A Second L.ook Allison Corporation’s statement of cash flows was illustrated earlier in this chapter, Now that we have explained the nature and, computation of each cash flow in that statement second illustration is in order,
We use this second illustration; which appears on the following, page, to illustrate the indirect method.of reporting net cash flows from operating. activities. (Our preceding illustration used the direct method.) hi this second illustration, we also iIlustrate two supplementary schedules that often accompany the statement of cash flows. Supplementary Schedule illustrates the determination of net cash flows from operating captivities by the indirect method.
The purpose of this schedule is to explain the differences between the reported net income and the net cash flows from operating activities. This supplement Courtesy of Linton Industries try schedule also is required’ of companies that use the direct method of reporting operating cash ” flows. Supplementary Schedule discloses any non cash aspects of the company’s investing and financing activities.
This type of supplementary schedule is required whenever some aspects of the company’s investing ‘and financing activities do not coincide with cash flows Occurring within the-current period.
.Using the Statement of Cash Flows The users of a statement of cash flows usually are most interested in the net ask flow; from operating activities.
Is the amount large enough to provide for ‘necessary replacements of plain assets and maturing liabilities? And if so, is there enough left for the current dividend to look secure-or even-be increased Even more important than cash flows from ‘operating activities in anyone year is the trend in cash flows over a period of years-s-and the consistency of that trend from year to year.
From everyone’s perspective; the best results are net cash flows from operating activities that increase each year by a substantial-but also predictable percentage
Free Cash Flow Many analysts’ put a company’s cash flows into perspective by computing a subtotal called free cash flow, Free cash flow is intended to represent the cash flow available to management discretionary purposes, after the ‘company Hammett all of its basic obligations, relating to business operations. The shallow is widely cited within the business community. Different analysts compute measure in different ways because there is no widespread agreement as to the basic obligations relating to business-operations,
For example, are all expenditures for plant assets “basic obligations,” or only those expenditures made to maintain the current level of productive capacity.
One common method ‘of computing free cash flow is to deduct from the net cash flows . from operating activities any net cash used for investments in plant assets and any dividends paid.
This computation is shown on page 572, using data from the Allison Corporation statement of cash flows shown earlier.
Statement of casn Flows. SPercentage change is’ the dollar amount of change from one year to the. next. expressed as a percentage of (divided by) the amount from the earlier of the two years, For example, if net cash provided by operating activities was $100,000 in the first year and $ f20,OOOin the second year, the percentage increase is 20th. computed as follows: ($120,000 – $100.000) ~ $100,000,
This computation suggests that Allison Corporation did not generate enough cash from operations to meet its basic obligations. Thus management had to raise cash from other sources.
But, of course, an analyst always should look behind the numbers.
For example, was Allison’s purchase of plant assets during the year a basic obligation, or did it represent a discretionary expansion of the business? As we have stated throughout this text, no single ratio or financial measurement ever tells the whole story.
Annotated Statement of Cash Flows: ABM Industries Incorporated .
A recent statement of cash flows of-ABM Industries Incorporated appears on the following page. We have added notations that highlight some of the concepts emphasized in this chapter
MANAGING CASH FLOWS
Management can do much to influence the cash flows of a particular period. In fact. it has a responsibility to manage cash flows. No business can afford to run out of cash and default on its obligations.
Even being a few days late in meeting payrolls, or paying suppliers
or creditors, can severely damage important business relationships. Thus one of management’s most basic responsibilities is to ensure that the business has enough cash to meet its obligations as they come due. Budgeting: The Primary Cash Management Tool The primary tool used by management to anticipate and shape future cash flows is a cash budget.
A cash budget is forecast of future cash receipts and payments.
This budget is not a financial statement and is not widely distributed to people outside of the organization. To managers, however, it is among the most useful of all accounting reports.
In many ways, a cash budget is similar to a statement of cash flows. However. the budget shows the results expected in future periods, rather than those achieved in the past.
Also, the cash budget is more detailed, usually showing expected cash flows month by month and separately for every department within the organization. Cash budgets serve many purposes. Among the most important ‘are:
• Forcing managers to plan and coordinate the activities of their departments in
• Providing managers with advance notice of the resources at their disposal and the reo: suits they are expected to achieve.Providing targets useful in evaluating departmental performance.
• Providing advance warnings of potential cash shortages