Financial Accounting I - Lecture 7

[email protected]
Vlad Andrei Porumb
Duisenberg 826
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Today
› Remember what we did last week?

› Statement of cash flows

› Cash flows from operating activities

› Cash flows from investing activities

› Cash flows from financing activities

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Remember what we did last week?

 Stockholders’ equity

Contributed capital
Retained earnings
Treasury stock

The stockholders’
investments in the
corporation Earnings of the
Shares of the corporation’s
corporation since its
own stock that it has
inception, less any losses, bought back on the open
dividends, or transfers to market
contributed capital
 Stock dividend
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› After the stock dividend:

Contributed capital
Common stock, $1 par value, 1,100,000
1,100,000 shares issued, 1,000,000 outstanding
Additional paid-in capital 54,900,000
Paid-in capital, treasury stock 500,000
Total contributed capital 56,500,000 Note that R.E. is
Retained earnings 94,000,000 now exactly $6
million lower!
Less: Treasury stock, common,
100,000 shares at cost (5,500,000)
Total stockholders’ equity 145,000,000
 Stock split
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› Before the stock split:

Common stock, $1 par value, 1,100,000 shares issued,
1,000,000 outstanding

› After the stock split:

Common stock, $0.50 par value, 2,200,000 shares
issued, 2,000,000 outstanding

› Obviously, the number of shares in Treasury stock has

also increased from 100,000 to 200,000!
 Statement of SE
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Statement of Stockholders‘ equity, Dec. 31, 2015

Additional paid-in Paid-in capital,

Common stock capital treasury stock Retained earnings Treasury stock Total

Balance, Dec. 31,

2014 1,000,000 49,000,000 100,000,000 (11,000,000) 139,000,000

Net income 50,000,000 50,000,000

Sale of treasury
stock 500,000 5,500,000 6,000,000

Stock dividend 100,000 5,900,000 (6,000,000) 0

Balance, Dec. 31,

2015 1,100,000 54,900,000 500,000 144,000,000 (5,500,000) 195,000,000
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Chapter 12: The Statement of Cash
Flows
• Analyzing cash flows
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
 The 4 Financial Statements
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Cash Flow Income Statement

Statement Revenues
Operating act. - Expenses
Investing act. = Net income
Financing act.
= Change in cash
+ Starting balance Balance Sheet
= Ending cash bal.
Assets Liabilities Statement of
Equity Retained Earnings
Starting balance
+ Net income
- Dividends
= Retained earnings
 Statement of cash flows

› The statement of cash flows shows how a company’s

operating, investing, and financing activities have
affected cash during an accounting period

› It explains the net increase or decrease in Cash

 Statement of cash flows

› Managers use the statement of cash flows to:

• Assess liquidity
• Determine the company’s dividend policy
• Evaluate the effects of major policy decisions
 Statement of cash flows

› Investors use the statement of cash flows to assess a

company’s ability to:

• Manage cash flows

• Generate positive future cash flows
• Anticipate the need for additional financing
 Operating activities

› Operating activities involve cash inflows and

outflows that result from ongoing, regular business
activities

› Cash inflows include cash receipts from the sale of

goods and services

› Cash outflows include cash payments for wages,

inventory, expenses, taxes, etc.
Operating activities
 Investing activities

› Investing activities involve the purchase and sale of

property, plant, and equipment and other long-term
assets (i.e., long-term investments)

› Investing cash flows are mostly related to the sale

and purchase of long-term assets, as well as
collecting on and making loans
Investing activities
 Financing activities

› Financing activities involve obtaining resources

from stockholders and creditors

› Financing cash flows are related to stock

transactions and short- and long-term borrowing

› Note that repayment of accounts payable and

accrued liabilities is part of operating activities!
Financing activities
Preparing the statement of CFs
 CFs from operations

› The income statement shows how successful a

company has been in making a profit from its
operating activities

› However, the income statement is prepared on an

accrual basis (i.e., sales on credit) and must
therefore be converted to a cash basis
 CFs from operations (2)

› There are two methods to convert the income

statement to a cash basis:

(Direct method: Adjusts each item on the income

statement from accrual basis to cash basis)

Indirect method: Does not require adjusting each

item on the income statement. It lists only the
adjustments necessary to convert net income to cash
flows from operations
 CFs from operations (3)
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Three steps to correct net income to net cash flows from

operating activities:
1) Non cash expenses (i.e. depreciation)
2) Gains / losses on sale / purchase of assets
3) Changes in current assets and current liabilities

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 CFs from operations (4)
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› The following items are included in the income statement

(and affect net income), but do NOT affect cash flows:
Add or deduct to net
income:
Depreciation expense Add
Amortization expense Add
Depletion expense Add
Losses on assets Add
Gains on assets Deduct
› Why do we add losses and deduct gains? To avoid double
counting! The actual cash involved in these transactions is
accounted for under investing activities!
13-25
Random fact…
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Taller minions have

the same haircut.
 CFs from operations (5)
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› Next, we look at changes in current assets

› A decrease in a current asset frees up invested cash and

increases cash flow. It is added to net income

› An increase in a current asset consumes cash, and

decreases cash flow. It is deducted from net income

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 CFs from operations (6)
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› For example, assume that the beginning balance of the

account Inventory is equal to $13,000 and the ending
balance is $15,000

› This means that we have expended $2,000 more in cash for

purchases than reflected in our cost of goods sold

› As a result, there is an increase in the current asset

Inventory, which means additional Cash has been
consumed -> $2,000 is deducted from net income

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 CFs from operations (7)
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› Obviously, the opposite applies to changes in current

liabilities

› A decrease in a current liability consumes cash and

decreases cash flow. It is deducted from net income

› An increase in a current liability frees up cash, and

increases cash flow. It is added to net income

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 CFs from operations (8)
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› For example, assume that the beginning balance of

Accounts payable is equal to $10,000 and the ending
balance is $15,000

› This means that we have paid $5,000 less to creditors than

the purchase of inventory

› As a result, there is an increase in the current liability

Accounts payable -> $5,000 is added to net income

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 Example
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› On New Year’s day, 2012, Vlad started his company

Resolutions Inc. The company uses personal trainers
to aggressively remind clients of their New Year’s
resolutions
 Example
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› Information for Resolutions Inc. for the year 2013:

The beginning balance of Cash is $42,600

1. Net income is equal to $17,900
2. Depreciation equals $19,300
3. Office equipment that cost $27,000 - with
accumulated depreciation of $15,300 - was sold for
$10,700 -> a loss of $1,000!
4. VLAD repaid a note in the amount of $20,000
5. VLAD issued $25,000 of common stock at par value
6. Dividends of $4,300 were also paid
 Example
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› The following information is available regarding

changes in current assets between 2012 and 2013:
7. Accounts receivable decreased by $5,000 -> more
cash was collected than sales were made, so added to net
income
8. Inventory decreased by $5,000 -> we used up existing
inventory and did not have to pay for new inventory, so
added to net income
9. Prepaid expenses increased by $600 -> we spent
additional cash on prepaying expenses, so deducted
from net income
 Example
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› The following information is available regarding

changes in current liabilities between 2012 and 2013:

10. Accounts payable decreased by $1,000 -> we paid

more to creditors than our cost of goods sold indicated,
so deducted from net income

11. Income taxes payable decreased by $600 -> we paid

more in income taxes than this year’s income taxes, so
deducted from net income
 Example
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› What does the statement of cash flows look like for

Resolutions Inc., using the indirect method?
› Starting point: Cash flows from operations

› What do we include here?

- 1. Net income ( = $17,900)
- 2. Depreciation ( = $19,300)
- 3. Loss on sale of office equipment ( = $1,000: added
back!)
- 7. – 11. Changes in current assets and current
liabilities
 Example
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Resolutions Inc.
Statement of cash flows, 2013 (in $)
Cash flows from operating activities
1. Net income 17,900
Adjustments to reconcile net income to net
cash flows from operating activities
2. Depreciation 19,300
3. Loss on sale of office equipment 1,000
Changes in current assets and liabilities
7. Decrease in accounts receivable 5,000
8. Decrease in inventory 5,000
9. Increase in prepaid expenses (600)
10. Decrease in accounts payable (1,000)
11. Decrease in income taxes payable (600)
Net cash flows from operating activities 46,000
 Example
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› Next, we look at cash flows from investing activities

› This is where we include the full cash amount of the
sale of our office equipment ($10,700)

Cash flows from investing activities

3. Sale of office equipment 10,700
Net cash flows from investing activities 10,700
 Example
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› Finally, we look at cash flows from financing activities

› This includes the repayment of notes, issue of
common stock, and dividends

Cash flows from financing activities

4. Repayment of notes payable (20,000)
5. Issue of common stock 25,000
6. Payment of dividends (4,300)
Net cash flows from financing activities 700
 Example
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Resolutions Inc.
Statement of cash flows, 2013 (in $)
Cash flows from operating activities
1. Net income 17,900
Adjustments to reconcile net income to net cash flows from operating activities
2. Depreciation 19,300
3. Loss on sale of office equipment 1,000
Changes in current assets and liabilities
7. Decrease in accounts receivable 5,000
8. Decrease in inventory 5,000
9. Increase in prepaid expenses (600)
10. Decrease in accounts payable (1,000)
11. Decrease in income taxes payable (600)

Net cash flows from operating activities 46,000

Cash flows from investing activities

3. Sale of office equipment 10,700
Net cash flows from investing activities 10,700

Cash flows from financing activities

4. Repayment of notes payable (20,000)
5. Issue of common stock 25,000
6. Payment of dividends (4,300)
Net cash flows from financing activities 700

Net increase in cash 57,400

Cash at beginning of year 42,600
Cash at end of year 100,000
 Q&A
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› Send any questions to [email protected] by January

20 before 12.00 at the latest!!!
 Final exam
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› The Final exam for E&BE is on Monday January

20 from 15.00 to 17.30 in the Aletta Jacobshal.

› The Final exam for IB is on Thuesday January 14

from 8.30 to 11.00 in the Aletta Jacobshal.

› Focus will be on Chapters 7-12, but mid term material

may also be tested!
 Course evaluation
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Please remember to fill out the

course evaluation after the exam!
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Good luck on your final exam!