BA102A

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BA102A

• Your very last 102A lecture
• (unless you fail the course and take it over)
• And todays topic is
• Statement of Cash Flows

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(No Transcript)
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What is a Statement of Cash Flows?

• What?
• The Statement of Cash Flows explains the
  difference between the beginning and ending cash
  balance for a period.
• When did it come into existence and why?
• In the mid-1980s
• To explain cash flows, since the income statement
  does not.
• For what is it used?
• To illustrate the relationship between income and
  cash.
• To predict future cash flows.
• To evaluate operating and investment decisions.
• To determine whether the firm can pay interest
  and/or dividends, and repay loans.

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How Does the Statement of Cash Flows Look?

• It is a separate financial statement.
• It has three sections divided by type of
  transaction (usually presented in this order)
• Operating activities
• Investing activities
• Financing activities
• Each sections net cash flows are added together
  to get a total change in cash.
• The total change in cash is added to the
  beginning cash balance to yield the ending cash
  balance, which should match cash on the current
  Balance Sheet.

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Operating Activities

• These are all cash transactions relating to
  operations, such as cash sales, cash purchases of
  inventory, payment of expenses, and receipts of
  incidental income such as dividends and interest.
• Receipts of cash are treated as inflows and
  payments are treated as outflows.
• Net cash from operations is the inflows minus
  the outflows.

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Two Methods to Deal with the Operations Section
of the Cash Flow Statement

• Indirect method
• This method is the more popular in the US than
  the direct method
• In this method, you start with the Income
  Statement and adjust it from the accrual to the
  cash basis.
• Noncash expenses are added back to net income.
• Losses are added back and gains are subtracted
  from Net Income
• The Income Statement is also adjusted for changes
  in current assets (other than cash) and current
  liabilities

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• Direct method
• This method is preferred by FASB
• This method is more complicated to produce, which
  is why it is used less than the indirect method
• The presentation of this method is easier to
  understand by users of financial information
• Cash receipts and cash payments are listed and
  netted

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How the Indirect Method Works (Income from
Operations Section)

• Start with Net Income
• Add back noncash expenses (e.g. depreciation,
  amortization)
• Add back losses and subtract gains the cash
  account has already been adjusted for the cash
  payment in these transactions.
• Subtract increases in current assetsbecause they
  tie up cash
• Add back decreases in current assetsthey
  represent increases in cash (e.g. receiving the
  accounts receivable)
• Add back increases in current liabilitiesbecause
  cash has not been spent, but the expense has been
  recorded
• Subtract decreases in current liabilitiesbecause
  you use cash to pay them off

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Example of Indirect Method for Cash from
Operations Section
These three financial statements have all the
info you need for a simple Stmt of Cash Flows
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So this is what the operating activities section
of the statement of cash flows would look like
for that set of financial statements.
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How the Direct Method Works

• Cash flows in and out are summarized for
  operating activities by looking at the individual
  transactions and grouping the cash transactions
  for operations together
• This requires a more thorough look at the
  financial records than does the indirect method

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Example of Direct Method, Cash from Operations
Section
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The cash flows from investing activities

• This section can be complicated if depreciable
  assets have been purchased and/or sold during the
  year
• If simple, just look at the changes in long term
  assets and record the purchases and sales at the
  value of the cash exchanged.

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Example of Investing Activities Suppose you
sell a 500 long term bond and buy a 700 plot of
land as an investment
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Cash flows from Financing Activities

• This section is fairly simple, though sometimes
  you have to pay attention to borrowing and
  repayment schedules.
• In our example, the changes in cash from
  financing come only from a long term loan and the
  payment of dividends.
• Typically, changes in long term liabilities,
  changes in equity, and dividend PAYMENTS
  (receipts are income) are in this section
• Interest payments are not in this section they
  are considered part of income.

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Example of Cash Flows from Financing Activities
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And here is what the entire statement looks like,
in the Indirect Method
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And here is what the entire statement looks like,
in the Direct Method
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So, what is this telling us?

• If this is a young firm, it is doing ok because
  young firms tend to have cash outflows from
  operations and have to borrow. However, the firm
  is not buying fixed assets, so it is not likely a
  young firm.
• If this is an old firm, its income looks ok, but
  its cash flows are not very good. I would worry
  that it cant pay back loans.

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To Review

• The Statement of Cash Flows describes the Sources
  and Uses of CASH
• Sources
• Sale of goods and services, receipt of other
  income (e.g. dividends) (operating)
• Sale of long term assets (investing)
• Long term borrowing and issuing of stock
  (financing)
• Uses
• Payment of expenses, including interest
  (operating)
• Purchase of long term assets (investing)
• Repayment of debt and payment of dividends
  (financing)

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• Sources and Uses of Cash from Operations
• Net income, adjusted for noncash items
• Changes in current assets (except cash)
• Changes in current liabilities
• Sources and Uses of Cash from Investing
  Activities
• Changes in long term assets
• Sources and Uses of Cash from Financing
  Activities
• Changes in long term liabilities
• Changes in equity accounts (except retained
  earnings)
• Dividend payments

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And of course the final is on Wednesday

• You may bring one index card (4x 6 or smaller)
  with formulas and notes on both sides.
• Bring a scantron. Dont forget your pencil and
  calculator. I dont have extras.
• There will be 50 multiple choice questions, each
  worth 2 points, and TWO PROBLEMS.
• All chapters that we covered will be on the
  final. Concentrate on the previous quizzes and
  the lecture notes (powerpoint.)

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Topics

• The accounting cycle, transactions, adjusting
  entries, preparation of financial statements
• Cash, bank reconciliation
• Receivables, bad debts.
• Accounting for investmentsshort term (trading
  securities) and long term (available for sale,
  equity method, held to maturity.)

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• Plant assets, purchase of, disposal of.
• Depreciation (depletion and amortization) by
  straight line, double declining balance and units
  of production.
• Current liabilities
• Bonds payable (and investments in bonds,)
  amortization of premium or discount, effective
  interest method.

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• Equityaccounting for stock transactions
  including sale, repurchase, retirement, dividend
  payments, stock dividends, stock splits.
• Preparation of the Statement of Cash Flows by the
  indirect method, and how the indirect differs
  from the direct method.

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So that is

• All