Chapter 14 notes
The Cash Flow statement is divided into three sections:
1. Operating activities section
a. Day-to-day activities in making profit
2. Investing activities section
a. Acquiring and disposing fixed assets
3. Financing activities section
a. Issuing and retiring debts
b. Issuing and buying back stock and pay dividends
4. Each section is further divided into sources and uses of cash
In order to build a Cash Flow statement, we need the following source documents:
1. Last year-end and this year-end balance sheet
2. Income statement for this year
3. Other necessary information (basically, we must have everything that is necessary to build the
Cash Flow statement).
There are two methods in building a cash flow statement:
1. Direct method
2. Indirect method
Under direct method, for the operating activities section, we actually keep track of every dollar going in
and out of the company throughout the entire year. Sources of cash include cash sale and collection of
A/R, and interest/dividends received. Uses of cash include buying inventory, supplies, and paying for
operating expenses/income tax and interest paid.
Under indirect method, we start out with net income in the operating activities section. Then we make
adjustments to the net income number based on the changes in current asset and current liability
accounts (between last year and this year). Any non-cash expenses and losses must be added back to
net-income. Any non-cash gains must be subtracted from net income.
In the investing activities and financing activities sections, we perform identical procedure under both
Direct and Indirect methods. In the investing section, we add and subtract numbers based on the
changes in the long-term asset accounts (between last year and this year). Adjustments include:
1. Purchasing and selling fixed assets
2. Purchasing and selling long-term investments
3. Lending and collecting from long-term N/R (for principal only).
In the financing section, we add and subtract numbers based on the changes in the long-term liability
and stockholders’ equity accounts (between last year and this year). Adjustments include:
1.
2.
3.
Issuing stock and bonds
Buying back treasury shares and retiring bonds
Borrowing and paying off long-term N/P (for principle only)
Under either method, we start out with the beginning cash balance of the year, add all sources of cash
(from all three sections) and subtract all uses of cash (from all three sections) to come up with the
ending cash amount. This ending cash amount is compared with the actual balance of the cash account
as of the end of the fiscal year and they should be the same.
In addition, a schedule of significant noncash activities must be generated to accompany the Cash Flow
statement. Although these activities do not affect the Cash Flow statement, they may have significant
impact on the cash position of the company in the future. e.g. acquiring a piece of land by issuing bonds.