Chapter 14

Statement of Cash Flows

Slide 14.1
Chapter 14 Learning
Objectives
Identify the principal uses of the
statement of cash flows for financial
decision makers.
Identify and distinguish among
operating, investing, and financing
activities.
Prepare a statement of cash flows using
the indirect method.
Compute and interpret cash flow per
share.
(Appendix) Prepare a statement of cash
flows using the direct method.

Slide 14.2
 Financial Decision-Making and
Cash-Flow Data

Profitable companies sometimes

fail because they don’t
generate sufficient cash
flows.
Decision makers’ demand for cash-flow
data motivated the FASB to require
businesses to begin reporting cash-
flow data in the late 1980s.

Statement of cash flows: a financial statement

that accounts for the net change in a business’s
cash balance during a given period.

. . . this financial statement summarizes the cash

receipts and disbursements from a business’s
operating, investing, and financing activities.

Slide 14.3
Principal Uses of A Statement
of Cash Flows

Evaluate a business’s ability to

produce positive cash flows in the
future.
Determine whether a company can
satisfy its financial obligations.
Identify sources of differences
between a business’s net income
and its related (net) cash flow
from revenue and expense
transactions.
Analyze the impact on a business’s
financial condition of its major
investing and financing
transactions.

Slide 14.4
 Specific Questions that Cash-Flow
Data Can Be Used to Address . . .

Will a company generate sufficient cash to retire

a long-term debt that matures soon?
Why doesn’t a company’s record profits translate
into positive cash flows?
Is a company likely to suspend (or increase) its
dividend payments?
How does the composition of a company’s cash
flows compare to that of its competitors?
How does a company’s
cash flows for the
current year compare
with those of prior
years?

Slide 14.5
 Examining the Statement
of Cash Flows
Two alternative approaches to preparing a
statement of cashflows:

Direct Method--See Exhibit 14.2, page 663

Indirect Method--See Exhibit 14.3, page 664

Under either method, a statement of cash

flows consists of four sections:
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Reconciliation of the beginning and ending cash
balances for a given period

Slide 14.6
 Defining the Three Major Types of
Business Activities . . .

Operating activities: those transactions

and events related to the
production and delivery of
goods and services.
Investing activities: include the
making and collecting of loans, the
acquisition and disposal of PP&E assets,
and the purchase and sale of securities other
than trading securities and cash equivalents.
Financing activities: involve obtaining cash
from lenders and repaying those amounts
and obtaining cash from investors and
providing them with a return of and a return
on their investments.

Slide 14.7
 Examples of Cash
Inflows & Outflows
Receipts from customers--operating
activity
Loans made to other firms--
investing activity
Dividend payments--financing
activity
Payments to acquire PP&E assets--
investing activity
Payments of taxes--operating
activity
Receipts from the issuance of
bonds--financing activity

Slide 14.8
Direct Vs. Indirect Methods of
Preparing the Statement of
Cash Flows
Only major difference involves presentation of
cash flows from operating activities . . .

Direct method: specific cash flows

from operating activities are reported
Indirect method: cash flows from
operating activities are derived from
net income

The FASB prefers the direct method . . .

. . . but the indirect method is used by the
large majority of companies.

Slide 14.9
 Applying the Indirect Method

Determining net cash flow

from operating activities:

Net Income $xxx

Plus: Depreciation & amortization xx
Losses xx
Decreases in noncash current assets xx
Increases in current liabilities xx
Less: Gains xx
Increases in noncash current assets xx
Decreases in current liabilities xx
Net cash flow from operating activities $xxx

Slide 14.10
 Determining Net Cash Flow
from Operating Activities under
the Indirect Method . . . .

Depreciation &
amortization are
added to net income
because they are
noncash expenses.
Gains & losses require
adjustments to net income since they
are nonoperating items.
Changes in current accounts require
adjustments to net income . . . since
they reflect differences between
revenues and expenses and the
related operating cash flows.

Slide 14.11
 Determining Net Cash Flow from
Operating Activities under the
Indirect Method . . .
. . . rules to apply in
analyzing current accounts
when computing net cash
flow from operating
activities.

Increases in noncash current asset

accounts are deducted from net income
and decreases in these accounts are
added to net income.
Increases in current liability accounts are
added to net income and decreases in
these accounts are deducted from net
income.
Slide 14.12
Applying the Indirect Method

Determining net cash flow

from investing and financing
activities:

Businesses typically have few

transactions each year that qualify as
investing or financing activities.
These transactions are often identifed
by simply scanning the accounting
records.
Note: companies must provide
supplemental disclosures of their
“noncash” investing and financing
activities.

Slide 14.13
 Interpreting Cash-Flow
Information

Comparative
analysis of a
firm’s cash flows
Computing cash flow
per share

Slide 14.14
 Comparative Analysis of
Cash Flows

This technique involves

comparing a firm’s
three types of cash
flows over a
span of several
years.
Decision makers prefer operating
activities to be a firm’s primary
source of cash.
There is a limit to the amount of cash
that can be raised from investing &
financing activities.

Slide 14.15
 Computing Cash Flow per
Share

The FASB prohibits firms from

reporting cash flow per share.
Why? Concern that reporting both
earnings per share and cash
flow per share would
confuse financial
statement users.

But . . . investment advisory firms

regularly report cash flow per share
data for large corporations.

Slide 14.16
 Common Equation for Cash
Flow per Share

Cash Flow Net Cash Flow from Operating Activities*

=
per Share Weighted Average # of Common Shares Outstanding

*Less any preferred stock dividends

One useful way to interpret cash flow per share

is to compare it over a period of several years
to a firm’s earnings per share.
Normally, cash flow per share exceeds earnings
per share . . . because of depreciation expense.
Any significant variation from the “normal”
historical pattern between these two key
financial amounts should be investigated.

Slide 14.17
Direct Method of Preparing a
Statement of Cash Flows

Again, the only major

difference between the
indirect and direct
methods involves the
computation of net cash
flow from operating activities.
Under the direct method, specific cash flows
from operating activities must be
reported . . . such as receipts from
customers.
The account-analysis technique is commonly
used to filter cash-flow data from accrual-
basis data when the direct method is
applied.

Slide 14.18
 Applying the Account Analysis
Technique . . . one example

Operating cash flow: cash receipts from

customers
Accounts involved: Sales and Accounts
Receivable
Equation to derive “cash receipts from
customers” from balances of Sales and
Accounts Receivable accounts:

( + decrease in Accounts Receivable )

Sales ( or )
( - increase in Accounts Receivable )

Slide 14.19