Statement of Cash Flows

Chapter 12 – Session 1

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Announcements

1) Next quiz will go live today. Will cover Chapter 11/11 CDN.
2) WileyPlus Assignment

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 Class Summary

Last Class

1) Discussed Cash Dividends

2) Explained Recording of Dividends

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 Class Summary

Today’s Class

1) Explain stock splits

2) Understand ratios
3) Introduce cash flows

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 Final Exam

How to Succeed in this Course?

Performing well in this course:

1) Understand the examples that we work in class from the slides
2) Practice the examples in exam-like conditions
3) Only topics from the slides will be tested
4) Come up with a study plan and follow it religiously

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 The Statement of Cash Flows

Statement of Cash Flows

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 The Statement of Cash Flows Need for Statement of Cash Flows

Need For Statement of Cash Flows

What do Delta Airlines, and Delphi have in common?

Both firms filed bankruptcy early 2000s despite being profitable years
preceding bankruptcy
I They were unable to generate enough cash to cover operating costs
and interest payments
Companies like Amazon
Earnings are important, but cash is lifeblood of companies
“Cash is King (Queen)”

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 The Statement of Cash Flows Need for Statement of Cash Flows

Need For Statement of Cash Flows

Cash is needed to:

I Pay dividends to shareholders
I Invest in plant assets
I Pay employees
I Take advantage of market opportunities
If a company has a positive net income, does not always imply it has
positive cash flows
The Statement of Cash Flows is used to determine whether a
company is generating cash

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 The Statement of Cash Flows Need for Statement of Cash Flows

Need For Statement of Cash Flows

Where is cash in the financial statements?

Statement of cash flows shows how cash has changed from beginning
of the accounting period to its end

Cash at Beginning of Period

Cash at End of Period
Change in Cash Balance

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 The Statement of Cash Flows Need for Statement of Cash Flows

Tracking Changes in Cash

Tracking cash changes from one period to another. Is there a cash increase
or decrease?
Suppose firm issues a bond, or borrows a loan =⇒
Suppose firm repays the bond, or loan =⇒
Firm buys plant assets with cash =⇒
Firm sells plant assets for cash =⇒
Firm buys stocks as investments =⇒
Firm sells these stocks as investments =⇒

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 The Statement of Cash Flows Need for Statement of Cash Flows

Need For Statement of Cash Flows

Cash includes cash and cash equivalents.

To systematically see changes, cash flow statement classifies the
change from three main activities:
1) Operating
2) Investing
3) Financing
Cash flow statement reports cash receipts (inflows) and cash payments
(outflows) in.

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 The Statement of Cash Flows Classification of Cash Flows

Classification of Cash Flows

1) Operating activities
I Income statement items
I Most important; showing how much cash is generated by operating
activities, involved in producing and delivering goods, and producing
services
2) Investing activities
I Cash flows from the acquisition and disposition of plant assets, and
investments
I Firm investing in “itself”
3) Financing activities
I Related to external sources of financing for the company
I Includes cash from issuing shares, paying dividends, debt repayment.

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 The Statement of Cash Flows Classification of Cash Flows

Classification of Cash Flows – Investing Activities

From investing activities

Cash Inflows
I Sale or disposal of plant assets
I Sale or maturity of investments in debt and equity
I Collection of principal on loans to other entities
Cash Outflows
I Purchase of plant assets
I Purchases of investment in debt and equity
I Offering loan to other entities

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 The Statement of Cash Flows Classification of Cash Flows

Classification of Cash Flows – Financing Activities

From financing activities

Cash Inflows
I Borrowings on notes, bonds, etc. from creditors
I Issuing shares to shareholders
Cash Outflows
I Dividend payments to shareholders
I Repayment of principal to creditors (excluding interest, if it is classified
as an operating activity)
I Reacquiring shares and redeeming long term debt

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 The Statement of Cash Flows Classification of Cash Flows

Classification of Cash Flows – Operating Activities

From operating activities

Cash Inflows
I Sale of good or services, customers
I Dividends and interest on investments
Cash Outflows
I Purchase of goods for resale and services (electricity)
I Wages and salaries
I Taxes
I Interest payments

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 The Statement of Cash Flows Classification of Cash Flows

Classification of Cash Flows

Activity Cash Inflows Cash Outflows

Cash received Cash paid

Operating
from revenues for expenses

Sale of plant assets Purchase of plant assets

Investing Sale of investments Purchase of investments
Collection of loans Loans to others

Dividend Payments
Issuing shares
Financing Share Repurchases
Issuing Bonds and notes
Repayment of debt
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 Cash Flow from Operating Activities Approaches

Cash Flow from Operating Activities

Two methods for Cash Flow from Operating Activities:

1) Direct Method:
Report component of cash flow from operating activities as cash
receipts(inflows) and cash payments(outflows)
Two main components in this method : cash collected from
customers, and cash paid to suppliers

2) Indirect Method:
Starts with the net income amount from statement of earnings, and
eliminates non cash transactions to get cash flow from operating
activities
Adjusts for differences between revenues and cash inflows, and
differences between expenses and cash outflows

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 Cash Flow from Operating Activities Approaches

Cash Flow from Operating Activities

Different approaches only for the cash flow from operating activities
section
Both these methods result in the same amount of cash flow from
operations
The cash flow from financing activities and investing activities
identical under both methods
For the purpose of our class, focus only on indirect method (direct
method will not be tested in the final)

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 Cash Flow from Operating Activities Approaches

Example – Cash Flow from Operating Activities

Cineplex Link Page 76 (Search “Consolidated Statements of Cash Flows”)

Three months ended September, 2019

Operating Activities
Net income from continuing operations 15,100
..
.
Net cash provided by operating activities 77,760
Investing Activities
..
.
Net cash used in investing activities (25,791)
Financing Activities
..
.
Net cash used in financing activities (52,336)
Cash and cash equivalents – End of period 30,074

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 Cash Flow from Operating Activities Approaches

Example – Cash Flow from Operating Activities

Note that $30, 074 is the amount listed in the balance sheet under
“Cash and cash equivalents” on Page (1)
Starbucks Link Page 51 (Search “Consolidated Statements of Cash
Flows”)
Significant investing and financing activities that do not affect cash
flows are not reported in the body of statement of cash flows.
Reported under cash flow statements as a supplemental disclosure (see
in Starbucks)

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 Cash Flow from Operating Activities Approaches

Cash Flow from Operating Activities

Most companies choose the indirect method

Both IFRS and GAAP require companies to reconcile net income and
operating cash flows
I even if companies choose direct method, need to supplement this
section with reconciliation (adjustments)
Indirect method uses income statement, balance sheet, and additional
information that includes transaction data

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 Cash Flow from Operating Activities Indirect Method

Indirect Method

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 Cash Flow from Operating Activities Indirect Method

Cash Flow from Operating Activities

Indirect methods : adjusts net income for items that do not affect cash
Net income for a particular period does not equal cash flow from
operations
Accrual accounting brings differences between revenues and expenses
incurred, and the inflows and outflows of cash

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 Cash Flow from Operating Activities Indirect Method

Cash Flow from Operating Activities – Accruals

Generally, revenue 6= cash received from customers in that period:

Companies recognize revenue at the time of sale, regardless of when
they receive the cash from the sale
I airlines receive cash before providing services and recognize revenues
I manufactures and distributors receive cash after providing goods and
recognizing revenues
Generally, expenses 6= cash paid to suppliers of materials and services for
that period:
Companies recognize expenses in the same period (matching) when
they recognize associated revenues
I cash outflow related to specific expenses do not always occur in the
period when the firm recognize the expense

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 Cash Flow from Operating Activities Adjustments

Cash Flow from Operating Activities

Indirect method adjusts net income to become actual cash flows by

“undoing” the impact of accruals, reconciling between net income and
the net operating cash flows
Where do we start?
Identify non-cash expenses in income statement for accounting period
Depreciation expenses are recognized, but cash is not paid out because
cash outflow when the asset was first purchased

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 Cash Flow from Operating Activities Adjustments

Cash Flow from Operating Activities

Depreciation and amortization decrease net income, but has no impact

on cash
To get net cash flow from operations, companies must add it back to
net income for that period
Adding back depreciation expense does not increase cash flow from
operations, it undoes (reverses) the effect of depreciation expense on
net income to get operating cash flow
Three type of adjustments to net income
1) add back non-cash expenses
2) deduct gains, and add losses
3) analyze asset accruals and liability accruals

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 Cash Flow from Operating Activities Adjustments

Cash Flow from Operating Activities

1) Non-cash expense also include depletion expense, and bad debt

expense, which must be added back
2) Deduct gains, and add losses:
Net income also includes non-operating gains and losses
Adjustment to exclude non-operating, and non-cash gains and losses
A gain, or loss can occur when company disposes a plant asset, and
the net book value differs from the amount received from the disposal
I gain makes net income higher
I loss makes net income lower

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 Cash Flow from Operating Activities Adjustments

Cash Flow from Operating Activities

These gains or losses are one-time transactions (and not related to

daily operations of the business), and are non-operating cash flows
Gains need to be subtracted from net income, and losses need to be
added back to net income
I Why? For e.g., as net income was inflated due to gains
The entire cash (proceeds) received from sale is included in the
investing section

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 Cash Flow from Operating Activities Current Assets

Cash Flow from Operating Activities

3) Analyze changes to asset accruals and liability accruals:

Consider changes to non-cash current assets and non-cash current
liabilities
3.a) Changes in Non-cash Current Assets:
Accounts receivable: recognizes revenue without receiving cash.
If accounts receivable decrease, company received cash that it had
already recognized as revenue in a previous period
I This cash inflow was not included in the net income for the current
period

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 Cash Flow from Operating Activities Current Assets

Cash Flow from Operating Activities

The decrease in accounts receivable would be added back to net

income on the cash flow statement
If accounts receivable increase, the increase would have been recorded
on the income statement without receiving cash
Company subtracts increase in accounts receivables from net income
to get operating cash flow

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 Cash Flow from Operating Activities Current Assets

Cash Flow from Operating Activities

Prepaid Expenses: Payment of cash prior to the recognition of

expenses
If prepaid expenses increased, then cash paid for expenses is higher
than expenses reported
Company has made cash payments in current period, but only in the
future period will it incur the expenses
I Company deducts from net income any increases in prepaid expenses
If prepaid expenses decreases, company adds to net income the
decrease in prepaid expenses

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 Cash Flow from Operating Activities Current Assets

Cash Flow from Operating Activities

Inventory: Suppose company has $30, 000 inventory in end of

December 2019, and $45, 000 one year later
Company increased inventory by $15, 000
The company paid cash to purchase the inventory but this is not
reflected in the cost of goods sold expense (cash outflow)
The company hence deducts from net income the inventory increase in
the period
If inventory decreases, the company adds to net income the amount of
the change

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 Cash Flow from Operating Activities Current Liabilities

Cash Flow from Operating Activities

Summary for current assets:

Increases in current assets: Subtract from Net Income
Decreases in current assets: Add back to Net Income

3.b) Changes in Non-cash Current Liabilities:

The calculations for non-cash current liabilities is opposite for
non-cash asset liabilities
Accounts Payable: Increases if a company receives a benefit before
paying cash for that benefit
If accounts payable increased, company postponed the cash outflow to
a later date and saved cash
Company must hence add increases in accounts payable to net income

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 Cash Flow from Operating Activities Current Liabilities

Cash Flow from Operating Activities

Income Tax Payable: When company incurs income tax expense but
not paid its taxes, it records income taxes payable
If income tax payable decreases, the company actually paid the tax
Company must adjust by subtracting from net income
Same idea for accounts payables, wages payable, interest payables, and
tax payables
Summary for current liabilities:
Increases in current liabilities: Add back to Net Income
Decreases in current liabilities: Subtract to Net Income

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 Cash Flow from Operating Activities Current Liabilities

Summary of Adjustments to Net Income

Noncash Income Statement Items:

Depreciation Add
Amortization Add
Disposal of plant assets:
Loss Add
Gain Deduct
Working capital adjustments:
Increase in current asset Deduct
Decrease in current asset Add
Increase in current liability Add
Decrease in current liability Deduct

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 Cash Flow from Operating Activities Current Liabilities

Summary Calculating Operating Cash Flows

Depreciation Expense
 
 Increase in Deferred taxes 
 

Decrease in Accounts receivables
 
Net Income +   Decrease in inventories –

 Decrease in prepaid expense 
 
 Increase in payables 
Loss on disposal
 
Decrease in deferred taxes
Increase in Accounts receivables
 
 Increase in inventories 
 Increase in prepaid expense  =
 
 
 Decrease in payables 
Gain on disposal


Net cash flow from operating activities

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