FINANCIAL REPORTING:

1
FINANCIAL REPORTING Part 2 The Statement of
Changes in Financial Position, or The Cash Flow
Statement, or the Statement of Cash Flows, or
that statement that Boulton never taught us way
back in grade 11 with eighteen versions of a
really, really long damn name that I cant even
be bothered to remember so Ill just call it
whatever comes into my head.
CHAPTERS
15 18
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CASH FLOW STATEMENT Purpose

• To provide information about cash receipts and
  cash payments during the period
• Recall that accounting numbers are NOT cash
  based, theyre accrual based.
• The Cash Flow Statement reconciles these two
  values (i.e. it turns accrual Net Income into
  real Cash Flow).

Note we are only going to learn the indirect
method.
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CASH FLOW STATEMENT Purpose
Achtungen!
Items that affect PROFIT but not cash Items that affect CASH but not profit
Sales on A/R Bad Debt Expense Inventory valuation (FIFO, etc) Revenue from significant investments Amortization (all kinds) LCM write downs Gains/Losses on sale of assets Changes in accounting policies Purchase of assets Investments in securities Redemption of investments Debt acquisition Debt repayment Stock issue (corp.) Dividends (corp.) Owners investment (sole prop.) Owners Drawings (sole prop.)
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CASH FLOW STATEMENT What You Need

• The cash flow statement is prepared differently
  from the other financial statements it is not
  prepared from the worksheet/trial balance.
• Instead, you require the following information
• 1. Comparative balance sheets (2 years)
• 2. Current income statement
• 3. Any additional information

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CASH FLOW STATEMENT What You Need

• Know that there are three sections to the
  Statement
• Operating activities
• Investing activities
• Financing activities

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CASH FLOW STATEMENT The Process

• RULE OF THUMB
• If it was subtracted from profit but didnt use
  cash, add it back
• If it was added to profit but didnt generate
  cash, deduct it.
• If it doesnt affect cash, dont put it in the
  Cash Flow Statement!

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CASH FLOW STATEMENTThe Process

• Step 1
• Go through the comparative balance sheets and
  determine the value of all differences
• Step 2
• Start the Cash Flow Statement. Begin by listing
  Net Income. Youll now convert this number to Net
  Change in Cash by doing the following
• Step 3
• Place the differences (from Step 1) into the
  appropriate section (be sure to list properly as
  an increase/decrease to cash)
• Step 4
• Complete the statement by taking any additional
  information into account. This may require
  adjustments to Step 3.

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CASH FLOW STATEMENTStep 2.

• Start with your NET INCOME figure.
• All changes will be made to this figure.
• Youll be converting it from an ACCRUAL number,
  into a CASH number.
• We do it this way so we have at least something
  to start with, otherwise wed have to start at
  zero and adjust for every transaction for the
  year.

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CASH FLOW STATEMENT Step 3 Operating Activities

• Operating activities include
• Regular business operations, i.e. the cash
  effects of transactions that create revenues and
  expenses
• Generally

From the Balance Sheet
From the Income Statement
Current Assets
Revenue Expense
An increase is a USE of cash, deduct it.
Since we start with the Net Income, revenues and
expenses are already accounted for. Only non-cash
revenues and costs are a concern. Examples
include
Why?
Example Accounts Receivable
Current Liabilities
An increase is a SOURCE of cash, add it back.
Why?
Example Accounts Payable
Amortization Increase add back
Losses Increase add back
Gains Increase deduct
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CASH FLOW STATEMENTStep 3 Investing Activities

• Investing activities include
• Purchasing and disposing of investments and
  capital (L-T) assets using cash, and
• Lending others money and collecting on those
  loans
• Generally

From the Income Statement
From the Balance Sheet
Capital Assets
Generally, items here are not a
concern Additional information should tell you if
you need to worry about Dividends Received for
significant ownership (gt20), since theyre not
recorded as revenue they must be added. Interest
Revenue on money lent is already in Net Income.
An increase in investments or other long-term
assets is a USE of cash, deduct it.
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CASH FLOW STATEMENTStep 3 Financing Activities

• Financing activities include
• Borrowing money from others and repaying the
  amounts borrowed, and
• Obtaining cash from owners/shareholders and
  paying them drawings/dividends
• Generally

From the Balance Sheet
From the Income Statement
Long-Term Debt and Equity
Generally, items here are not a concern.
An increase in debt or equity is a SOURCE of
cash, add it. Dividends are a USE of cash,
deduct. Note if youve issued bonds or shares,
youve probably used the funds to buy assets, so
youll have entries under Investing Activities.
Note Interest paid on bonds is an operating item
and is already incorporated in the Net Income
figure that you start with.
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CASH FLOW STATEMENTStep 4 Additional Information

• Remember
• You must take additional information into account
  (provided in question)
• Why?
• Example value of Land may change by 10,000 over
  the course of the year
• However, this may be due to a purchase of 20,000
  of new land, and a sale of 10,000 of old land.
• Both activities need to be shown, not just the
  net change of 10,000

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CASH FLOW STATEMENT Whats It Look Like?
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CASH FLOW STATEMENT Whats It Mean?

• A Cash Flow Statement tells you many things
• You need to learn how to spot red flags and
  understand their significance

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CASH FLOW STATEMENT Whats It Mean? The
Operating Section

• Meaning of Significant USE of Cash in
• Accounts Receivable
• Giving credit to risky customers bad debt
• Not collecting quickly enough week credit
  policies
• Poor management of A/R department
• Incompetence in A/R department
• Inventory other Short-Term Assets
• Purchasing too much inventory
• Could be poor sales, bad forecasts, management
  incompetence
• May be a result of lax controls in purchasing,
  or a sudden change in demand
• Building up inventory in anticipation of business
  expansion

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CASH FLOW STATEMENTWhats It Mean? The
Operating Section

• Meaning of Significant USE of Cash in
• Accounts Payable
• Youre paying of debt too quickly
• Not taking advantage of credit granted
• Not having a good credit rating and not being
  granted credit
• Poor management in A/P department

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CASH FLOW STATEMENTWhats It Mean? The
Investing Section

• Meaning of Significant USE of Cash in
• Capital Assets
• May signal a business restructuring
• May indicate that many assets are old and need to
  be replaced
• May signal an up-coming change in product lines
  or business focus
• May be an indication of over zealous ambitions
  buying far too expensive equipment, unnecessary
  purchases, etc.
• Investments
• If investments rise, may be an indication that
  the company has very healthy cash flows, and can
  afford to invest in stocks/bonds
• Increase in equity investments may indicate an
  intention of a takeover

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CASH FLOW STATEMENTWhats It Mean? The
Financing Section

• Meaning of Significant USE of Cash in
• Debt Equity
• Looking to purchase new assets or a new business
• Indication of intention to expand in some way
• Indication of a need to refinance debt (current
  loans have interest that is too high)(look to
  see whats going on in the investing section)
• May be showing that company is short on funds and
  needs loans to keep itself a float (look at other
  areas of statement for clues)
• Dividends
• May be paying out too much in dividends, drain on
  cash
• Could be a result of poor decisions,
  demands/expectations of shareholders

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CASH FLOW STATEMENT Whats It Mean?

• Liquidity
• Cash current debt coverage ratio
• Profitability
• Cash return on sales ratio
• Cash flow per share
• Solvency
• Cash total debt coverage

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CASH CURRENT DEBT COVERAGE

• Cash current debt coverage indicates the amount
  of cash to pay off current debt that is generated
  from operating activities.
• The ratio provides a better picture of liquidity
  than using the current ratio because it uses cash
  provided by operating activities rather than the
  year-end asset balance.

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CASH RETURN ON SALES

• Cash return on sales indicates how quickly sales
  are turned into cash.
• The company is efficient at turning sales into
  cash when its cash return on sales is greater
  than its accrual-based counterpart, the profit
  margin.

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CASH FLOW PER SHARE

• Cash flow per share indicates the cash flow
  generated for each common share.

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CASH TOTAL DEBT COVERAGE

• Cash total debt coverage indicates the amount of
  cash to pay off total debt that is generated from
  operating activities.
• The ratio is the cash based counterpart to the
  debt to total assets ratio.