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Week 14

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Chapter

13
STATEMENT OF
CASH FLOWS

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Learning Objective
Explain the purposes and
uses of a statement of
cash flows.

LO1
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Purpose of the Statement of Cash Flows

Provides information about the cash receipts
and cash payments of a business entity
during the accounting period.
Helps investors with questions about the company’s
• Ability to generate positive cash flows.
• Ability to meet its obligations and to pay dividends.
• Need for external financing.
• Investing and financing transactions for the period.

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Learning Objective
Describe how cash
transactions are classified
in a statement of cash
flows.

LO2
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Classification of Cash Flows

The Statement of Cash Flows must
include the following three sections:
• Cash Flows from Operating Activities
• Cash Flows from Investing Activities
• Cash Flows from Financing Activities

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Learning Objective
Compute the major cash
flows relating to operating
activities.

LO3
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Operating Activities
Inflows from:
• Interest and dividends
received.
+ Cash
• Sales to customers.
Flows
Outflows to: from
• Suppliers of merchandise and Operating
services.
• Employees.
_ Activities
• Lenders for interest.
• Governments for taxes.

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Learning Objective
Compute the cash flows
relating to investing and
financing activities.

LO4
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Investing Activities
Inflows from:
• Selling investments and
plant assets.
• Collecting of principal on + Cash
loans.
Flows
from
Outflows to:
• Purchase of investments and Investing
plant assets. _ Activities
• Purchase debt or equity
investments.
• Make loans.
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Financing Activities
Inflows from:
• Short-term and long-term
borrowing. +
• Owners (for example, from Cash
issuing stock). Flows
from
Outflows to: Financing
• Make payments on borrowed _ Activities
funds.
• Owners for dividends.
• Purchase treasury stock.

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Cash and Cash Equivalents

Cash Cash
Equivalents Currency

• Short-term, highly liquid investments.

• Readily convertible into cash.
• So near maturity that market value is unaffected by
interest rate changes.
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Learning Objective
Distinguish between the
direct and indirect
methods of reporting
operating cash flows.

LO5
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Now, let’s
prepare a direct
method
Statement of
Cash Flows for
Martin Co.

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Direct Method
Martin Co.
Comparative Balance Sheets - Assets
December 31,
2006 2007
Cash $ 60,000 $ 70,370
Accounts Receivable, net 27,000 35,000
Inventory 230,000 200,000
Trading Securities - 25,000
Equipment, net 500,000 425,000
Investments 100,000 130,000
Total Assets $ 917,000 $ 885,370

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Direct Method
Martin Co.
Comparative Balance Sheets - Liabilities and Equity
December 31,
2006 2007
Accounts Payable $ 15,000 $ 12,000
Salaries Payable 7,000 5,000
Interest Payable 11,950 7,350
Income Tax Payable 20,000 17,000
Notes Payable, Bob's Bank 70,000 60,000
Bonds Payable 250,000 150,000
Premium on Bonds Payable 5,000 4,000

Common Stock 450,000 500,000

Retained Earnings 88,050 130,020
Total Liabilities and Equity $ 917,000 $ 885,370
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 13-18

Direct Method
Martin Co.
Income Statement Amounts
For the Year Ending December 31, 2007

Sales Revenues $ 800,000

Cost of Goods Sold 560,000
Depreciation Expense 5,000
Interest Expense 28,050
Income Tax Expense 27,980
Salary Expense 80,000
Other Expenses 71,000
Amortization of Bond Premium 1,000
Gain on Sale of Equipment 3,000
Extraordinary Loss 30,000
Equity in Investee Income 40,000
Net Income $ 41,970
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Direct Method
Additional Information
• Trading Securities were purchased during 2007
at a cost of $25,000.
• Equipment with a book value of $40,000 was
sold during the year for $43,000.
• Equipment with a book value of $30,000 was
destroyed during a freak flood in 2007. There
was no insurance.
• Martin owns 25% of the common stock of
another company and uses the equity method
to account for this investment.

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Direct Method
Additional Information
• Martin’s tax rate is 40%.
• The Notes Payable to the bank carry a 12%
rate. The payments are due on the first day of
each month.
• The Bonds Payable carry a 9% rate. Interest is
payable semiannually on July 1 & Jan. 1.
• Sold stock during 2007 for $50,000.
• Received $10,000 dividends from its equity
investment.

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Direct Method
Cash Received from Customers

Sales Revenues $ 800,000

Less: Increase in A/R (8,000)
Cash Received from Customers $ 792,000

Cash Paid to Employees

Salary Expense $ 80,000
2000
Add: Decrease in Salary Payable 2,000
Cash Paid to Employees $ 82,000

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Direct Method
Cash Paid for Inventory
Cost of Goods Sold $ 560,000
Add : Decrease in A/P 3,000
Less: Decrease in Inventory (30,000)
Cash Paid for Inventory $ 533,000

Cash Paid for Interest

Interest Expense $ 28,050
2000
Add: Decrease in Interest Payable 4,600
Cash Paid for Interest $ 32,650

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 13-23

Direct Method
Cash Paid for Taxes

Income Tax Expense $ 27,980

2000
Add: Decrease in Taxes Payable 3,000
Cash Paid for Taxes $ 30,980

Other Operating Cash Flows

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Direct Method
Cash Flows From Operating Activities

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Martin Co.
Equipment with a bookof
Statement value
CashofFlows
For the
$40,000 Period
was sold Ending December 31, 2007
for $43,000.
Operating Cash Flows $ 27,370
Investing Cash Flows
Bonds Payable decreased from
Proceeds
$250,000 from saleduring
to $150,000 of Equipment
2007. 43,000
Financing Cash Flows
Proceeds from sale of Stock $ 50,000
Principal paid on Bonds (100,000)
Principal paid on Notes (10,000) (60,000)
Net Cash Flows for the Period $ 10,370
Notes Payable decreased from
Add: Beginning
$70,000 Cashduring
to $60,000 Balance
2007. 60,000
Ending Cash Balance $ 70,370

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Martin Co.
Statement of Cash Flows
For the Period Ending December 31, 2007
Notice that the Ending $ 27,370
Operating Cash Flows
Cash Balance per the
Investing Cash Flows
Statement of Cash Flows
Proceeds from sale of Equipment
agrees with the 12/31/07 43,000
Financing Cash Flows
Cash balance on the
Proceeds from saleBalance
of Stock Sheet.
$ 50,000
Principal paid on Bonds (100,000)
Principal paid on Notes (10,000) (60,000)
Net Cash Flows for the Period $ 10,370
Add: Beginning Cash Balance 60,000
Ending Cash Balance $ 70,370

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Learning Objective
Explain why net income
differs from net cash
flows from operating
activities.

LO6
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Reconciling Net Income with

Net Cash Flows
There are two major categories of
reconciling items. They include
adjusting for:
1. Noncash Expenses.
2. Timing Differences.

Depreciation Expense
Accounts receivable

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Let’s look at the

indirect method
that is used by
over 97% of all
companies.

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Learning Objective
Compute net cash flows
from operating activities
using the indirect method.

LO7
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Indirect Method
Changes in current assets and current
liabilities as shown on the following table.

Cash Flows
Net
from Operating
Income
Activities

+ Losses and + Noncash

- Gains expenses such as
depreciation and
amortization.

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Indirect Method

Use this table when adjusting Net

Income to Operating Cash Flows.

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Indirect Method
Joyce, Inc. has prepared the Balance Sheet
as of March 31, 2006, and March 31, 2007.
The Income Statement for the year ended
3/31/07 has also been prepared. Joyce
needs help preparing the Statement of
Cash Flows using the indirect method.

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Indirect Method
The $8,000 gain was the
Joyce, Inc.
result of selling land
Income Statement
costing $32,000 for $40,000
For the Year Ending 3/31/07
cash during the period.
Revenues $ 727,000
Operating Expenses (748,000)
Depreciation Expense (6,000)
Gain on Sale of Land 8,000
Net Loss $ (19,000)

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Indirect Method

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Indirect Method
Joyce issued $50,000 of no
par common stock to
settle the $50,000 note
payable.

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Indirect Method

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Indirect Method

With the indirect method, always

start with the net income or net
loss for the period.

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Indirect Method

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Indirect Method

Accounts receivable decreased.

3/31/07 3/31/06
$23,000 - $40,000 = $(17,000)

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Indirect Method

Accounts payable increased.

3/31/07 3/31/06
$38,000 - $27,000 = $11,000

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Indirect Method

Inventory increased.
3/31/07 3/31/06
$350,000 - $300,000 = $50,000

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Indirect Method

Salaries payable decreased.

3/31/07 3/31/06
$ 9,000 - $14,000 = $(5,000)
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Indirect Method

Add back non-cash expenses.

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Indirect Method

Subtract gains.

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Indirect Method

The operating cash

flows amount comes
from the schedule
just prepared.

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Indirect Method

Land originally costing $32,000

was sold for $40,000.

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Indirect Method

Dividends of $20,000 were paid to

owners during the year.

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Indirect Method

Compute the net change in cash

for the period.

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Indirect Method

Complete the Statement of Cash

Flows by reconciling beginning
cash to ending cash.

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Indirect Method
Note that the ending
cash amount ties
back to Joyce’s
Balance Sheet at
3/31/07.

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Indirect Method
In addition, on the face of the statement or in
a supplemental schedule, disclose the
$50,000 noncash financing activity.

Cash interest payments and cash tax

payments must be disclosed.

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Learning Objective
Discuss the likely effects
of various business
strategies on cash flows.

LO8
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Managing Cash Flows

Cash Budgets are used by management to plan and
forecast future cash flows.

A C as h Bu d ge t c an b e u s ed to:

Force m anagem ent to coordinate activities.

P rovide managers w ith advance notice of available resources.

P rovide targets use ful in evaluating performance.

P rovide advance w arnings of potential cash shortages.

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Managing Cash Flows

 Increase collection of accounts receivables.
 Keep inventory low.
 Delay payment of liabilities.
 Plan timing of major expenditures.
 Invest idle cash.

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Learning Objective
Explain how a worksheet
may be helpful in
preparing a statement of
cash flows.

LO9
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Using a Spreadsheet
Cash Budget
May June July August
Beginning cash balance $ 27,500 $ 15,000 $ - $ -
Add: Cash receipts 3,500
Total available cash $ 31,000

Less: Cash disbursements 16,000

Excess (deficiency) of
available cash over cash
disbursements $ 15,000
Financing needed
Financing repayments -
Ending cash balance $ 15,000

The ending cash balance of one month becomes the

beginning cash balance of the next month.
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Using a Spreadsheet
Cash Budget
May June July August
Beginning cash balance $ 27,500 $ 15,000 $ 10,000 $ 10,000
Add: Cash receipts 3,500 2,000 9,000 14,000
Total available cash $ 31,000 $ 17,000 $ 19,000 $ 24,000

Less: Cash disbursements 16,000 18,000 6,000 8,000

Excess (deficiency) of
available cash over cash
disbursements $ 15,000 $ (1,000) $ 13,000 $ 16,000
Financing needed 11,000 - -
Financing repayments - - 3,000 6,000
Ending cash balance $ 15,000 $ 10,000 $ 10,000 $ 10,000

Financing is needed in June because the company

must maintain a minimum cash balance of $10,000.
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End of Chapter 13

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