash Flows from Operating Activities

Cash inflows: sales and collections Outflows: purchase of inventory and payment of expenses and taxes

Information Sources for Preparing the Statement of Cash Flows

The three primary sources: 1.Income statement: Revenues and expenses provide information in determining cash flows from operating activities. 2.Balance sheet: We look at the change in 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. 3.Detailed accounting records: Sometimes we need additional information from the accounting records to determine specific cash inflows or cash outflows for the period.

Cash Flows from Financing Activities

Cash Inflows:Issuance of bonds or notes payable Issuance of stock Outflows: Repayment of bonds or notes payable Acquisition of treasury stock Payment of dividends Dividends received are included in operating activities. Dividends paid are included in financing activities.

Components of Cash Return on Assets

Cash Return on assets = cash flow to sales * asset turnover •Cash return on assets measures the operating cash flow generated per dollar of assets (operating cash flows/average total assets) •Cash flow to sales measures the operating cash flows generated for each dollar of sales (operating cash flows/net sales) •Asset turnover measures the sales revenue generated per dollar of assets (net sales/ average total assets)

Effects of Changes in Current Assets and Current Liabilities on Cash From Operating Activities

Increase in a current asset—decrease in cash Decrease in a current asset—increase in cash Increase in a current liability—increase in cash Decrease in a current liability—decrease in cash •Example: Accounts Receivable (current asset) increases; adjustment in Operating Activities is a decrease to cash.

Relationship of the Income Statement and Balance Sheet to the Statement of Cash Flows

Operating activities generally relate to income statement items and changes in current assets and current liabilities. Investing activities primarily involve changes in long-term assets. Financing activities primarily involve changes in long-term liabilities and stockholders' equity.

Convert Income Statement Items to Operating Cash Flows

Revenue: - increase in related current asset + decrease in related current asset + increase in related current liability - decrease in related current liability = cash received Expense: + increase in related current asset - decrease in related current asset - increase in related current liability + decrease in related current liability = cash paid

Statement of Cash Flows

The purpose of the statement of cash flows is to report the activities that caused the change in cash balances reported in the balance sheets from period to period

Financing Activities

•Examine changes in long-term liabilities and stockholders' equity accounts from the balance sheet qCash transactions with a company's creditors and shareholders We can find a firm's financing activities by examining changes in long-term liabilities and stockholders' equity accounts from the balance sheet.

Investing Activities

•Increase or decrease in investments •Increase or decrease in long-term assets, such as: -Property -Plant -Equipment -Intangible Assets

Cash Flow Ratios

•Often used to supplement analysis of a company •Substitute cash flow from operations in place of net income •Positive cash flow from operations is important to a company's survival in the long run Cash return on assets = Operating cash flows ÷ Average total assets.

Cash Flow Activities

•Operating activities •Investing activities •Financing activities

Examples of Significant Noncash Investing and Financing Activities

•Purchase of long-term assets by issuing debt •Purchase of long-term assets by issuing stock •Conversion of bonds payable into common stock Exchange of long-term assets

Operating Activities—Direct Method

•Report the cash inflows and cash outflows directly •Converts each revenue and expense item to its cash-basis amount •Income statement items that have no cash effect are not reported The best way to apply the direct method is to convert each revenue and expense item to its cash-basis amount

Noncash Activities

•Significant investing and financing activities that do not affect cash •Reported after the cash flow statement or in a note to the financial statements