The
Statement of
Cash Flows
2
Learning Objectives
 Describe the circumstances in which the
cash flow statement is a particularly
important companion of the income
statement.
 Outline the structure of and information
reported in the three main categories of
the cash flow statement: operating,
investing, and financing.
3
Learning Objectives
 Appreciate the historical process involved
in the development of the modern
statement of cash flows.
 Compute cash flow from operations using
either the direct or the indirect method.
 Prepare a complete statement of cash
flows and provide the required
supplemental disclosures.
4
Learning Objectives
 Understand the differences among cash
flow statements prepared according to
U.S. GAAP, U.K. GAAP, and
International Accounting Standards.
 Assess a firm’s financial strength by
analyzing the relationships among cash
flows from operating, investing, and
financing activities and by computing
financial ratios based on cash flow data.
5
Learning Objectives
 Use knowledge of how the three
primary financial statements tie together
in order to prepare a forecasted
statement of cash flows.
EXPANDED MATERIAL
 Use a T-account or work sheet approach
to prepare a statement of cash flows.
What Good Is a Cash Flow
Statement?
Does a statement of cash
flows tell us anything we
don’t already know from other
statements?
6
What Good Is a Cash Flow
Statement?
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7
8
Purposes of Cash Flow Statement
• Statement of Cash Flows--The primary
financial statement that summarizes an
entity’s cash receipts and payments
during a period.
• Predicts an entity’s ability to:
– generate positive future cash flows.
– meet current and long-term obligations.
– pay future dividends.
9
Cash Equivalent
It must be readily convertible to cash
and it must be so near to maturity
It is a short-term,
that there is insignificant
risks of
What is changes
a cash in value due to
highly
liquid
changes
in
equivalent?
interest rate.investment.
10
Three Categories of Cash Flows
Cash Inflows
Operating
Activities
Investing
Activities
Financing
Activities
11
Cash Flow Categories
 Operating Activities--Transactions and events
that enter into the determination of net
income.
 Investing Activities--Transactions and events
that involve the purchase and sale of
securities, property, plant, equipment, and
other assets not generally held for resale, and
the making and collecting of loans.
 Financing Activities--Transactions and events
whereby cash is obtained from or repaid to
owners and creditors.
General Format of a
Statement of Cash Flows
Cash Provided by or Used in:
Operating Activities
$XXX
Investing Activities
XXX
Financing Activities
XXX
Net Increase (Decrease) in Cash
$XXX
Cash--Beginning of Year
XXX
Cash--End of Year
$XXX
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13
Operating Activities
Cash Inflow
Cash Outflow
• Cash Receipt of
Sales
•Inventory Payments
• Collection of •Interest Payments
Receivables
•Wages
• Interest Revenue
•Utilities
• Dividend Revenue
•Rent
14
Investing Activities
Cash Inflow
Cash Outflow
• Sale of plant assets
• Purchase of plant assets
• Sale of securities,
• Purchase of securities,
other than trading
other than trading
securities
securities
• Collection of
• Making of loans with
principal on loans
other entities
15
Financing Activities
Cash Inflow
Cash Outflow
• Issuance of own
• Dividend payments
stock
• Repayment of
• Borrowings
loans
• Treasury stock
purchase
16
Noncash Transactions

Noncash Transactions--Investing and
financing activities that do not affect
an entity’s cash flow.
 Significant transactions should be
disclosed separately.
 These transactions do not affect the
statement of cash flows.
17
Reporting Operating Cash Flows
• Direct Method--A method of reporting
net cash flows from operations that
shows cash receipts and payments for a
period of time. This method is more
straight forward.
• Indirect Method--A method of reporting
net cash flow from operations that
involves reconciling net income to a
cash basis. It shows how noncash flows
affect net income.
18
The Direct Method
• This method reports directly the major
classes of operating cash receipts and
payments of an entity during a period.
• Accrual-basis revenues and expenses
must be converted to equivalent cash
receipts and payments.
• The amount of cash actually collected
or paid is determined.
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Example: Cash Receipts
Sales and Cash Collected from Customers:
Beginning accounts receivable
$140
+ Sales
150
= Cash available for collection
$190
- Ending accounts receivable
60
= Cash collected from customers
$130
20
Example: Inventory
Cost of Goods Sold and Cash Paid for Inventory:
Ending inventory
$ 75
+ Cost of goods sold
80
= Required inventory
$155
- Beginning inventory
100
= Cash paid for inventory this year
$ 55
21
Example: Wages
Wages Expense and Cash Paid for Wages:
Beginning wages payable
$ 7
+ Wages expense
25
= Total obligation to employee
$32
- Ending wages payable
10
=
Cash paid for wages
$22
22
Indirect Method
The indirect method makes the
following adjustments:
• Adjustments for receivables and other
current operating assets.
• Adjustments for payables and other
current liabilities.
• Adjustments for depreciation and other
noncash items.
• Adjustments for gains and losses.
Adjustments for Gains
and Losses
Gains or losses do not represent the cash
effect of the transaction.
Account
Adjustment to
Net Income
Losses
Gains
These adjustments are made to net income since
the sale of an investment is an investing activity,
not an operating activity.
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24
Adjustments for Receivables
Changes in accounts directly affect
revenues recorded on an accrual basis.
Account
Accounts Receivable
Accounts Receivable
Account
Change
Adjustment to
Net Income
25
Adjustments for Payables
Changes in liabilities mean the reverse of
changes in current operating asset accounts.
Account
Accounts Payable
Accounts Payable
Account
Change
Adjustment to
Net Income
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Noncash Adjustments
• Depreciation and similar noncash items
do not affect cash and are not reported
on the statement of cash flows.
• Any noncash item that reduces net
income should be added back to net
income in the indirect method.
• Any noncash item that increases net
income should be subtracted from net
income in the indirect method.
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Relationship Between Net
Income and Operating Cash Flow
Business engages in
operating activities
Cash is received and
disbursed
Operating cash flow
“Undo” accrual
accounting to get
back to cash flow
Apply accrual
accounting rules
Net income
Steps for Preparing a
Cash Flow Statement
 Compute how much the cash balance changed
during the year.
 Convert the income statement from an
accrual-basis to a cash-basis summary of
operations.
a. Eliminate expenses that do not involve the
outflow of cash, such as depreciation.
b. Eliminate gains and losses associated with
investing or financing activities.
c. Adjust for changes in the balances of
current assets and current liabilities.
28
Steps for Preparing a
Cash Flow Statement
 Analyze the long-term assets to identify the
cash flow effects of investing activities.
 Analyze the long-term debt and stockholders’
equity accounts to determine the cash flow
effects of any financing transactions.
 Make sure that the total net cash flow from
operating, investing, and financing activities
is equal to the net increase or decrease in cash
as computed in Step 1. Then, prepare a
formal statement of cash flows.
 Prepare supplement disclosure of significant
noncash transactions.
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Example: Comparative
Balance Sheet
Assets
Cash and Cash Equivalents
Accounts Receivable
Inventory
Equipment
Accumulated Depreciation
Total Assets
Liabilities and Equity
Accounts Payable
Long-Term Notes Payable
Common Stock
Retained Earnings
Total Liabilities and Equity
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20X2
$ 82
180
170
200
(72)
$560
20X1
$ 40
150
200
140
(60)
$470
$100
100
250
110
$560
$ 80
50
250
90
$470
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Income Statement, 20X1
Sales
Expenses:
Cost of Goods Sold
Selling and General Expense
Depreciation
Interest Expense
Operating Income
Gain from Sale of Equipment
Income before Income Taxes
Income Tax Expense
Net Income
$345
$120
58
20
2
200
$145
5
$140
30
$110
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Step 1
Determine change in cash and cash
equivalents:
Cash 20X1........................... $ 40
Cash 20X2...........................
82
Change in Cash................... $ 42
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Step 2
Convert from an accrual-basis to a cashbasis summary of operations:
EXAMPLE: Eliminate depreciation
expense, $44, because it does
not require the use of cash.
Cash Provided by Operations
Accumulated Depreciation
44
(T-account or work sheet entry)
44
34
Step 2
Convert from an accrual-basis to a cashbasis summary of operations:
EXAMPLE: Eliminate the $5 gain from
selling equipment.
Cash
33
Add back $5 to cash
provided
by operations.
Accumulated
Depreciation
32
Equipment
Gain on Sale of Equipment
60
5
35
Step 3
Analyze the long-term assets to identify the
cash flow effects of investing activities.
Expenditures for Property, Plant, and Equipment:
Beginning equipment
$140
- Equipment sold during the year
60
=
$ 80
- Ending equipment
200
= Expenditures for equipment during
year
$120
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Step 4
Analyze the long-term debt and
stockholders’ equity accounts to determine
the cash flow effects of any financing
transactions:
Expenditures for Long-Term Debt:
Beginning L-T notes payable balance
- Notes reacquired during the year
=
- Ending L-T notes payable balance
= L-T notes payable issued during year
$ 50
0
$ 50
100
$ 50
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Step 4
Analyze the long-term debt and
stockholders’ equity accounts to determine
the cash flow effects of any financing
transactions:
Payment of Dividends:
Beginning retained earnings balance
+ Net income
=
- Ending retained earnings balance
= Dividends paid
$ 90
110
$200
110
$ 90
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Steps 5 and 6
Steps 5 and 6 relate to
actually preparing the
formal and
supplementary
statements.
Operating Activities Section:
Indirect Method
Cash Flows from Operating Activities:
Net Income
Adjustments:
Depreciation Expense
Gain on Sale of Equipment
Increase in Accounts Receivable
Decrease in Inventory
Increase in Accounts Payable
Net Cash Provided by Operating
Activities
$110
44
(5)
(30)
30
20
$169
Continued on slide 42
39
Operating Activities Section:
Direct Method
Cash Flows from Operating Activities:
Cash Collected from Customers
$ 414
Cash Payments for:
Inventory
(155)
Selling & General Expenses
(58)
Interest
(2)
Income Taxes
(30)
$(245)
Net Cash Provided by Operating
Activities
$169
Continued on slide 42
4
0
Investing and Financing
Activities Sections
The investing and
financing sections are
the same whether the
direct or indirect
approach is used.
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Investing and Financing
Activities Sections
Cash Flows from Investing Activities:
Continued from either
Proceeds from Sale of Equipment
slide 39 or 40
Purchase of equipment
Net Cash Provided by Investing
Activities
Cash Flows from Financing Activities:
Issuance of Long-Term Notes Payable
Payment of Cash Dividends
Net Cash Used for Financing Activities
Net Increase in Cash
Cash, January 1, 2001
Cash, December 31, 2001
$ 33
(120)
$(87)
50
(90)
$(40)
$ 42
40
$ 82
42
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The End