Nguyen Tan Binh 1 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 1 Principles of Accounting Fulbright Economics Teaching Program Ho Chi Minh City, Vietnam Academic Year: 2005-2006 7/17/2006 Nguyễn Tấn Bình 2 Lecture Notes 4 Statement of Cash Flows Nguyen Tan Binh 2 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 3 The main objective of the statement of cash flows • Shows the relationship between the Net Income and Net Cash Flow • Explains how cash is generated and used during a business period • Evaluates the ability to pay debt in time • This information is very useful to decision makers (managers, lenders, shareholders…) in forecasting the future cash flows 7/17/2006 Nguyễn Tấn Bình 4 The necessity of the statement of cash flows Additionally provides a lot of important information that the balance sheet and the income statement cannot to provide: • The balance sheet only reflects the values and the sources of assets at a certain date (a point of time) 9 How to know how much the firm has disbursed for purchases (or collected from liquidations) of fixed assets during a business period? 9 How to know how much the firm has borrowed (or paid back) during a business period? Nguyen Tan Binh 3 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 5 The necessity of the statement of cash flows Additionally provides a lot of important information that the balance sheet and the income statement fail to provide : • The income statement is made on the accrual, not the cash, basis of accounting 9 Why does a firm show profit but have no cash, and vice versa? 9 How to explain changes (increases or decreases) in cash balance from the beginning to the end of the business period? 7/17/2006 Nguyễn Tấn Bình 6 What is called “cash” in the statement of cash flows • Cash, bank deposits, floats, and cash equivalent securities • Cash equivalent securities include – Marketable securities with high liquidity – Easy to be transferred into cash Nguyen Tan Binh 4 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 7 Classification of cash flows A firm of any form or any size has 3 types of activities: 1. Operating 2. Investing 3. Financing The statement of cash flows reflects three cash flows from the three above activities 7/17/2006 Nguyễn Tấn Bình 8 Cash flow from operating • Disbursement flows into and receipt flows from the main operating activity of the firm • There are two methods to calculate the cash flow from operating activity: –Direct method –Indirect method Nguyen Tan Binh 5 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 9 Cash flow from operating Receipt flows (inflows) include: – Collections from customers – Interest receipt, receipt from other operations – Dividend receipt (from investments in other companies) 7/17/2006 Nguyễn Tấn Bình 10 Cash flow from operating Disbursement flows (outflows) include – Payment to suppliers – Interest, tax payments – Salary payment – Payment to other operations P a y t o t h e o r d e r o f Nguyen Tan Binh 6 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 11 Cash flows from investing and financing • Only one method to prepare cash flows from investing and financing: the direct method •Shows the actual disbursement and receipt flows 7/17/2006 Nguyễn Tấn Bình 12 Cash flow from investing • Disbursement and receipt flows for purchases and sales of fixed assets, investments, and investment recovery Nguyen Tan Binh 7 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 13 Cash flow from investing • Receipt flows (inflows) include – Liquidations of fixed assets – Sales of marketable securities – Recovery of investment or lending 7/17/2006 Nguyễn Tấn Bình 14 • Disbursement flows (outflows) include – Purchases of fixed assets – Purchases of marketable securities – Lending or capital contribution to other companies Cash flow from investing Nguyen Tan Binh 8 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 15 • Disbursement flows into and receipt flows from financing activity (capital mobilization) for the firm’s operations • Funds raised from owners and lenders Cash flow from financing 7/17/2006 Nguyễn Tấn Bình 16 • Receipt flows (inflows) include – Stock issue – Corporate bond issue – Bank loans Cash flow from financing Nguyen Tan Binh 9 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 17 • Disbursement flows (outflows) include – Repurchases of stock (treasury stock) – Recall or payment of corporate bond – Debt payment – Dividend payment Cash flow from financing 7/17/2006 Nguyễn Tấn Bình 18 Non-cash investing and financing activities Example: – Debt-equity conversion – Purchases and sales of fixed assets on credit • These activities do not generate cash flows, hence, are not shown on the statement of cash flows • However, the endnotes to the statement of cash flows or a separate statement is prepared to explain their changes on the balance sheet Nguyen Tan Binh 10 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 7/17/2006 Nguyễn Tấn Bình 19 Some common transactions and their impacts on the cash flows Operating transactions • Sales of goods/services for cash + • Sales on credit 0 • Interest receipt from investments + • Collections from accounts receivable + • Record of cost of goods sold 0 • Inventory purchases for cash - • Purchases on account 0 • Payment for accounts payable - 7/17/2006 Nguyễn Tấn Bình 20 Some common transactions and their impacts on the cash flows (cont.) Operating transactions • Expense payable 0 • Expense payment - • Taxes payable 0 • Tax payment - • Interest payable 0 • Interest payment - • Prepaid expense (for example, insurance) - • Records decreases in prepaid expense 0 • Records insurance expense 0 [...]... is the statement of cash flows? • Shows a more complete picture on the firm’s financial position • Many big firms fail because they are failed to manage their cash flows • And remember, the statement of cash flows is required by the international accounting standard and by many countries’ • In Vietnam? 7/17/2006 Nguyễn Tấn Bình 39 Analysis of the statement of cash flows • The statement of cash flows. .. net cash flows 7/17/2006 Nguyen Tan Binh Nguyễn Tấn Bình 24 12 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 Preparing the statement of cash flows A statement of cash flow includes three parts Net cash flow from operating (I) Net cash flow from investing (II) Net cash flow from financing (III) Total net cash flows = I + II + III + Beginning cash balance = Ending cash. .. 4 Cash flow concept Conventions on cash flows: Inflows, or receipt flows Outflows, or disbursement flows Net Cash Flows = Inflows – Outflows Total net cash flows (from three activities) equal the difference between ending and beginning cash balances 7/17/2006 Nguyễn Tấn Bình 23 Cash flow concept (cont.) Total net cash flows (from three activities) equal the difference between ending and beginning cash. .. Nguyễn Tấn Bình 40 20 Principles of accounting Fulbright Economics Teaching Program 2005-2006 Lecture 4 Analysis of the statement of cash flows Cash flows of the 4 companies, I, II, III, and IV Activity I II III VI Operating (6) 12 35 8 Investing (14) (22) (10) (2) Financing 20 10 Total Net Cash Flows (1) 0 0 (25) (6) 0 0 (1) Assume a zero difference between the ending and the beginning cash balances 7/17/2006... infeasible – Cash book is recorded in chronologic order, while the statement of cash flows classifies cash flows into various activities (operating, investing, and financing) – How can outsiders have this book? • This lecture presents the inferential direct method, which infers cash flows from the income statement and the balance sheet 7/17/2006 Nguyen Tan Binh Nguyễn Tấn Bình 28 14 Principles of accounting...Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4 Some common transactions and their impacts on the cash flows (cont.) Financing transactions • Purchases of fixed assets for cash • Purchases of fixed assets on account • Liquidations of assets for cash • Sales of fixed assets on credit • Purchases of marketable securities • Sales of marketable securities • Lending 7/17/2006... Program 2005-2006 Principles of accounting Lecture 4 Sources of data used for preparing the statement of cash flows 1 Balance sheet, showing the beginning and ending balances 2 Income statement 3 Notes of financial statements 7/17/2006 Nguyễn Tấn Bình 27 Direct method • The simple direct method uses accounting books such as ledgers and cash book to pick up the receipt and disbursement flows However, the... slower It shows profits and generates positive cash flows from operating (12) However, cash flows from operating are not sufficient to invest in PPE (-22), so it still has to mobilize funds (10) 7/17/2006 Nguyễn Tấn Bình 43 Analysis of the statement of cash flows Company III Activity I II III VI Operating (6) 12 35 8 Investing (14) (22) (10) (2) Financing 20 10 (25) (6) Total Net Cash Flows (1) 0 0 0... been directly accounted in the category of Cash Flows from Investing and Financing (+/-) Changes in working capital (receivables, inventory, payables) are added (subtracted) (*) See Lecture Notes 4a, Preparing the Statement of Cash Flows, Song Ha Company 7/17/2006 Nguyễn Tấn Bình 37 Notes of the two methods • The direct method provides more details of the cash flows from operating – Specifically and... cash balance 7/17/2006 Nguyễn Tấn Bình 25 Two methods of preparing the statement of cash flows (for net cash flows from operating) Indirect method – Net cash flow from operating is calculated by adjusting from net income – Most of companies use this method Direct method – Net cash flow from operating is calculated from actual receipt and disbursement flows – This method is comprehensible to readers, but . Preparing the statement of cash flows A statement of cash flow includes three parts Net cash flow from operating (I) Net cash flow from investing (II) Net cash. net cash flows = I + II + III + Beginning cash balance = Ending cash balance 7/17/2006 Nguyễn Tấn Bình 26 Two methods of preparing the statement of cash flows