Lesson 3 Statement of Cash Flows PDF

ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No....

ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance Subject: Business Finance ce Grading/Topic No.: 1st Grading (1st Semester) | 3 Lesson 3: Statement of Cash Flows an TOPIC LEARNING OUTCOMES At the end of this session, the learners are expected to be able to: discuss the components and structures of a Cash Flow Statement, such as operating in activities, investing activities, and financing activities. (ABM_FABM12-If10) prepare a Cash Flow Statement based on provided financial data by accurately F categorizing and calculating cash flows from operating, investing, and financing activities. (ABM_FABM12-If11) s demonstrate attention to detail and accuracy when preparing a Cash Flow Statement es through ensuring proper categorization and calculation of cash flows. develop critical thinking and problem-solving skills by analyzing financial data and making appropriate decisions when preparing the Cash Flow Statement. in LEARNING CONTENT us A statement of cash flow is a financial statement which summarizes cash transactions of a business during a given accounting period and classifies them under three heads, namely, cash flows from operating, investing and financing activities. It shows how cash moved during the period by indicating whether a particular line B item is a cash in-flow or a cash out-flow. The term cash used in the statement of cash flows refers to both cash and cash equivalents. The cash flow statement provides relevant information in assessing a company's liquidity, quality of earnings and solvency. - Though the statement of cash flows is generally considered less critical than the income statement and U balance sheet, it can be used to discern trends in business performance that are not readily apparent in the rest of the financial statements. It is especially useful when there is a divergence between the amount of profits dD reported and the amount of net cash flow generated by operations. ESSENCE OF STATEMENT OF CASH FLOW A Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected or turned into cash. Similarly, the expenses reported on the income statement might not have been paid. A person could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy businesspeople and investors recognize the Statement of Cash Flow as an important financial statement. 1 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance Here are a few ways the statement of cash flows is used. ce 1. The net cash from operating activities is compared to the company's net income. ("Net cash" is the cash inflows minus the cash outflows.) If the net cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the net cash from operating activities is less than net income, a red flag is raised as to why the reported net an income is not turning into cash. 2. Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the in company will be able to expand its operations, replace inefficient equipment, increase its dividend, buy back some of its stock, reduce its debt, or acquire another company. All of these are perceived to F be good for stockholder value. 3. Some financial models are based upon cash flow. s The cash flow statement is intended to provide information on a firm’s liquidity and solvency, improve the es comparability of different firms’ operating performance, and to indicate the amount, timing, and probability of future cash flows. in Cash Flows from Operating Activities us Operating activities in a cash flow statement refer to the cash flows that result from a company’s primary business operations. It includes cash inflows from sales revenue, interest received, and dividends received. It also includes cash outflows from payments to suppliers, employees’ salaries, and operating expenses. Cash flows from operating activities can be computed using two methods. B Direct Method vs Indirect Method of Presentation - In the direct method, all individual instances of cash that is received or paid out are tallied up and the total is the resulting cash flow. In financial modeling, the cash flow statement is always produced via the indirect U method. dD A 2 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance ce an in F s es In the indirect (addback) method for calculating cash flows, the accrual basis net income is established first. in This net income is then indirectly adjusted for items that affected the reported net income but did not involve cash. The indirect method adjusts net income (rather than adjusting individual items in the income statement) us for the following phenomena: changes in current assets (other than cash), changes in current liabilities, and items that were included in net income but did not affect cash. Companies tend to prefer the indirect presentation to the direct method because the information needed to create this report is readily available in B any accounting system. In fact, you don’t even need to go into the bookkeeping software to create this report. All you need is a comparative income statement. - U dD A 3 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance ce an in F s es in Let’s take a look at the format and how to prepare an indirect method cash flow statement. us The indirect operating activities section always starts out with the net income for the period followed by non-cash expenses, gains, and losses that need to be added back to or subtracted from net income. These B non-cash activities typically include: Depreciation expense Amortization expense - Depletion expense U Gains or Losses from sale of assets Doubtful Accounts Expense dD The non-cash expenses and losses must be added back in and the gains must be subtracted. The next section of the operating activities adjusts net income for the changes in asset accounts that affected cash. These accounts typically include: A Accounts receivable Inventory Prepaid expenses Receivables from employees and owners Other Current Assets 4 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance This is where preparing the indirect method can get a little confusing. You need to think about how changes ce in these accounts affect cash in order to identify what way income needs to be adjusted. When an asset increases during the year, cash must have been used to purchase the new asset. Thus, a net increase in an asset account actually decreased cash, so we need to subtract this increase from the net income. The opposite is true about decreases. If an asset account decreases, we will need to add this amount back into the income. an Here’s a general rule of thumb when preparing an indirect cash flow statement: Asset account increases : subtract amount from income in Asset account decreases : add amount to income F The last section of the operating activities adjusts net income for changes in liability accounts affected by cash during the year. Here are some of the accounts that usually are used: Accounts Payable s Wages Payable es Payroll Taxes Payable Interest Payable Income Taxes Payable in Unearned Revenues Other Current Liabilities us When a liability increases during the year, cash must have been provided to purchase a new asset or a service. Thus, a net increase in a liability account actually increased cash, so we need to add this increase from the net income. The opposite is true about decreases. If a liability account decreases, we will need to deduct this B amount back into the income. Here’s a general rule of thumb when preparing an indirect cash flow statement: Liability account increases : add amount from income Liability account decreases : deduct amount to income - Illustration 1 - Cash Flows From Operations (Indirect Method) U dD A 5 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance Cash Flows from Investing Activities ce Cash flows from investing activities are cash in-flows and out-flows related to activities that are intended to generate income and cash flows in future. This includes cash in-flows and out-flows from sale and purchase of long-term assets. an Other activities include purchasing of investments, settlement collections, loaning money, or collecting on loans you have made. This section deals with investing activities, like purchasing shares of stock, not in financing activities such as securing funding. Long-term Investments F Land Buildings Equipment s Furniture & Fixtures es Vehicles When you purchase assets, investments, or create new loans, you document a negative flow of cash. If you sell them or collect on a debt, you record a positive cash flow—you brought cash in. In short, investing in activities involve the purchase and/or sale of long-term investments and property, plant, and equipment. us Illustration 2 - Cash Flows From Investing Activities B - U dD A 6 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance Cash Flows from Financing Activities ce Cash flows from financing activities are the cash flows that will alter the equity or borrowings of a business. The sale of company stock for financing can be recorded in this section, along with repurchase of stock, dividend payment, debt repayments (as long as it is for a financing activity). Any payment going out are negative cash flows, and any payments received are positive cash flows. an Other items included in the Operating Activities Short-term Notes or Loans Payable in Long-term Notes or Loans Payable Bonds Payable F Deferred Income Taxes Preferred Stock Paid-in Capital in Excess of Par-Preferred Stock s Common Stock es Paid-in Capital in Excess of Par-Common Stock Paid-in Capital from Treasury Stock Retained Earnings in Treasury Stock us In short, financing activities involve the issuance and/or the repurchase of a company's own bonds or stock as well as short-term and long-term borrowings and repayments. Cash dividends paid to stockholders are also reported in this section. B Illustration 3 - Cash Flows from Financing Activities - U dD A Assume that the cash balance of Season 5 Technologies at the beginning period is $256,000. Compute for Cash balance at the end of the period. 7 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance ce Illustration 4 - Statement of Cash Flow an in F s es in us B - U dD A 8 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance Look at the summary below to see where the changes in the balance sheet accounts should be entered on the ce statement of cash flows: an in F s es in Negative Cash Flow Statements Of course, not all cash flow statements look healthy or exhibit a positive cash flow, but negative cash flow us should not automatically raise a red flag without further analysis. Sometimes, negative cash flow is the result of a company's decision to expand its business at a certain point in time, which would be a good thing for the future. This is why analyzing changes in cash flow from one period to the next gives the investor a better idea B of how the company is performing, and whether or not a company may be on the brink of bankruptcy or success. - Balance Sheet and Income Statement U As we have already discussed, the cash flow statement is derived from the income statement and the balance sheet. Net earnings from the income statement are the figure from which the information on the Statement of dD Cash Flows is deduced. As for the balance sheet, the net cash flow in the Statement of Cash Flows from one year to the next should equal the increase or decrease of cash between the two consecutive balance sheets that apply to the period that the cash flow statement covers. (For example, if you are calculating cash flow for the year 2019, the balance sheets from the years 2018 and 2019 should be used.) A The Bottom Line A cash flow statement is a valuable measure of strength, profitability, and of the long-term future outlook for a company. The Statement of Cash Flows can help determine whether a company has enough liquidity or cash to pay its expenses. A company can use a cash flow statement to predict future cash flow, which helps with matters of budgeting. 9 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance For investors, the cash flow statement reflects a company's financial health since typically the more cash ce that's available for business operations, the better. However, this is not a hard and fast rule. Sometimes a negative cash flow results from a company's growth strategy in the form of expanding its operations. By studying the cash flow statement, an investor can get a clear picture of how much cash a company an generates and gain a solid understanding of the financial well being of a company. POINT TO PONDER in How does analyzing the statement of cash flows provide insights into a company's financial health and ability to manage cash effectively? F FORMATIVE ASSESSMENT s Problem 1 – Analyze the effects (INCREASE or DECREASE) of the following transactions and es determine whether it is an Operating, Investing, or Financing Activity. 1. Payment of Dividends 2. Purchase of Building in 3. Payment of Tax 4. Increase in Prepaid Insurance 5. Increase in Inventory us 6. Gain on Sale of Plant Assets 7. Increase in Salaries Expense 8. Payment of Notes Payable (Principal) B 9. Decrease in Accounts Receivable 10. Proceeds from Sale of Land - 11. Decrease in Accounts Payable 12. Cost of New Plant Assets U 13. Payment of Interest on Notes Payable 14. Issuance of Common Stock dD 15. Depreciation ANSWER KEY: A PROBLEM 1 1. D - FA, 2. D- IA, 3. D- OA, 4. D- OA, 5. D - OA, 6. I - IA, 7. I - OA, 8. D - FA, 9. D - OA, 10. I - IA, 11. D - OA, 12. D- IA, 13. D - OA, 14. I- FA, 15. I - OA 10 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance ce Problem 2 - Lowry Locomotion had the following transactions for the year ended December 31, 2018 an in F s es in Requirement: Prepare the Statement of Cash Flows. us B - U dD A 11 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows  ATENEO DE DAVAO UNIVERSITY Km. 7 Central Park Blvd, Talomo, 8016 Davao City, Philippines Tel No. +63 (82) 221.2411 local 6200 E-Mail: [email protected] * www.addu.edu.ph In Consortium with Ateneo de Zamboanga University and Xavier University SENIOR HIGH SCHOOL – Business Finance ANSWER KEY ce an in F s es in us B - U dD A 12 AdDU Senior High School | Business Finance | Lesson 3 Statement of Cash Flows