Chapter 16 - Statement of Cash Flows

Statement of cash flows- it reports a business's major cash inflows and outflows of a period
*it provides useful information about a company's ability to generate cash from operations

Three types of activities are associated with the statement of cash flow reports

1. Cash flows from operating activities- cash flow transactions that affect net income.
                      Ex. sale and purchase of merchandise by a retailer
2. Cash flows from investing activities- cash flows from transactions that affect the investments and non-current assets.
                     Ex. sale and purchase of fixed assets, buildings or equipment
3. Cash flows from financing activities- cash flows from transactions that affect the debt and equity of a business.
                     Ex. transactions such as issuing or retiring equity and debt securities

-Statement of cash flows include cash flows from operating activities, which are usually presented first.
-Then the cash flows from investing activities and financial activities follow.
-Cash balance from the beginning of the period is added to the net or decrease in cash, which results in the cash balance for the end of the period.

Cash Inflow- A source of cash that causes cash flow to increase
Cash Outflow- A use of cash that causes cash flow to decrease

Cash Flows From Operating Activities

There are two alternative methods for reporting cash flows for operating activities which include
1. The Direct Method and 2. The Indirect Method.

The Direct Method- Reports the sources of operating cash and uses of operating cash. Major source of operating cash comes from customers and major uses are from cash paid for supplies and merchandise.
The Indirect Method- Reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses  that do not involve the receipt or payment of cash.

Cash Flows From Investing Activities

Cash inflows from investing activities normally come from selling fixed assets, investments and intangible assets. and cash outflows usually come from payments to acquire fixed assets, investments or intangible assets.

If the inflows are greater than the outflows, net cash flow provided by investing activities is reported.
If the inflows are less than the outflows, net cash flow used for investing activities is reported.

Part of the Cash Flow Report Cash flows from Investing Activities

     Cash flows from investing activities:
          Cash payments for purchase of land ....................$20,000


Cash  Flows From Financing Activities

Cash inflows from financing activities normally come from issuing debt or equity securities.
                     Ex. issuing bonds, notes payable, preferred common stocks
Cash outflows from financing activities usually occur from paying cash dividends, repaying debt, and acquiring treasury stock.

If inflows are greater than outflows, net cash flow provided by financing activities is reported.
If inflows are less than outflows, net cash used fir financing activities is reported.

Part of Cash Flow Report Cash flows from financing Activities

     Cash flows from financing activities:
          Cash received as owner's investment .....................$25,000
          Deduct cash withdrawal by owner ..........................$2,000
          Net cash flow provided by financing activities ......$23,000

Noncash Investing and Financing Activities

Since not all transactions involve cash, non cash transactions must still be documented because even though they do not affect cash flows directly affect cash flows they will affect cash flows later on in terms of cash payments of interest and retiring of bonds. Thus transactions should still be reported in the persons financial statements.
Noncash transactions that occur during that specific period are reported in a separate schedule usually at the bottom of the cash flows report.

No Cash Flow Per Share

Cash Flow Per Share- sometimes reported in the financial press. The term really means, cash flow from operations per share.
                 Ex. when people interpret cash flow per share as the amount available for dividends.

Statement of Cash Flows - The Indirect Method

-The indirect method is usually less costly and more efficient than the direct method. It was reported that 99% of  companies surveyed in 2005 used the indirect method.
-Collecting data for the statement of cash flows, all the receipts and cash payments for a period can be analyzed, but this process is very costly and time consuming.
- The more effective way to analyze this data is to analyze the changes in the noncash balance sheet accounts.
-The  logic behind this is that a change in any balance sheet account (including cash) can be analyzed in terms of changes in the other balance sheet accounts.

Assets = Liabilities + Stockholders Equity
Cash + Noncash Assets = Liabilities + Stockholders Equity
Cash = Liabilities + Stockholders Equity - Noncash Assets

Retained Earnings
The retained earnings account should be looked at carefully because some of the entries to retained earnings may not affect cash.
          Ex. a decrease in retained earnings resulting from issuing a stock dividend does not affect cash

Cash Flows From Operating Activities- Indirect Method

-Net income of companies usually doesn't equal the amount of cash generated from operations in a period. This is because net income is determined using the accrual method of accounting. With the accrual method revenues and expenses are recorded at different times from when cash is received or paid.
-With the indirect method these differences are used to reconcile the net income to cash flows from operating activities. And the roper adjustments to net income under the indirect method are reported in the statement.
-The next adjustments to net income come are gains and losses from disposal of assets. These adjustments happen because cash flows from operating activities should not include investing or financial transactions.
*also adjustments must be made so that there is no double counting taking place as well

Depreciation- Comparative Balance Sheet indicates accumulated depreciation increases or decreases. So if building depreciation increased by $7000, the 7k of depreciation reduced net income but didn't require an outflow of cash. So the 7k is added to net income in determining cash flows from operating activities.

Cash flows from operating activities:
      Net Income                                  $108,000
      Add Depreciation                        $7,000         $115,000

Gain on Land- On a land gain, since it is a sale proceed, which include the gain and the carrying value of land, are included in cash flows from investing activities. The gain is also included in net income, so to avoid double counting the gain is deducted from net income

cash flows from operating activities:
     Net income                                 $108,000
     Deduct gain on sale of land       $12,000

Changes in current operating Assets and Liabilities- decreases in noncash current assets and increases in current liabilities are added to net income. In contrast, increases in noncash current assets and decreases to current liabilities are deducted from net income.