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Chapter 5

Chapter 5 BU227.docx

6 Pages
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Department
Business
Course Code
BU227
Professor
Carolyn Mac Tavish

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BU227 Chapter 5 – Reporting and Interpreting Cash Flows Week 5 Classification of Cash Flows -Cash equivalent – a short-term, highly liquid investment with an original maturity of less than three months -The statement of cash flows explains how the cash balance at the beginning of the period hanged to another cash balance at the end of the period -The definition of cash includes cash and cash equivalents -Highly liquid investments are both: 1. Readily convertible to known amounts of cash 2. So near their maturity that there is little risk that their value will change if interest rates change -An investment qualifies as a cash equivalent only when it has an original maturity of three months or less from the date of acquisition – treasury bills, commercial papers -The statement of cash flows reports cash inflows and outflows based on three broad categories: 1. Operating activities, 2. Investing activities, 3. Financing activities -Statement of Cash Flows defines each category in the required statement Cash Flows from Operating Activities -The cash inflows and outflows that directly relate to revenues and expenses reported on the income statement -These are not affected by accruals, deferrals, and allocations that result from the timing of revenue and expense recognition 1. The direct method reports the components of cash flow from operating activities listed as gross receipts and gross payments Inflows Outflows Cash received from Cash paid for Customers Purchase of goods for resale and services Dividends and interest on investments (electricity, etc) Salaries and wages Income taxes Interest on borrowings -The difference between the inflows and outflows is called the net cash inflow (outflow) from operating activities -This way is more expensive to implement 2. The indirect method starts with profit for the period and then eliminates non-cash items to arrive at net cash inflow (outflow) from operating activities Profit +/- Adjustments for non-cash items_______ Net cash inflow (outflow) from operating activities -Both the direct and indirect method should give the same answer – they are just different ways to do it Cash Flows from Investing Activities -Cash inflows and outflows related to the purchase and disposal of long-term productive assets and investments in the securities of other companies -Typical activities include: BU227 Chapter 5 – Reporting and Interpreting Cash Flows Week 5 Inflows Outflows Cash received from Cash paid for Sale or disposal of property, plant, and equipment Purchase of property, plant, and equipment Sale or maturity of investments in securities Purchase of investments in securities -The difference between these cash inflows and outflows is called net cash inflow (outflow) from investing activities Cash Flows from Financing Activities -Include exchanges of cash with external sources (owners and creditors) to finance the enterprise and its operations -Usual cash flows include: Inflows Outflows Cash received from Cash paid for Borrowing on notes, mortgages, bonds, etc. from Repayment of principal to creditors creditors Interest on borrowings if it is classified as a financing Issuing shares to shareholders activity Repurchasing shares from owners Dividends to shareholders -The different between these cash inflows and outflows is called net cash inflow (outflow) from financing activities Net Increase (Decrease) in Cash -The combination of the net cash flows from operating activities, investing activities, and financing activities must equal the net increase/decrease in cash for the reporting period Relationships to the Statement of Financial Position and the Income Statement -To prepare the statement of cash flows, the following data is needed: 1. Comparative statements of financial position 2. A complete income statement 3. Additional details – concerning selected accounts that reflect different types of transactions and events. Analysis of individual accounts is necessary because often the net change in an account balance during the year does not reveal the underlying nature of the cash flows Cash = Liabilities + Shareholder’s Equity – Non cash assets -Given this relationship, it can also be applied to the change in each one -Any transaction that changes cash must be accompanied by a change in liabilities, shareholders’ equity or non-cash assets -In general increases in cash are associated with decreases in non-cash accounts and increases in liability and shareholders’ equity accounts Decrease in non-cash assets  Cash inflow Increase in liabilities and shareholders’ equity  Cash inflow Increase in non-cash assets  Cash outflow Decrease in liabilities and shareholders’ equity  Cash outflow -The financial position accounts related to earning income (operating items) should be marked with an O: most current assets other than short-term investments, most current liabilities other than amounts BU227 Chapter 5 – Reporting and Interpreting Cash Flows Week 5 owed to investors and financial institutions, and retained earnings -The financial position account related to investing activities should be marked with an I and include the remaining assets – property, plant and equipment, long-term investments and goodwill -The financial position accounts related to financing activities should be marked with an F – all remaining liabilities and shareholders’ equity Reporting and Interpreting Cash Flow from Operating Activities -The operating activities section can be prepared in one of two formats: the direct method and the indirect method Profit = Cash elements +/- non-cash elements Cash elements = Profit +/- non-cash elements -Remember that: 1. Cash flows from operating activities is always
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