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Week 2 – Assignment: Assess the Components of Cash Flow Statements

Research the development, components and the analyses of the statement of cash flows. You will need to become very familiar with the statement of cash flows and the components in order to successfully respond to the questions listed below. Your analysis of cash flow should address the following points:

1. Present and describe the components of the statement of cash flows. Use illustrative numerical examples to clarify the discussion.

2. Describe the two alternative methods to develop and present the statement of cash flows.

3. Using one of the two methods, discuss how the different components of the statement of cash flows either serve to increase or decrease the cash account. Discuss what meaning this can have for the analyst.

4. Identify two Statements of cash flow for two different companies. You might find these companies within the textbook or more basically gather the information from the financial statements of two known companies by looking through their web sites (investor relations) Compare the two statements and offer insight for which of the statements seems to represent a stronger company. Discuss.

Support your paper with a minimum of five (5) external resources In addition to these specified resources, other appropriate scholarly resources, including older articles, may be included.
Length: 5-7 pages not including title and reference pages
Your paper should demonstrate thoughtful consideration of the ideas and concepts presented in the course and provide new thoughts and insights relating directly to this topic. Your response should reflect scholarly writing and current APA standards.

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Chapter 10
Statement of Cash Flows

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2

Uses a concept of cash that includes not only cash but also short-term, highly liquid investments
Referred to as the cash and cash equivalent focus
Explains the changes in focus accounts
Basic Elements of the Statement of Cash Flows

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Uses of the statement of cash flows
Internal (management) users
Determine dividend policy
Evaluate cash generated by operations
Review investing and financing policy
External users
Determine a firm’s ability to increase dividends
Determine a firm’s ability to pay debt from operations
Determine the percentage of cash from operations in relation to the cash from financing
Basic Elements of the Statement of Cash Flows—Continued

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
4

Structure of the Statement of Cash Flows
Cash Flows from Operating Activities
Add: Cash Flows from Investing Activities
Add: Cash Flows from Financing Activities
Change in Cash

Beginning Cash Balance
Add: Change in cash
Ending Cash Balance
Supplemental disclosure: Noncash investing and financing activities

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5

Operating Activities
Cash inflows from
Sale of goods or services
Returns on loans (interest)
Return on equity securities (dividends)
Cash outflows for payments
For acquisitions of inventory
To employees
For taxes
For interest expenses
For other expenses
Include the cash effects of events that enter into the determination of net income

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6

Investing Activities
Cash inflows from
Receipts from loans collected
Sales of debt or equity securities of other corporations
Sale of property, plant, and equipment
Cash outflows for
Loans to other entities
Investment in debt or equity securities of other entities
Purchase of property, plant, and equipment
Lending and collecting money and acquiring and selling investments and long-term assets

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7

Financing Activities
Cash inflows from
Sale of equity securities
Sale of bonds, mortgages, notes, and other short- and long-term borrowings
Cash outflows for
Payment of dividends
Reacquisition of capital stock
Payment of amounts borrowed
Include cash flows relating to liability and owners’ equity

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8

Direct method
Converts the income statement from accrual basis to a cash basis
Encouraged by SFAS No. 95
Supplemental information required
Reconciliation of net income to cash provided by operations
Indirect method
Adjusts net income for items that affected net income but did not affect cash
Supplemental information required
Cash paid for income taxes and for interest
Presentation of Cash Flows From Operations

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9

Exhibit 10-1—Statement of Cash Flows: Direct Method

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10

Exhibit 10-1—Statement of Cash Flows: Direct Method

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11

Exhibit 10-1—Statement of Cash Flows: Indirect Method

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12

Exhibit 10-1—Statement of Cash Flows: Indirect Method

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13

Traditional ratios related income statement item(s) to a balance sheet item(s)
Statement of cash flows became a required statement in 1987
Cash flow financial ratios were slowly developed
Operating cash flow to current maturities of debt
Operating cash flow to total debt
Operating cash flow per share
Operating cash flow to cash dividends
Financial Ratios and the
Statement of Cash Flows

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14

Indicates a firm’s ability to meet its current maturities of debt
Higher ratio indicates better liquidity
Operating Cash Flow to Current Maturities of Debt

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
15

Indicates a firm’s ability to cover total debt with the yearly operating cash flow
The higher the ratio, the better the firm’s ability to carry its total debt
Conservative approach is to include all possible balance sheet debt
Operating Cash Flow to Total Debt

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16

Indicates the funds flow per common share outstanding
Higher than earnings per share as depreciation is not deducted
Operating Cash Flow per Share

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
17

A better indication of a firm’s ability to make capital expenditure decisions and pay dividends than is earnings per share
Does not reflect firm’s profitability
Firms are prohibited from reporting this on financial statements
Operating Cash Flow per Share—Continued

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18

Indicates a firm’s ability to cover cash dividends with the yearly operating cash flow
Higher the ratio, the better the firm’s ability to cover cash dividends
Operating Cash Flow to Cash Dividends

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19

No standard definition of cash flow
Alternative definition
Net income plus depreciation expense
Less useful than the net cash flow from operating activities
Alternative Cash Flow

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
20

Analyze all balance sheet accounts other than cash and cash equivalents.
Procedures to Develop the Statement of Cash Flows
Increase Decrease
Current assets Operating outflow Operating inflow
Noncurrent assets Investing outflow Investing inflow
Current liabilities Operating inflow Operating outflow
Long-term liabilities Financing inflow Financing outflow
Stockholders’ equity Financing inflow Financing outflow

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
21

Three techniques used to prepare the statement of cash flows
The visual method
Determine change in cash and cash equivalents
Compute the net change in all other balance sheet accounts
Classify as operating, investing, and financing
The T-account method
The worksheet method
Procedures to Develop the
Statement of Cash Flows

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
22

Operating section describes income statement accounts in terms of receipts or payments
Cash receipts
From customers
From other operating sources
Cash payments
For merchandise
To employees
For other operating expenses
Procedures to Develop Operating Cash Flows: Direct Approach

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
23

Begin with net income
Add or deduct adjustments to change accrual basis net income to cash basis net income
Changes in current noncash assets
Changes in noncash assets go in the inverse direction of changes in cash
Changes in current liabilities
Changes in noncash liabilities go in the same direction of changes in cash
Procedures to Develop Operating Cash Flows: Indirect Approach

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24

Adjust net income (loss) for noncash expenses (like depreciation expense) and noncash revenues
Eliminate non cash gains and losses that relate to investing and financing activities
Procedures to Develop Operating Cash Flows: Indirect Approach

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25

Operating Cash Flow
Current Maturities of Long-Term Debt and
Current Note Payable
Operating Cash Flow
Total Debt
Operating Cash
Operating Cash Flow Preferred Dividends
=
Flow per Share
Diluted Weighted Average Common
Shares Outstanding
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–
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Operating Cash Flows
Cash Dividends