PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Statement of Cash Flows

Chapter 12

12-2

Statement of Cash Flows

Income Income StatementStatement

Balance Balance SheetSheet

Statement of Statement of Cash FlowsCash Flows

The statement of cash flows highlights the major activities that impact cash flows and ,hence, affect the overall cash

balance.

12-3

Purpose of the Statement of Cash Flows

Are cash flows sufficient to

support ongoing operations?

Are cash flows sufficient to

support ongoing operations?

Can we pay debts?

Can we pay debts?

Can we pay dividends?

Can we pay dividends?

Why is there a difference

between net income and net

cash flow?

Why is there a difference

between net income and net

cash flow?

Will the company have to borrow money to make

needed investments?

Will the company have to borrow money to make

needed investments?

12-4

A Fundamental Principle

Cash Balance = Noncash Balance Sheet Accounts

This principle ensures that properly analyzing the changes in all noncash

balance sheet accounts always quantifies the cash inflows and

outflows that explain the change in the cash balance.

12-5

A Review of Basic Equations

Basic Equation for Asset Accounts

Beginning balance + Debits – Credits = Ending balance

Basic Equation for Contra-Asset, Liability, and Stockholders’ Equity Accounts

Beginning balance – Debits + Credits = Ending balance

12-6

Statement of Cash Flows: Key Concepts

The term cash on the statement of cash flows refers broadly to both currency and cash equivalents.

Currency and Bank Accounts

Cash

Treasury Bills

Money Market Funds

Commercial Paper

Cash Equivalents

12-7

Organizing a Statement of Cash Flows

Operating Operating ActivitiesActivities

Revenue and expense Revenue and expense transactions that affect transactions that affect

net income. net income.

Investing Activities

Acquiring or disposing of noncurrent assets.

Financing Activities

Borrowing from and repaying principal to

creditors and transactions with stockholders.

12-8

Organizing a Statement of Cash Flows

12-9

Operating Activities: Direct or Indirect Method?

Reconstructs the income statement on a cash basis

from top to bottom

Direct Method

Accrual net income is adjusted

to a cash basis; Used by 99%

Indirect Method

Both methods result in the exact same amount of cash provided by operating activities.

12-10

The Indirect Method: A Three-Step Process Step 1

Step 2

Step 3

12-11

Summary of Key Concepts

12-12

Summary of Key Concepts

12-13

Free Cash Flows

Free Cash Flow =Net Cash Provided by Operating Activities – Capital

Expenditures – Dividends

Free cash flow measures a company’s ability to fund its capital expenditures and dividends from

its net cash provided by operating activities.

12-14

Earnings Quality

Managers generally perceive that earnings are of higher quality when the earnings: 1.are not unduly influenced by inflation, 2.are computed using conservative accounting principles and estimates, and 3.are correlated with net cash provided by operating activities.

12-15

Computing Net Cash Provided by Operating Activities

The direct method computes net cash provided by operating activities by reconstructing the

income statement on a cash basis from top to bottom.

Net cash provided by operating activities under the direct method will

always agree with the amount computed using the indirect method.

12-16

Similarities and Differences in Handling Data

Adjustments for accounts that affect revenue are the

same in the direct and indirect methods.

Adjustments for accounts that affect expenses are

handled in opposite ways for the direct and indirect

methods.

12-17

Similarities and Differences in Handling Data

Under the direct method, no adjustments for gains and losses on the sale of

assets are needed.

12-18

Special Rules—Direct and Indirect Methods

Requires a reconciliation between net

income and the net cash provided by

operating activities

Direct Method

Requires disclosure of

amount of interest and income taxes

paid during the year

Indirect Method

12-19

End of Chapter 12