Note on Cash Flow Statements

Note on Cash Flow Statements Indirect Cash Flow Statements can be pretty confusing, but they don't have to be if you think about their relationship to the other financial statements. Here I present several examples to help you to intuitively think about how you can use the income statement and the balance sheet to determine the statement of cash flows using the indirect method. After looking at these examples, you can construct even more complicated ones for yourself to strengthen your intuition. There is a mathematical method for thinking about the indirect method. Here I will repeat the derivation that you saw in class. You should also have this information in • the note entitled "Understanding the Statement of Cash Flow" in the course packet, and • the class slides "The Statement of Cash Flow." Balance Sheet Equation: A(t) = L(t) + SE(t) A(t+1) = L(t+1) + SE(t+1) Beginning Balance Sheet Equation (at time t) Ending Balance Sheet Equation (at time t+1 period) Differences: ∆A = ∆L + ∆SE Decompose: ∆Cash + ∆OCA + ∆NCA = ∆CL + ∆NCL + ∆CC + ∆OE + ∆RE Note that ∆RE = NI - Div so we have: ∆Cash + ∆OCA + ∆NCA = ∆CL + ∆NCL + ∆CC + ∆OE + NI - Div Since we are interested in the change in cash, we re-arrange to solve for the change in cash: ∆Cash = - ∆OCA - ∆NCA + ∆CL + ∆NCL + ∆CC + ∆OE + NI - Div = + NI - ∆OCA + ∆CL - ∆NCA + ∆NCL + ∆CC + ∆OE - Div Putting in the accounts we know about: ∆Cash = + NI - ∆netA/R - ∆Inv. - ∆OCA + ∆CL - ∆netPPE - ∆NCA + ∆NCL + ∆CC + ∆OE - Div But the change in net PP&E can be broken down even further into B/S and I/S effects: ∆netPPE = ∆PPE - ∆AccDepreciation = Gain(Loss) - DepExp + (∆PPE - ∆AccDepreciation) -Gain(Loss) + DepExp • Since Gains(Losses) should not affect the Operating Section, but are included in the IncomeStatement, they need to be subtracted(added) from Net Income in this section. • Since Depreciation Expense is a non-cash expense (but affects Net Income), it needs to be added back to the Net Income in the Operating Section. Inserting the expanded ∆netPPE: ∆Cash = + NI - ∆netA/R - ∆Inv. - ∆OCA + ∆CL - (Gain(Loss) - DepExp + (∆PPE – ∆AccDepreciation) -Gain(Loss) + DepExp) - ∆NCA + ∆NCL + ∆CC + ∆OE - Div Rearranging: ∆Cash = + NI + DepExp - ∆netA/R - ∆Inv. - ∆OCA + ∆CL - Gain(Loss) OPERATING INVESTING - (∆PPE - ∆AccDepreciation) +Gain(Loss) - DepExp - ∆NCA + ∆OE + ∆NCL + ∆CC - Div FINANCIING Further: ∆PPE =Acquisition – Disposal at Original Cost ∆AccDepreciation = DepExp – AccDepreciation of Disposed Item Thus: ∆PPE - ∆AccDepreciation -Gain(Loss) + DepExp = Acquisition – (Disposal at Original Cost - AccDepreciation of Disposed Item) - Gain(Loss) = Acquisition – Proceeds from Disposal Example 1 - Revenues and the indirect statement of cash flows A Simple Example - Services sold with no COGS Transaction Assets Cash $30,000 Make a sale for cash Make a sale on credit Customer pays part of A/R = $42,000 (37,000) $5,000 37,000 $67,000 Cash Collected Equals Increase of $67,000 in A/R of $5,000 Statement of Cash Flows Cash from Operating Net Income Adjustments $ 72,000 1 (Less increases in Current Assets) Increase in A/R (5,000) Cash Increase from Operating $ 67,000 Cash from Investing $ 0 Cash from Financing $ 0 Change in cash Beginning cash balance Ending cash balance $ 67,000 0 $ 67,000 1 Decreases in Current Assets would be Added Liabilities A/R + Shareholders' Equity Retained Earnings $30,000 42,000 $72,000 Minus the Net Income of $72,000 Notes Sales Revenue Sales Revenue Example 2 - Revenues with COGS and the indirect statement of cash flows An Example - Goods sold with COGS (Goods sold at 10 times the value of COGS ) Note that each sale is split up into 2 transactions on the BSE: a Revenue component and COGS component Transaction Assets Cash Purchase Inv w/cash Make a sale for cash COGS Make a sale on credit COGS Customer pays part of A/R ($10,000) 30,000 A/R (37,000) $5,000 Increase in A/R of $5,000 Cash from Operating $64,800 (Less increases2 in Current Assets) (5,000) (2,800) Cash from Investing Cash from Financing $57,000 $0 $0 Change in cash Beginning cash balance Ending cash balance $57,000 $0 $57,000 2 Decreases would be added Minus the and Shareholders' Equity Retained Earnings (4,200) $30,000 (3,000) 42,000 (4,200) $2,800 $64,800 $42,000 37,000 $57,000 + Notes $10,000 Equals Statement of Cash Flows Increase in A/R Increase in Inventory Cash Change in Operating Inventory (3,000) Cash Collected of $57,000 Net Income Adjustments = Liabilities Increase in Inv. Of $2,800 Net Income of $64,800 Sales Revenue COGS Sales Revenue COGS Example 3 - Expenses An Example - Salary Expenses Transaction Assets Cash ($13,000) Pay Salaries Accrue Salaries = Liabilities Salaries Payable $1,000 ($13,000) $1,000 Cash Spent of $13,000 Equals Increase in Salary Pay. of $1,000 Statement of Cash Flows Cash from Operating Net Income Adjustments ($ 14,000) (Less increases3 in Current Assets) none (0) (Plus increases4 in Current Liabilities) Change in Salaries Payable Cash Increase from Operating 1,000 ($ 13,000) Cash from Investing $ 0 Cash from Financing $ 0 Change in cash Beginning cash balance Ending cash balance ($ 13,000) 0 ($ 13,000) 3 4 + Decreases in Current Assets would be added Decreases in Current Liabilities would be subtracted Shareholders' Equity Retained Earnings ($13,000) (1,000) ($14,000) Plus the Net Income of ($14,000) Notes Salary Expense Salary Expense Example 4 - PP&E An Example - Acquiring and Selling PP&E Transaction Buy PP&E Sell PP&E (gain) Deprec. Exp. - Accum. Deprec. Shareholders' Equity Retained Earnings ($25,000) 35,000 $10,000 $4,000 (35,000) ($31,000) Assets = Liabilities Cash PP&E ($60,000) 9,000 $60,000 (30,000) ($51,000) $30,000 Cash spent of $51,000 Equals Increase in PP&E of $30,000 Statement of Cash Flows Cash from Operating Net Income Adjustments Minus Increase in Accum Depr of $10,000 + Add Cash from Investing Purchase of PP&E Sale of PP&E ($31,000 ) ($60,000 ) 9,000 ($ 51,000) none (0 ) (Plus increases in Current Liabilities) none 0 (and adjustments due to PP&E) Cash Increase from Operating Gain on sale Deprec. Exp. Net Income of ($31,000) (Less increases in Current Assets) Add back Depreciation Exp Subtract (add) Gain (Loss) Notes ( 35,000 4,000 ) $ Cash from Financing $ Change in cash Beginning cash balance Ending cash balance ($ 51,000) 0 ($ 51,000) 0 Alternate method for determining Cash from Investing: Less Change Net PP&E ($30,000 ) Change in PP&E Change in Accum Deprec 10,000 ($ 20,000 ) Plus Gains 4,000 (35,000 ) Less Deprec. Exp. ($ 51,000 ) TOTAL Cash from Investing 0