Cash Flow Statement
The cash flow statement reports the
cash generated and used during the
time interval specified in its heading.
The period of time that the statement
covers is chosen by the company.
For example, the heading may state
"For the Three Months Ended
December 31, 2009" or "The Fiscal
Year Ended September 30, 2009".
The official name for the cash flow
statement is the statement of cash
flows. We will use both names
throughout Accounting.
The statement of cash flows is one of
the main financial statements. (The
other financial statements are the
balance sheet, income statement, and
statement of stockholders' equity.)
The cash flow statement organizes and reports the cash
generated and used in the following categories:
1 Operating activities
.
–
2 Investing activities
.
– reports the purchase and sale of long-term
investments and property, plant and equipment.
3 Financing activities
.
– reports the issuance and repurchase of the
company's own bonds and stock and the
payment of dividends.
4 Supplemental
. information
– reports the exchange of significant items that did not
involve cash and reports the amount of income
taxes paid and interest paid.
converts the items reported on the income statement
from the accrual basis of accounting to cash.
Because the income statement is
prepared under the accrual basis of
accounting, the revenues reported may
not have been collected. Similarly, the
expenses reported on the income
statement might not have been paid.
You could review the balance sheet
changes to determine the facts, but the
cash flow statement already has
integrated all that information. As a result,
savvy business people and investors
utilize this important financial statement.
Here are a few ways the statement of cash flows is used.
The cash from operating activities is compared to the company's
net income. If the cash from operating activities is consistently
greater than the net income, the company's net income or
earnings are said to be of a "high quality". If the cash from
operating activities is less than net income, a red flag is raised
as to why the reported net income is not turning into cash.
Some investors believe that "cash is king".
The cash flow statement identifies the cash that
is flowing in and out of the company. If a
company is consistently generating more cash
than it is using, the company will be able to
increase its dividend, buy back some of its
stock, reduce debt, or acquire another
company. All of these are perceived to be good
for stockholder value.
Some financial models are based upon cash
flow.
Matt is a college student who enjoys buying and
selling merchandise using the Internet. On January 2,
2009, he decides to turn his hobby into a business
called "Good Deal Co." Each month the Good Deal
Co. will have one or two transactions. At the end of
each month we will prepare an income statement,
balance sheet, and a statement of cash flows for the
current month and for the year-to-date period. The
purpose is to show how these transactions are
reported on the cash flow statement.
On January 2, 2009 Matt invests $2,000 of his
personal money into his sole proprietorship, Good
Deal Co. On January 20, Good Deal buys 14
graphing calculators for $50 per calculator—this is
about 50% less than the selling price Matt has
observed at the retail stores.
The total cost to Good Deal for all 14 calculators is
$700. Good Deal has no other transactions during
January.
Matt prepares financial statements for his new
business as of January 31, 2009:
Good Deal Co.
Income Statement
For the Month Ended January 31, 2009
Revenues
$0
Expenses
0
Net Income
$0
Good Deal Co.
Balance Sheet
January 31, 2009
Liabilities &
Owner's
Equity
Assets
Cash
Inventory
Total
Assets
$1,300
700
$2,000
Liabilities
$
0
Owner's Equity
Matt Jones,
Capital
2,000
Total Liab. &
Owner's
Equity
$2,000
Good Deal Co.
Statement of Cash Flows
For the Month Ended January 31, 2009
Operating Activities
Net Income
$
Increase in Inventory
Cash Provided (Used) in Operating Activities
Investing Activities
0
(700)
(700)
0
Financing Activities
Investment by Owner
Net Increase in Cash
Cash at the beginning of the month
Cash at the end of the month
2,000
1,300
0
$1,300
Good Deal's income statement for January showed no
profit or loss, since it did not have any sales or
expenses. However, the cash flow statement reports
that Good Deal's operating activities resulted in a
decrease in cash of $700. The decrease in cash
occurred because the company increased its
inventory by $700 during January.
The financing activities section shows an increase in
cash of $2,000 which corresponds to the increase in
Matt Jones, Capital (Matt's investment in the
business). The net change in the Cash account from
the owner's investment and the cash outflow for
inventory is a positive $1,300.
This net change of a positive $1,300 is verified at
the bottom of the cash flow statement and on the
balance sheet. There was a $0 cash at January 1,
but at January 31, the Cash balance is $1,300.
For a change in assets (other than cash)—the
change in the Cash account is in the opposite
direction. Recall that when Inventory increased by
$700, Cash decreased by $700.
For a change in liabilities and owner's equity—the
change in the Cash account is in the same
direction. Recall that when the owner invested
cash in the company Cash increased and Owner's
Equity increased.
On February 25, 2009, Good Deal sells 10 calculators to a
nearby high school for $80 each. Matt delivers the calculators
on February 25 and gives the school an $800 invoice due by
March 10. Matt receives $800 from the school on March 8.
Matt prepared financial statements for his new business as of
February 28, 2009:
Good Deal Co.
Income Statement
For the Month Ended Feb. 28, 2009
Revenues
$800
Expenses
500
Net Income
$300
The income statement for the month of February
shows revenues (or sales) of $800. Under the
accrual basis of accounting—revenue is
recognized when title passes (at the time of
shipment or time of delivery), not when the money
is received. Expenses (such as the cost of goods
sold for $500) appear on the income statement
when they best match up with revenues, not when
the expenses or goods are paid for.
(Other expenses will also appear on the income
statement when they are used, not when they are
paid for.) As a result of the accrual basis of
accounting, the income statement reports $300 of
net income even though there was no cash inflow
or cash outflow during February.
Statement of Cash Flows
For the Month Ended February 28, 2009
Operating Activities
Net Income
$ 300
Increase in Accounts Receivable
(800)
Decrease in Inventory
Cash Provided (Used) in Operating Activities
500
0
nvesting Activities
0
Financing Activities
Investment by Owner
Net Increase in Cash
Cash at the beginning of the month
Cash at the end of the month
0
0
1,300
$1,300
As you can see above, the cash flow
statement for the month of February
reports no change in cash. That agrees
with the company's balance sheet that
reported Cash of $1,300 on January 31
and will show $1,300 on February 28.
The year-to-date net income of $300
increases the owner's equity on the balance
sheet. Please note the connection between
the bottom line of the year-to-date income
statement and the change in Matt Jones,
Capital on the balance sheet. Matt Jones,
Capital has increased from $2,000 to $2,300.
Good Deal Co.
Balance Sheet
February 28, 2009
Assets
Liabilities & Owner's Equity
Cash
$1,300
Liabilities
Accounts Receivable
800
Owner's Equity
Inventory
200
Matt Jones, Capital (excl. net
inc.)
Matt Jones, Curr Yr. Net
Income
Total Owner's Equity
Total Assets
$2,300
Total Liabilities & Owner's
Equity
$
0
2,000
300
2,300
$2,300