Part 3 Cash Flow Statement

Slide # 1 Cash Flow Statement

The Cash Flow Statement is the second statement you will complete, since it draws information from the Income Statement and provides information for the Balance Sheet.

The ChCash Flow Sta temen t summarizes the cash actlltually entitering and lileaving the company over a period of time.

Slide # 2 Cash Flow Statement

How is Cash different from Net Income? All companies have at least one non‐cash expense, which is depreciation. For companies that allow accounts receivable, revenues may be recorded without a cash inflow. Likewise with accounts payable, expenses can be deducted from Net Income without a cash outflow. Additionally, Net Income reflects activity for a period of time but does not indicate how much cash was available at the start of the period. Therefore, Net Income is not the same as Cash.

Example: Cash Adjustment for Depreciation If you’re working on a cash‐basis, how much of a difference could there really be between Net Income and cash? Consider this example. A newspaper company spends $250,000 in cash on a new printing press. Using a 10‐year depreciation schedule, the only expense subtracted from Net Income for the year is $25,000 in depreciation. However, cash reserves have been reduced by the full $250,000 cost. If you looked only at Net Income, you might think the company’ s cash balance is $225,000 higher than it really is.

Slide # 3 Cash Flow Statement

Why do you care about the cash balance?

Companies only continue operating only while there is cash to pay suppliers and employees. After about thirty days without paychecks, employees will find other jbjobs. UllUsually after siitxty days withou t payment, suppliers will withdraw credit. Idea lly, a company should reserve enough cash and/or have a line of credit to cover six months of operating expenses.

Slide # 4 Cash Flow Statement

There are four main categories on the Cash Flow Statement: . Operating Activities . Investing Activities . Financing Activities . Changes in Cash Balance

Slide # 5 Cash Flow Statement

Operating Activities are the day‐to‐day revenues and expenses. These figures come from the Income Statement.

Investing Activities and Financing Activities are sources of cash flow from non‐ operating activiti es. To keep these two stihttraight in your midind, remember tha t you are looking at these from the company’s perspective. The company invests in things, like land and equipment, in order to earn Income. The company finances their activities through bank or owner loans that will be paid back.

It can get confusing to keep straight what to add or subtract on the Cash Flow Statement. Keep in mind that cash inflows are positive values and cash outflows are negative values on the Cash Flow Statement. Therefore, repayment of a loan is a cash outflow that results in a negative value. Also remember that since it is negative, you’ll show the amount in parentheses.

Slide # 6 Cash Flow Statement

Operating Activities This section is, in essence, an adjustment to Net Income for cash that was not actually received and expenses that were not actually paid.

Start with Net Sales to Customers from the Income Statement. Don’t make the common mistake of sttitarting with Gross SlSales, since it d’tdoesn’t account for the cash you gave back to customers for returns and discounts.

Is there an adjustment to make? How would Net Sales differ from actual cash received from customers?

There is no adjustment to make. In our simplified accounting module, we assume that all customers will pay cash at the time of the sale. However, if you allowe d your customers shthort‐term credit, you would have non‐cash receipts in the form of Accounts Receivable. (Note: This is different from accepting credit cards. Ask your instructor for more information.)

Slide # 7 Cash Flow Statement

Operating Activities

Next look back to your Income Statement for the Total Operating Expenses. This is a cash outflow so the amount will negative.

Is there an adjustment to mak?ke? What could cause a difference between Operating Expenses and actual payments made for expenses?

When you moved the Total Opgperating Expenses figure from the Income Statement, it included a non‐cash payment of Depreciation. Depreciation expenses are theoretical adjustments. The actual outflow of cash for the equipment purchase is dealt with later, in the investing section of the Cash Flow Statement. Therefore, if you do not adjust for depreciation, you are reducing cash twice for the same outflow. Add depreciation to undo this non‐cash expense.

Slide # 8 Cash Flow Statement

Operating Activities If you received goods or services from a supplier without paying, this would also skew Total Operating Expenses. We will not address Accounts Payable in this module, since our examples reflect the cash‐basis.

The final variable to consider in the Oppgerating section is Taxes. If you pay taxes as you earn income, you are actually prepaying the taxes that will be due by April of the following year. After the end of the period, any taxes owed are no longer a prepayment. Whether for prepayment of taxes in the current year or a payment for taxes owed from the previous year, taxes are an outflow of cash that must be subtracted.

Looking back at the Income Statement, you’ll see that Inventory Purchases are subtracted in the Cost of Goods Sold section. So far on the Cash Flow Statement, we have only drawn figures for Net Sales and Total Operating Expenses. Accordingly, this outflow of cash has yet to be accounted for on the Cash Flow Statement. Only the inventory purchases made in the current year are relevant. Subtract the figure for Inventory Purchases that you find on the Income Statement.

Slide # 9 Cash Flow Statement

Operating Activities

By making these adjustments to Net Sales and Operating Expenses, you’re left with NtNet ChCash Flow from OOtiperating AAtiitictivities.

Normally the Cash Flow is positive and the company needs to retain cash from its operating activities each year. We’ll look at this issue in more depth in the investing and financing sections.

Slide # 10 Cash Flow Statement

Investing Activities Again, Investing Activities include equipment, property, or land acquired for the company’s own use or to be sold. Basically, investing is what a company does with money it already has (as opposed to financing, which is getting money it doesn’t have).

Large companies sometimes leverage extra cash thhhrough tradlditional investment tools like bonds, money market accounts, or rentable property. In a sole proprietorship, this type of investing activity rarely occurs because it makes more sense for owners to withdraw surplus cash for personal use or investment. Therefore, our samples and activities do not show this type of investment.

Slide # 11 Cash Flow Statement

Investing Activities

If the company sold any long‐term physical assets in the period, you record a positive value for Proceeds from the Sale of Property, Plant, and Equipment. The stress here is on “long‐term”, since you do not really “invest” in things that are disposable. In particular, remember that inventory is not an investment and was already accounted for in the Operating Activities section.

Next, find the amount spent on Purchased Property, Plant, and Equipment in the current year. Again, this is the purchase of long‐term fixed, not disposable, assets. The purchase of inventory was accounted for in the Operating Activities section.

Add the two figures from the sale and purchase of property, plant, and equipment to find the Net Cash Flows from Investing Activities.

Slide # 12 Cash Flow Statement

Financing Activities Financing Activities reflect the borrowing and repayment of loans. Companies can borrow from owners, banks, or other investors. When the time comes for repayment, it may be in the form of owner withdrawals or repayment of long‐term debt.

Slide # 13 Cash Flow Statement

Financing Activities Owner Investment is simply money that the owner lends to the company. As a cash inflow, it is a positive number. It does not include any non‐cash investments, like the contribution of personal property, such as a vehicle or furniture. Non‐cash investments do not disappear; they are simply irrelevant to this statement, which reflects cash transactions. You will learn more about non‐cash owner investments in the section on the Balance Sheet.

On a separate line, subtract Owner Withdrawals. Again, this reflects only cash withdrawals by the owner from the current year. Owners withdraw money to repay the ir ittinvestment or to tktake a profit share. In small businesses, for which the owners are responsible for taxes on business income, you would see withdrawals for the payment of taxes in this category.

Slide # 14 Cash Flow Statement

Financing Activities If the company has borrowed money from sources other than the owner, like a bank loan, the inflow of cash will be added in the Proceeds from Long‐term Debt Receipts.

When these loans come due, the amount of the principal paid back will be subtracted through Repayment of Long‐term Debt. It is especially important to realize that only the principal is dddeduc tdted here. ItInterest paid in any year is recorded on the Income Statement as an Operating Expense and was already deducted in the Operating Activities section of the Cash Flow Statement.

Slide # 15 Cash Flow Statement

Financing Activities The sum of these entries is Cash Flow from Financing Activities.

Slide # 16 Cash Flow Statement

Net Change in Cash Having completed the cash flows from operating, investing, and financing activities, you are nearly done with the Cash Flow Statement.

Sum the totals of Cash Flow from Operating, Investing, and Financing Activities in order to find the Net Change in Cash for the Current Year.

Slide # 17 Cash Flow Statement

Adjusting for the Beginning Cash Balance So far, the ChCash Flow Sta temen t has dltdealt only with the inflows and outflows of cash in the current year. We haven’t taken into account the cash with which the company started the year. To do so, add the Beginning Cash Balance, which you will find on the Cash Flow Statement from the previous year. In the case of new businesses that do not have a Cash Flow Statement from the previous year, the Beginning Cash Balance is usually zero.

Once you have the Ending Cash Balance, the Cash Flow Statement is complete. You will need to keep the Cash Flow Statement and Income Statement handy as we move on to the Balance Sheet. Before moving on, try the Cash Flow Statement Activities provided.

Slide # 18 Cash Flow Statement

This concludes the Cash Flow Statement portion of the Financial Statements tutorial. Now complete the activities provided for the Cash Flow Statement. Feel free to revisit the information provided here any time.

Slide # 19