Statement of Cash Flows-Discussion

Reasons for Cash Flow Statement

  1. Accrual was becoming full of too many arbitrary allocation devices.
  2. Financial Statements didn't account for inflation.

FASB's intent behind the Statement of Cash Flows

  1. Assess firm's ability to generate positive future cash flow.
  2. Assess ability to meet obligations.
  3. Assess differences between net income and cash inflows and cash outflows
  4. Assess effects of firm's investing and financing of cash and noncash assets on financial position.

Statement of Cash Flows is segregated into three sections:

  1. Operating Activities
  2. Investing Activities
  3. Financing Activities

Operating Activities include:

Cash inflow

  1. Revenue from sale of goods and services
  2. Interest (from debt instruments of other entities)
  3. Dividends (from equities of other entities)

Cash outflow

  1. Payments to suppliers
  2. Payments to employees
  3. Payments to Government
  4. Payments to Lenders
  5. Payments for other expenses

Investing Activities include:

Cash inflow

  1. Sale of Property, Plant, and Equipment
  2. Sale of Debt or Equity Securities (other entities)
  3. Collection of principal on loans to other entities

Cash outflow

  1. Purchase Property, Plant, and Equipment
  2. Purchase Debt or Equity Securities (other entities)
  3. Lending to other entities

Financing Activities include:

Cash inflow

  1. Sale of Equity Securities
  2. Issuance of Debt Securities

Cash outflow

  1. Dividends to shareholders
  2. Redemption of long-term debt
  3. Redemption of capital stock

Information for the preparation of the Statement of Cash Flows is derived from three sources:

  1. Comparative Balance Sheets
  2. Current income statements
  3. Selected transaction data

Three steps:

  1. Determine Change in Cash
  2. Determine net cash flow from operating activities **
  3. Determine cash flow from investing and financing activities

**

There are two methods of determining the net cash flow from operating activities, indirect and direct.  The direct method is the preferred method under FASB 95 and presents cash flows from activities through a summary of cash outflows and inflows.   This may be the more intuititive method for individuals that have no accounting training.  However, this is not the method preferred by most firms.  The indirect method is preferred by most firms because is shows a reconciliation from reported net income to cash provided by operations.  FASB 95 permits both methods and if the direct method is used a schedule showing the indirect method must be provided. 

The indirect method is harder to understand but the following table should provide some guidance as to how the reconciliation takes place.  It begins with net income and adjusts net income for changes in account balances that affect available cash.

 

Net Income

+

 Depreciation Expense

_

 Decrease in Deferred Taxes = Net Cash Flow from Operating Activities
Increase in Deferred Taxes Increase in Accounts Receivable
Decrease in Accounts Receivable Increase in Inventories
Decrease in Inventories Increase in Prepaid Expenses
Decrease in Prepaid Expenses Decrease in Payables
Increase in Payables Gain on Disposal
Loss on Disposal  
   

To help you put this altogether three examples are provided below. The first two examples should be relatively easy given class discussion. The third is more complex than either of the previous examples. Be sure you are comfortable with Examples 1 and 2 before proceeding to Example 3.   After considering all three examples please select "Diane" and continue the process began in Chapters 2 and 3.

Acct 500 Page


Professor Omer