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Wiley Financial Accounting powerpointCh. 5 - Cash Flow Statement
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Prepared by R. E. Harms CMA John Wiley & Sons Canada, Ltd. ©2015
CHAPTER 5 THE STATEMENT OF CASH FLOWS
Canadian Edition
FINANCIAL ACCOUNTING
Understanding
Significance of the Cash Flow Statement
¨ Information in the statements enable the user to retrospectively: ¤ Assess company’s ability to generate cash flows from
operations ¤ Evaluate where cash has come from – debt or equity ¤ Assess level and type of capital asset investments ¤ Determine how much cash was used for debt
repayment ¤ Evaluate the distribution of cash dividends
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Significance of the Cash Flow Statement
¨ Information in the statements enable the user to prospectively: ¤ Estimate the value of the company based on cash flows ¤ Assess the company’s ability to repay debt in the
future ¤ Evaluate the potential for dividend payments in the
future ¤ Estimate the company’s future cash requirements and
capital structure
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Cash Flow versus Income
¨ The statement of cash flows differs from the income statement because is: ¤ Reflects the cash basis rather than the
accrual basis of accounting ¤ Focuses on more than just the operating
activities – it includes investing and financing activities as well
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The Cash Flow Statement
¨ Measures the cash flow the company in three categories: ¤ Operating Activities ¤ Investing Activities ¤ Financing Activities
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The Cash Flow Statement
¨ Operating activities ¤ Sale of goods and services to customers ¤ Changes to current assets and current liabilities ¤ All other transactions not covered by financing or investing
activities
¨ Cash flows from operating activities are key because: ¤ They are result of day to day business operations ¤ They are the source for future debt repayment ¤ They are the source for future dividend payments
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Cash Flow Statement
¨ Financing activities ¤ Obtaining and repaying resources from shareholders
and lenders ¤ Examples: shares, bonds, mortgages, notes, dividends
¨ Investing activities ¤ Investment, sale, or disposal of long-term assets ¤ Examples: property, plant, equipment, long-term
marketable securities
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Cash Flow Transactions by Category 8
Definition of “Cash”
¨ Includes both cash and cash equivalents ¨ Cash includes cash on hand together with demand
deposits ¨ Cash Equivalents include short term, highly liquid
investments, for example: ¤ Money market funds ¤ Short term deposits ¤ Treasury bills
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The Cash Flow Statement
¨ Companies may choose between the direct method and the indirect method
¨ The only difference is how the cash flows from operating activities are determined – total cash flows are the same under both methods
¨ The choice of method has NO effect on cash flows from investing or financing activities
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Direct vs Indirect Method
¨ Most companies prefer the indirect method for the following reasons: ¤ Simpler to prepare ¤ Uses information available in most accounting systems ¤ Provides a link b/w profit and cash flows from operating
activities
¨ The indirect method is also known as the reconciliation method
¨ Standards setters prefer the direct method; however, most public companies still use the indirect method
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Preparing the Cash Flow Statement
¨ In order to prepare the cash flow statement, a company requires the following information: ¤ Comparative Statement of Financial Position, for the
current and previous period ¤ Statement of Income for the current period ¤ Any additional relevant information
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Comparative Statement of Financial Position 13
Statement of Income 14
Additional Information 15
Steps for Preparing the CF Statement
¨ Step 1 – Determine the net change in cash during the period ¤ Subtract the balance of cash and cash equivalents at
the beginning of the period from the balance at the end of the period
¨ Step 2 – Read the additional information provided and cross reference it to the related statement of financial position accounts
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Steps for Preparing the CF Statement
¨ Step 3 – Using the statement of income: ¤ record net income ¤ adjust if for non cash items included in the statement,
such as depreciation / amortizations, ¤ and any items that do not involve operating activities,
such as gains / losses from sale of capital assets and investments
¤ This is the process under the Indirect method
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Steps for Preparing the CF Statement
¨ Step 4 – Determine the net change in cash in each current asset and currently liability account (other than cash and dividends payable) and record the impact of these change on cash
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Steps for Preparing the CF Statement
¨ Step 5 – Determine and record the cash proceeds received from selling and buying capital assets with cash during the year. In our example: ¤ Equipment that originally cost $25,000 and had a net
book value of $5,000 was sold for $8,900 during the year
¨ A T-account may be useful in your analysis
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Steps for Preparing the CF Statement
¨ Reconstruct the transactions in the PPE account
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Equipment
Beginning Balance 62,000 25,000 Cost of Equipment sold
Balance after sale 37,000 Of Equipment
Cost of Equipment 90,000 Purchased
This is the missing amount, which will produce the ending balance
Ending Balance 127,000
Steps for Preparing the CF Statement
¨ Step 6 – Determine and record the cash proceeds from the sale of shares of other companies (investments) and the cost of any investments in other companies purchased with cash during the year
¨ Step 7 – Determine the amount of cash dividends paid during the year
¨ A T-account can help organize the data
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Steps for Preparing the CF Statement
¨ Reconstruct the transactions in the R/E account
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Retained Earnings
23,750 Beginning Balance 86,000 Net Earnings for 2016
109,750
Dividends Declared 3,200 This is the missing amount, which will produce the ending balance
106,550 Ending Balance
Steps for Preparing the CF Statement
¨ Reconstruct the transactions in the Dividends Payable account
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Dividends Payable
5,200 Beginning Balance 3,200 Dividends Declared
8,400
Dividends Paid during yr 5,200 This is the missing amount, which will produce the ending balance
3,200 Ending Balance
Steps for Preparing the CF Statement
¨ Step 8 – Determine and record the cash received from borrowings (new loans or increases to existing loans) made during the year and the amount of cash principal repaid on loans during the year
¨ A T-account can help organize the data
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Steps for Preparing the CF Statement
¨ Reconstruct the transactions in the Loan Payable account
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Loan Payable
36,000 Beginning Balance
Balance after principal repayments 36,000
This is the missing amount, which will produce the ending balance
7,000 New Borrowings
43,000 Ending Balance
Steps for Preparing the CF Statement
¨ Step 9 – Determine the cash received from shares issued during the period
¨ Step 10 –Calculate the sum of the cash flows from operating, investing and financing activities. It should reconcile back to the amount in Step 1
¨ Companies are also required to disclose: ¤ Interest paid and received during the period ¤ Dividends paid and received during the period ¤ Income taxes paid during the period
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Statement of Cash Flows 27
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Statement of Cash Flows
Direct Method
¨ The direct method differs only in the way the operating activities section of the cash flow statement is prepared. The direct method categorizes cash flows by cash receipts and cash payments.
¨ These categories are as follows: ¤ Receipts from customers ¤ Payments to suppliers ¤ Payments to employees ¤ Payment to interest ¤ Payments of income taxes
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Using the Direct Method 30
Using the Direct Method 31
Investing / Financing Activities
¨ It is possible to have activities that do NOT appear on the cash flow statement. For example: ¤ Company purchased assets by assuming debt or issuing
shares ¤ Company acquired the shares of another company by
assuming debt or issuing shares rather than paying cash ¤ Company repaid debt by issuing shares rather than paying
debt
¨ Since there is no cash inflow or outflow needs only to be disclosed in the notes to the financial statements
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Interpreting the CF Statement
¨ The longer a company’s cash-to-cash cycle the more pressure placed on cash flows
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Mitigating Cash Flow Challenges
¨ Companies can resolve common cash flow challenges by taking the following measures: ¤ Reduce the rate of growth ¤ Shorten the cash-to-cash cycle ¤ Increase company’s capitalization
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Cash Flow Patterns 35
36
Cash Flow Patterns
Financial Statement Analysis
¨ Cash Flow to Total Liabilities = Cash Flows from Operating Activities
Total Liabilities ¨ This ratio measures the percentage of a company’s
total liabilities that could be met with one year’s operating cash flows
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Danier Leather Example 38
Financial Statement Analysis
¨ Net Free Cash Flow is a Non-IFRS financial measure, and therefore is not standardized. Used to measure amount of cash generated from operations that is in excess of cash require to maintain the company’s productive capacity
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Danier Leather Example 40
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