chapter twenty-five

CHAPTER TWENTY-FIVE

STATEMENT OF CASH FLOWS


Purpose: To provide information about how cash was generated and used during the period

Divides cash related activities into three categories:o Operating Activities

o Investing Activities

o Financing Activities

OPERATING ACTIVITIES

Transactions and events associated with:

• selling a product or providing a service

• the revenues and expenses reported on the Income Statement

Represent the company’s primary source of cash over the life of the business

INFLOW EXAMPLES

Cash receipts from the sale of goods or services

Interest received on loans made to outside entities

Dividends received on investments made in the stock of other companies

OPERATING ACTIVITIES

Transactions and events associated with:

• selling a product or providing a service

• the revenues and expenses reported on the Income Statement

Represent the company’s primary source of cash over the life of the business

OUTFLOW EXAMPLES

Payments for the acquisition of inventoryPayments to employees and the government

Payments for interest on loans

Payments to other suppliers and for other expenses

CASH FLOWS FROM OPERATING ACTIVITIES

TWO METHODS:o DIRECT

• Revenues and expenses are adjusted

– to reflect the amount of cash received or paid for each item

o INDIRECT• Net income is adjusted

– for transactions that affect net income, but have no effect on cash flows

INVESTING ACTIVITIES

Transactions involving long-term assets, investments in debt and equity securities, and lending money and collecting the principalon the related loans

INFLOW EXAMPLESProceeds from:

collection of principal on loans made

sale of property, plant and equipment; intangibles; and other productive assets

sale of investments in debt and equity securities

discounting notes receivable


Transactions involving long-term assets, investments in debt and equity securities, and lending money and collecting the principal on the related loans

OUTFLOW EXAMPLES

Loans made to other parties

Payments to acquire property, plant, and equipment; intangibles; and other productive assets

Payments to acquire investments in debt and equity securities

FINANCING ACTIVITIES

Transactions dealing with the exchange of cash between the company and its owners and creditors

INFLOW EXAMPLES

•Proceeds from additional investments by the owners or the issuance of stock

•Proceeds from borrowing money through the signing of a mortgage, issuing a bond or other long- or short-term loans


Transactions dealing with the exchange of cash between the company and its owners and creditors

OUTFLOW EXAMPLES

•Payments of dividends to stockholders or withdrawals by the owners

•Payments to purchase treasury stock

•Repayment of the principal on loans


EXAMPLE: Simplex Company has prepared its Income Statement, Statement of Retained Earnings and Balance Sheet for 20-3.

Now it needs to prepare itsStatement of Cash Flows.

Comparative Balance Sheet

160,000$ 90,000

Simplex Company

December 31, 20-3 and 20-2

Assets20-3 20-2

Increase (Decrease)

Current Assets:CashAccounts ReceivableMerchandise Inventory

Total current assets

Property, Plant and Equipment:LandBuildingEquipment

Total property, plant and equip.Total assets

$ 200,000 $(110,000)190,000 (30,000)

180,000 200,000 (20,000)$430,000 $590,000 (160,000)

$ 40,000 $ 40,000 0140,000 0 140,000100,000 0 100,000

$ 280,000 $ 40,000 $240,000$ 710,000 $ 630,000 $ 80,000

The Statement of Cash Flows willexplain how the cash account

decreased by $110,000 in 20-3.

Schedule for the Calculation of Cash Generated from Operating Activities

600,000$ 900,000

Simplex Company

For Year Ended December 31, 20-3

Income Statement Additions DeductionsCash Flow

SalesCost of Goods SoldGross ProfitOperating ExpensesNet Income

220,000$ 300,000

$ 80,000

The revenues and expenses from theIncome Statement are used in computing the

“Cash Flow Generated from Operating Activities.”


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

We’ll start with the Sales…Sales (revenues) are recognized when earned,

regardless of the amount of cash actually received.Sales must be converted to the amount of

“Cash Received from Customers.”

CASH RECEIVED FROM CUSTOMERS

ACCOUNTS RECEIVABLE

To convert Sales into the“Cash Received from Customers” we need

to examine the Accounts Receivable account.

$190,000Beg. balance


ACCOUNTS RECEIVABLE

Sales increases theAccounts Receivable

account.


Sales


ACCOUNTS RECEIVABLE

Accounts Receivable is decreasedby customers making payments.


?Sales


ACCOUNTS RECEIVABLE


?

$160,000End. balance

Accounts Receivabledecreased by $30,000

during 20-3.

Sales


ACCOUNTS RECEIVABLE


?


When Accounts Receivable decreases…Cash rec’d from customers > Sales

Sales


ACCOUNTS RECEIVABLE


?


Sales for the year were $900,000…

$900,000


ACCOUNTS RECEIVABLE



Cash Rec’d from Customers = Sales + Decrease in A/R

$900,000 + $30,000

$900,000 $930,000


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

Cash Received from Customers.

$ 930,000$30,000


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

Cost of Goods Soldis adjusted next….

$ 930,000$30,000

CASH PAID FOR MERCHANDISE

MERCHANDISE INVENTORY

We need to determine the amountof merchandise purchased during the year.




Purchases increase inventory.


?



Selling goods (merchandise)reduces inventory.


? Cost of Goods Sold



Inventory decreased by $20,000 during 20-3.






When inventory decreases during the year…..Cost of Goods Sold > Purchases







?


$600,000

Cost of Goods Sold for 20-3 is $600,000.





$600,000

Purchases for 20-3 =Cost of Goods Sold - decrease in Merch. Inventory

$600,000 - $20,000

$580,000





$600,000$580,000

Cost of merchandise purchased.


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

Decrease in Merchandise Inventory

$ 930,000 $(20,000)

$30,000


ACCOUNTS PAYABLE

$180,000 Beg. balance

$120,000 End. balance

Now that we know Simplex’ purchases,we need to determine how much cash

was paid for these goods.


ACCOUNTS PAYABLE



Purchases increase Accounts Payable and cashpayments on these purchases decrease Accts. Payable.

$580,000?


ACCOUNTS PAYABLE



Accounts Payable decrease by $60,000 during 20-3,Purchases < Cash paid

$580,000?


ACCOUNTS PAYABLE


$120,000 End balance

Cash paid for merchandise =Purchases + decrease in Accounts Payable

$580,000 + $60,000

$580,000$640,000


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

Decrease in Accounts Payable

$ 930,000 $(20,000)$ 640,000

$30,000$60,000


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

Operating Expenses are generallyadjusted for prepaid expenses,

accrued liabilities, and depreciation.

$ 930,000 $(20,000)$ 640,000

$30,000$60,000


600,000$ 900,000

Simplex Company




220,000$ 300,000

$ 80,000

Simplex does not have any ofthese items , so there is no needto adjust operating expenses.

$ 930,000 $(20,000)$ 640,000

220,000

$30,000$60,000

Cash flows from operating activities:Cash received from customers

$(640,000)$930,000

Simplex CompanyStatement of Cash Flows

For Year ended December 31, 20-3

Cash paid for merchandiseCash paid for operating expenses (220,000)

Total cash disbursed for operating act. (860,000)$ 70,000Net cash provided by operating activities

Cash flows from investing activities:

Now that the operating sectionis completed, we turn our

attention to the investing section.


160,000$ 90,000

Simplex Company


Assets20-3 20-2

Increase (Decrease)





$ 200,000 $(110,000)190,000 (30,000)

180,000 200,000 (20,000)$430,000 $590,000 (160,000)

$ 40,000 $ 40,000 0140,000 0 140,000100,000 0 100,000

$ 280,000 $ 40,000 $240,000$ 710,000 $ 630,000 $ 80,000

Investing activities involve the purchaseand sale of Plant Assets.


BUILDING$ 0Beg. balance

$140,000End balance

Beg. balance $ 0

$100,000End balance

EQUIPMENT

Simplex Company informs us the only activity inthe building and equipment accounts in 20-3

was the purchase of a building and equipmentfor cash, just before year end.


$(640,000)$930,000





Cash flows from investing activities:

On to the Financing section...

Purchased building $(140,000)Purchased equipment (100,000)

(240,000)Net cash used by investing activities

Cash flows from financing activities:


160,000$ 90,000

Simplex Company


Assets20-3 20-2

Increase (Decrease)





$ 200,000 $(110,000)190,000 (30,000)

180,000 200,000 (20,000)$430,000 $590,000 (160,000)

$ 40,000 $ 40,000 0140,000 0 140,000100,000 0 100,000

$ 280,000 $ 40,000 $240,000$ 710,000 $ 630,000 $ 80,000

Financing activities involve exchangesof cash between the company and

its stockholders and creditors.

120,000$ 60,000

LiabilitiesCurrent liabilities:

Notes PayableAccounts Payable

Total liabilities

Stockholders’ EquityCommon Stock $5 par, 100,000

shares auth.; Issued 58,000

Paid-in-capital in excess of par-

$ 50,000 $ 10,000

50,000

(60,000)$180,000

100,000

(50,000)$230,000

$250,000$290,000 40,000

130,000 30,000110,000

130,000$ 530,000$ 630,000$ 710,000$ 400,000

$ 80,000

180,000

in 20-3, 50,000 in 20-2

common stockRetained Earnings

Total liab. & stockholders’ equity

60,000Total stockholders’ equity

Let’s begin by analyzingthe cash related activities

in the Notes Payable account.


NOTES PAYABLE

$ 50,000 Beg. balance

$ 60,000

$10,000 increase in 20-3from issuing a note.

$10,000


$(640,000)$930,000





Cash flows from investing activities:Purchased building $(140,000)Purchased equipment (100,000)


Cash flows from financing activities:Issued Note Payable $ 10,000

120,000$ 60,000



Total liabilities




$ 50,000 $ 10,000

50,000

(60,000)$180,000

100,000

(50,000)$230,000

$250,000$290,000 40,000

130,000 30,000110,000

130,000$ 530,000$ 630,000$ 710,000$ 400,000

$ 80,000

180,000

in 20-3, 50,000 in 20-2




We will move now tothe Capital Stock accounts.


COMMON STOCK



Beg. balance

$ 100,000


PAID-IN CAPITAL IN EXCESS OF PAR-COMMON STOCK

The only types of transactionsthat increase or decrease

the Capital Stock accounts areissuing and retiring stock.


COMMON STOCK



Beg. balance

$ 100,000



Since Common Stock increasedduring 20-3, stock with parvalue of $40,000 was issued.

$40,000


COMMON STOCK



Beg. balance

$ 100,000



Since Paid-In Capital increasedduring 20-3, stock was issued for a price

$30,000 above the par value.

$40,000 $30,000


$(640,000)$930,000





Cash flows from investing activities:Purchased building $(140,000)Purchased equipment (100,000)


Cash flows from financing activities:Issued Note Payable $ 10,000Issued Common Stock 70,000

120,000$ 60,000



Total liabilities




$ 50,000 $ 10,000

50,000

(60,000)$180,000

100,000

(50,000)$230,000

$250,000$290,000 40,000

130,000 30,000110,000

130,000$ 530,000$ 630,000$ 710,000$ 400,000

$ 80,000

180,000

in 20-3, 50,000 in 20-2




The final account to beanalyzed is Retained Earnings.

Retained Earnings, January 1, 20-3Net Income $ 80,000

$ 50,000

Simplex CompanyStatement of Retained EarningsFor Year ended December 31, 20-3

Less dividendsNet increase in retained earnings

20,000

Retained Earnings, December 31, 20-360,000

$110,000

The Statement of Retained Earningsprovides us with a summary ofall the activity in the account.

Retained Earnings, January 1, 20-3Net Income $ 80,000

$ 50,000

Simplex CompanyStatement of Retained EarningsFor Year ended December 31, 20-3

Less dividendsNet increase in retained earnings

20,000

Retained Earnings, December 31, 20-360,000

$110,000

The Net Income has already beenanalyzed for cash activities….

But dividends involve the paymentof cash and therefore must be recorded

on the Statement of Cash Flows.


Paid cash dividends60,000Net cash provided by financing activities

Issued Note Payable $ 10,000Issued Common Stock 70,000

(20,000)

Net increase in cash $(110,000)

OperatingInvestingFinancing

$ 70,000(240,000)

60,000$(110,000)


Paid cash dividends60,000Net cash provided by financing activities

Issued Note Payable $ 10,000Issued Common Stock 70,000

(70,000)

Net increase in cash Cash balance, January 1, 20-3 200,000Cash balance, December 31, 20-3

What about more complex companies?

$(110,000)

$ 90,000


1,800$ 22,980

Multiplex Company


Assets20-2 20-1

Increase (Decrease)

Current Assets:CashGovernment notesAccrued interest receivable

Total current assetsSupplies and prepayments

Property, plant and equipmentStore equipmentLess accumulated depreciation

$ 20,000 $ 2,9803,200 (1,400)

100 300 (200)

4,000 2,750(2,930)

$153,665 $145,260

9,200$ 48,000(14,000) 4,000

Accounts Receivable (net) 60,215 51,510 8,705Merchandise inventory 64,570 67,500

1,2508,405

$ 38,800(18,000)

Delivery equipment $ 45,000 $ 32,000 13,000Less accumulated depreciation (12,500) ( 8,000) 4,500

Step #1Compute the change in

cash and cash equivalents.

CASH AND CASH EQUIVALENTSTo qualify as a cash equivalent:

•an investment must be readily convertible to a known amount of cash

These are considered the same as cash when preparing the statement of cash flows

20-1

Cash

Gov’t Notes

$20,000

3,200$23,200

20-2

$22,980

1,800$24,780

$1,580 increase

Income Statement

270,100$ 460,000

Multiplex Company



Net SalesCost of Goods SoldGross ProfitOperating Expenses

Operating Income

144,750$ 190,000

$ 45,250

Step #2 Prepare a schedule to calculatecash from operating activities.

Interest revenue 155Interest expense 650Net Income $ 44,755

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250Increase in

Accounts Receivable

$(8,705) $ 451,395


Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250 Decrease in Inventory….purchased less than what

was sold

$(8,705) $ 451,395


(2,930)

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250 Decrease in Accounts Payable...paid for more than what

was purchased

$(8,705) $ 451,395


(2,930) $11,400

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250

Operating expensesinvolve many accounts.

$(8,705) $ 451,395


(2,930)$11,400 278,570$ 172,825

OPERATING EXPENSES

SUPPLIES AND PREPAYMENTS$2,750Beg. Balance

$4,000End Balance

Supplies purchased and prepayments made

OPERATING EXPENSES


$4,000End Balance

Supplies and prepaymentsconsumed (Operating Expenses)

OPERATING EXPENSES


$4,000End Balance

$1,250 Increase indicates more werepurchased (paid) than were consumed (expensed).

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250

$(8,705) $ 451,395


(2,930)$11,400

1,250

278,570$ 172,825

OPERATING EXPENSES

Multiplex informs us that Depreciation Expense of $10,400 is included in the Operating Expenses reported on the Income Statement.

Depreciation does not use or provide cash…therefore it should be subtracted fromOperating Expenses on our schedule.

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250

$(8,705) $ 451,395


(2,930) $11,400

1,250 (10,400)

278,570$ 172,825

OPERATING EXPENSES

Beg. Balance

End Balance

$1,520

$ 950

ACCRUED AND WITHHELD PAYROLL TAXES

The $570 decrease indicates morewas paid than expensed.

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250

$(8,705) $ 451,395


(2,930)$11,400

1,250 (10,400)570

278,570

136,170

$ 172,825

$ 36,655

Let’s analyze theInterest Revenue

account.

INTEREST REVENUE

Beg. Balance

End Balance

$300

$ 100

INTEREST RECEIVABLE

The $200 decrease indicates morewas received than earned this period.

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250

$(8,705) $ 451,395


(2,930) $11,400

1,250 (10,400)570

278,570

136,170

$ 172,825

$ 36,655 200 355

Interest Expense is thefinal account to be analyzed.

INTEREST EXPENSE

Beg. Balance

End Balance

$ 80

$ 100

INTEREST PAYABLE

The increase indicates all but $20 of this year’s Interest Expense

was paid.

Income Statement

270,100$ 460,000

Multiplex Company




Operating Income

144,750$ 190,000

$ 45,250

$(8,705) $ 451,395


(2,930)$11,400

1,250 (10,400) 570

278,570

136,170

$ 172,825

$ 36,655200 355

(20) 630$ 36,380


355$451,395

Multiplex CorporationStatement of Cash Flows


Cash paid for merchandiseCash provided by operating activities

Cash paid for merchandise $(278,570)$451,750

Cash paid for operating expensesInterest paid

Total cash disbursed for oper. activities (415,370)

(136,170)(630)

Net cash provided bv operating activities $ 36,380Cash flows from investing activities:


Bal.

Bal.

$ 34,000

$ 38,000

OFFICE EQUIPMENT

$ 48,000

$ 38,800Bal.

Bal.

STORE EQUIPMENT

Multiplex informs us the only equipmenttransactions were the purchases

of new equipment for cash.


Bal.

Bal.

$ 34,000

$ 38,000

OFFICE EQUIPMENT

$ 48,000

$ 38,800Bal.

Bal.

STORE EQUIPMENT

Cash paid forequipment

9,200 4,000


355$451,395







(136,170)(630)


Purchased store equipmentPurchased office equipment

$ (9,200)(4,000)


Beg. Balance

End Balance

$ 32,000

$ 45,000

DELIVERY EQUIPMENT

Purchase of newequipment in

exchange for a note.

13,000


Beg. Balance

End Balance

$ 32,000

$ 45,000

DELIVERY EQUIPMENT

Since this transaction does not involvecash, it will not be shown on the

Statement of Cash Flows.

13,000


355$451,395







(136,170)(630)



$ (9,200)(4,000)

(13,200)Net cash used bv investing activitiesCash flows from financing activities:


Bal.

Bal.

$ 39,000

$ 40,000

PAID-IN CAPITAL

$ 100,000

$ 98,000COMMON STOCK

Multiplex issued additionalshares of stock for $3,000.

2,000 1,000

Bal.

Bal.


355$451,395







(136,170)(630)



$ (9,200)(4,000)

(13,200)Net cash used bv investing activitiesCash flows from financing activities:

Issued common stock $ 3,000

Multiplex informs usthat cash dividends

of $22,800 were paidin 20-2.

Cash flows from financing activities:Issued Common Stock $ 3,000Paid cash dividends (22,800)


Beg. Balance

End. Balance

$ 11,800

$ 10,000

NOTES PAYABLE

Cash was paid to reduce theNotes Payable balance.

1,800

Cash flows from financing activities:Issued Common Stock $ 3,000Paid cash dividends (22,800)Retired note payable (1,800)

Net cash used bv financing activities (21,600)$ 1,580Net increase in cash and cash equivalents

Cash and cash equivalents, January 1, 20-2Cash and cash equivalents, December 31, 20-2

23,200$24,780

Schedule of noncash investing and financing activities:

Non-cash investing and financing activitiesare activities that involve no cash flow,

but represent a significant changein the company’s financial position.

Cash flows from financing activities:Issued Common Stock $ 3,000Paid cash dividends (22,800)Retired note payable (1,800)

Net cash used bv financing activities (21,600)$ 1,580Net increase in cash and cash equivalents

Cash and cash equivalents, January 1, 20-2Cash and cash equivalents, December 31, 20-2

23,200$24,780

Schedule of noncash investing and financing activities:

Multiplex had one such transaction…The issuance of a note payable to purchase

new Delivery Equipment.

Acquired delivery equip. by issuing a note

INTERPRETING THE STATEMENT

Most important indicator of financial health of a business is “Net cash used or provided by operating activities”o Positive cash flows are needed to purchase

property, plant and equipment. • This could be done through borrowing but loans

must be repaid.

• This could be done through issuance of stock but dividends have to be paid.

o Chronic inability to generate positive cash flows is a sure sign of financial instability.

chapter twenty-five

Documents