Chapter 12 – Statement of Cash Flows
12-1
CHAPTER 12
STATEMENT OF CASH FLOWS
Learning Objectives and Related Assignment Materials
Learning Objectives
Mini-
Exercises
Exercises
Problems
Alternate
Problems
Continuing
Problem
Cases and
Projects
12-1 Classify cash flow
statement items as part
of net cash flows from
operating, investing, and
financing activities.
1, 3
1, 2, 3,
4, 5, 6
1, 2
1, 2
1
2, 4, 6,
7
12-2 Report and interpret cash
2
7, 8, 9,
1, 2, 5
1, 2
1
1, 2, 4,
12-3 Analyze and interpret the
quality of income ratio.
4
15
3, 7
12-5 Analyze and interpret the
capital acquisitions ratio.
19, 20
3, 7
12-6 Report and interpret cash
flows from financing
activities.
6
16, 17,
18, 19
1, 2, 5
1, 2
1
1, 2, 4,
6, 7
Chapter Supplement B:
Indirect Method
13, 14
5
Chapter Supplement C: T-
Account Approach
24
6
12-7 Understand the format of
the cash flow statement
and additional cash flow
7
20
1
1
(Indirect Method)
Synopsis of Chapter Revisions
Focus Company: National Beverage Corporation
Chapter 12 – Statement of Cash Flows
12-2
• Chapter can be used any time after Chapter 4.
• Focus company information updated and new contrast companies are included to reflect changes
in the beverage industry.
• Two GUIDED HELP features provide free access to step-by-step video instruction on (1)
PowerPoint Slides
PowerPoint® Slides
12-4 through 12-17
12-18 through 12-30
12-48 through 12-50
12-51
12-52
Chapter Take-Aways
12-1 Classify cash flow statement items as part of net cash flows from operating, investing, and
financing activities.
The cash flow statement has three main sections: Cash Flows from Operating Activities, which are
12-2 Report and interpret cash flows from operating activities using the indirect method.
The indirect method for reporting cash flows from operating activities reports a conversion of net
Chapter 12 – Statement of Cash Flows
12-3
Chapter 12 – Statement of Cash Flows
12-4
Chapter Take-Aways, continued
12-3 Analyze and interpret the quality of income ratio.
Quality of income ratio (Cash Flow from Operating Activities ÷ Net Income) measures the portion
12-4 Report and interpret cash flows from investing activities.
12-5 Analyze and interpret the capital acquisitions ratio.
The capital acquisitions ratio (Cash Flow from Operating Activities ÷ Cash Paid for Property, Plant,
12-6 Report and interpret cash flows from financing activities.
Cash inflows from financing activities include cash proceeds from the issuance of short- and long-
12-7 Understand the format of the cash flow statement and additional cash flow disclosures.
The statement of cash flows splits transactions that affect cash into three categories: Operating,
Investing, and Financing Activities. The operating section is most often prepared using the indirect
Chapter 12 – Statement of Cash Flows
12-5
Key Ratios
The quality of income ratio indicates what portion of income was generated in cash. It is computed as
follows:
Finding Financial Information
Balance Sheet
Changes In Assets, Liabilities, and
Stockholders’ Equity
Income Statement
Net Income and Noncurrent Accruals
Statement of Cash Flows
Notes
Chapter 12 – Statement of Cash Flows
12-6
Chapter Outline
Teaching Notes
LO 1 – Classify cash flow statement items as part of net cash flows from operating, investing, and
financing activities.
I. Classifications of the Statement of Cash Flows
A. Cash and Cash Equivalents
1. Statement of cash flows explains how cash on the balance
Illustrated in Exhibit 12.1
2. “Cash” includes cash and cash equivalents
a. Cash equivalents––Short-term investments with
original maturities of three months or less that are:
B. Cash Flows from Operating Activities—Indirect and Direct
Methods
earnings from normal operations
1. Cash flows from operating activities (cash flows from
2. Two alternative approaches for presenting the operating
activities section of the statement:
a. Direct method––a method of presenting the operating
activities section of the statement of cash flows that
reports components of cash flows from operating
Chapter 12 – Statement of Cash Flows
C. Cash Flows from Investing Activities
companies
called net cash inflow (outflow) from investing activities
1. Cash flows from investing activities––cash inflows and
D. Cash Flows from Financing Activities
1. Cash flows from financing activities––cash inflows and
E. Net Increase (Decrease) in Cash
1. The combination of the net cash flows from operating
activities, investing activities, and financing activities
F. Relationships to the Balance Sheet and Income Statement
1. To prepare the statement of cash flows, we need the
following data:
b. A complete income statement used primarily in
a. Comparative balance sheets used in calculating the
2. Approach to preparing and understanding cash flow
statement focuses on changes in balance sheet accounts;
relies on manipulation of balance sheet equation:
Chapter 12 – Statement of Cash Flows
12-8
assets
3. Any transaction that changes cash must be accompanied
Illustrated in Exhibit 12.2
4. Next, compute the change in each balance sheet account
(Ending Balance – Beginning Balance) and classify each
change as relating to operating (O), investing (I), or
financing (F) activities by marking it with the
corresponding letter
Use Supplemental
Enrichment Activity #1
a. The accounts that should be marked with an O include
the following:
Illustrated in Exhibit 12.3
i. Most current assets (other than short-term
b. The balance sheet accounts related to investing
activities should be marked with an I; these include all
of the remaining assets on the balance sheet:
Illustrated in Exhibit 12.3
i. Short-Term Investments
ii. Property, Plant, and Equipment, net
accounts on the balance sheet:
i. Long-Term Debt
iii. Additional Paid-in Capital
iv. Retained Earnings (for decreases resulting from
LO 2 – Report and interpret cash flows from operating activities using the indirect method.
II. Reporting & Interpreting Cash Flows from Operating Activities
A. Reporting Cash Flows from Operating Activities—Indirect
Method
Use Supplemental
Enrichment Activity #2
1. The indirect method starts with net income and converts it
to cash flows from operating activities
2. This involves adjusting net income for the differences in
Chapter 12 – Statement of Cash Flows
12-9
3. The general structure of the operating activities section is:
Net income
Adjustments to reconcile net income to cash flow from
operating activities:
Illustrated in Exhibit 12.4
4. Completing the operating section using the indirect
method involves two steps:
a. Step 1: Adjust net income for depreciation and
amortization expense and gains and losses on sale of
investing assets such as property, plant, and equipment
and investments
i. Recording depreciation and amortization expense
does not affect the cash account (or any other
activities
b. Step 2: Adjust net income for changes in assets and
liabilities marked as operating (O)
i. Each change in operating assets (other than cash
and short-term investments) and operating
Chapter 12 – Statement of Cash Flows
12–10
iii. Change in Accounts Receivable
a decrease is added
• When sales revenues are recorded, accounts
iv. Change in Inventory
• Purchases of goods increase the balance in
inventory, and recording merchandise sold
decreases the balance in inventory
• An increase (extra purchases) is subtracted
from net income to convert to cash flow from
operating activities; a decrease is added
v. Change in Prepaid Expenses
prepaid expenses, and recording of expenses
decreases the balance in prepaid expenses
vi. Change in Accounts Payable
• Purchases on account increase accounts
payable and cash paid to suppliers decreases
• Cash prepayments increase the balance in
increase is added
vii. Change in Accrued Expenses
See International Perspective
feature “Classification of
Interest on the Cash Flow
Statement”
decrease is subtracted
• Recording accrued expenses increases the
balance in the liability accrued expenses and
cash payments for the expenses decrease
B. Interpreting Cash Flows from Operating Activities
Refer students to Guided
Help 12-1
1. The operating activities section of the cash flow statement
focuses attention on the firm’s ability to generate cash
Chapter 12 – Statement of Cash Flows
12–11
LO 3 – Analyze and interpret the quality of income ratio.
C. Key Ratio Analysis: Quality of Income Ratio
1. Quality of Income Ratio = Cash Flow from Operating
Activities ÷ Net Income
2. Ratio measures how much cash each dollar of net income
increase net income
5. When this ratio does not equal 1.0, analysts must
establish the sources of the difference to determine the
significance of the findings; four potential causes:
a. Corporate life cycle (growth or decline in sales)
i. When sales are increasing, receivables and
inventory normally increase faster than accounts
payable.
i. Inefficient management will increase operating
assets and decrease liabilities, reducing operating
cash flows and the quality of income ratio.
6. The quality of income ratio can be interpreted only based
on an understanding of the company’s business
operations and strategy
a. For example, a low ratio for a quarter can be due
Chapter 12 – Statement of Cash Flows
LO 4 – Report and interpret cash flows from investing activities.
III. Reporting and Interpreting Cash Flows from Investing Activities
Illustrated in Exhibit 12.5
A. Reporting Cash Flows from Investing Activities
1. Preparing this section of the cash flow statement requires
an analysis of the related accounts
a. Property, plant, and equipment;
i. Outflow—Purchase of property, plant, and
equipment for cash
b. Intangible assets;
d. Remember that:
equivalents are included
B. Interpreting Cash Flows from Investing Activities
1. There are common ways to assess a company’s ability to
internally finance its expansion:
i. Capital acquisitions ratio
ii. Free cash flow
LO 5 – Analyze and interpret the capital acquisitions ratio.
C. Key Ratio Analysis: Capital Acquisitions Ratio
Activities ÷ Cash Paid for Property, Plant, and Equipment
equipment with cash provided by operating activities
3. A high ratio indicates less need for outside financing for
1. Capital Acquisitions Ratio = Cash Flow from Operating
D. Financial Analysis: Free Cash Flow
1. Free Cash Flow = Cash Flows from Operating Activities
− Dividends − Capital Expenditures
investment opportunities
mergers and acquisitions
Chapter 12 – Statement of Cash Flows
12–13
4. Free cash flow also can represent a hidden cost to
shareholders
unprofitable investments just for the sake of growth or
were paid as additional dividends or used to
a. Managers may use free cash flow to pursue
LO 6 – Report and interpret cash flows from financing activities.
IV. Reporting & Interpreting Cash Flows from Financing Activities
A. Reporting Cash Flows from Financing Activities
Illustrated in Exhibit 12.6
1. Preparing this section of the cash flow statement requires
an analysis of the related accounts
a. Short-term debt (notes payable)
i. Inflow—Borrowing cash from banks or other
financial institutions
b. Long-term debt
ii. Outflow—Repurchase (retirement) of stock with
d. Retained earnings
e. Remember that:
i. Cash repayments of principal are cash flows from
ii. Interest payments are cash flows from operating
iv. If debt or stock is issued for other than cash, it is
not included in this section
Refer students to Pause for
Feedback – Self-Study Quiz
2. Interpreting Cash Flows from Financing Activities
a. The long-term growth of a company is normally
financed from three sources:
Refer students to Guided
Help 12-2
iii. Money borrowed on a long-term basis
i. Internally generated funds (cash from operating