CHAPTER
13
Cash Flow Statement
Purpose of Cash Flow Statement
• Ability to generate future cash flow
• Ability to pay dividends and meet obligations
• Reasons for the difference between net
earnings and net cash provided (used) by
operating activities
• Investing and financing transactions during
the period
Operating Activities
• Include:
– Cash effects of transactions that create
revenues and expenses
– These enter into determination of net
earnings
• On the balance sheet, operating activities
items include:
– Noncash current assets and current
liabilities
– Statement of earnings items
Investing Activities
• Include:
– Purchasing and disposing of investments
and productive long-lived assets using cash
– Lending money and collecting the loans
• On the balance sheet, investing activities
items include:
– Investments
– Long-term asset items
Financing Activities
• Include:
– Obtaining cash from issuing debt and
repaying the amounts borrowed
– Obtaining cash from shareholders and
paying them dividends
• On the balance sheet, financing activities
items include:
– Notes payable
– Long-term liabilities
– Shareholders’ equity items
Significant Noncash Activities
• If it does not affect cash, do NOT report
in cash flow statement
• Report in separate note or supplementary
schedule to the financial statements
Format of Cash Flow Statement
COMPANY NAME
Cash Flow Statement
Period Covered
Operating activities
(List of individual items)
Net cash provided (used) by operating activities
Investing activities
(List of individual items)
Net cash provided (used) by investing activities
Financing activities
(List of individual items)
Net cash provided (used) by financing activities
Net increase (decrease) in cash
Cash, beginning of period
Cash, end of period
$XX
$XXX
$XX
XXX
$XX
XXX
XXX
XXX
$XXX
Cash flows from the three activities–operating,
investing, and financing–constitute the general format
of the cash flow statement
Preparing the Cash Flow Statement
Step: 1
Definition of Cash
• Cash includes cash and cash equivalents
• Cash equivalents are short-term, highly liquid
investments that are readily converted to
cash within a short period of time
• Examples include:
–
–
–
–
Treasury bills
Money market funds
Short-term investments
Short-term debt
Because the definition of “cash” varies,
companies must clearly define cash equivalents
Preparation of the
Operating Activities Section
• Net earnings must be converted from an
accrual basis to a cash basis in the operating
activities section
• Conversion may be done by two methods:
– Indirect
– Direct
Indirect and Direct Methods
• Both methods arrive at the same total amount
of cash provided (used) by operating
activities
• Methods differ in disclosing the items that
make up the total amount
• Choice of methods affects only the operating
activities section, the investing and financing
activities sections are the same
Indirect Method
• Used extensively
• Most companies favour the indirect method
for the following reasons
– Easier to prepare
– Focuses on the differences between net
earnings and net cash flow from operating
activities
– Reveals less company information to
competitors
Direct Method
• CICA prefers the direct method but allows
the use of either method
• Details cash receipts and payments
• Easier to understand
Preparing the Cash Flow Statement
Step: 2
Net Earnings to Net Cash Provided
(Used) by Operating Activities
• Cash flow statement prepared by the indirect
method starts with net earnings and adds or
deducts items not affecting cash in order to
arrive at net cash provided (used) by
operating activities
– Changes in specific noncash current assets
and current liabilities and
– Noncash items reported in the statement of
earnings
Net Earnings to Net Cash Provided
(Used) by Operating Activities
(Balance Sheet: Noncash Current Assets and Current Liabilities)
Adjustments to Convert Net Earnings
to Net Cash Provided (Used) by
Operating Activities
Add*
Deduct*
Change in Current Asset Account Balance
Accounts receivable
Decrease
Inventory
Decrease
Prepaid expenses
Decrease
Other current assets
Decrease
Increase
Increase
Increase
Increase
Change in Current Liability Account Balance
Accounts payable
Increase
Accrued expenses payable
Increase
Other current liabilities
Increase
Decrease
Decrease
Decrease
* Add (deduct) change in account balance to net earnings
Net Earnings to Net Cash Provided
(Used) by Operating Activities
(Statement of Earnings: Noncash Items)
Adjustments to Convert Net
Earnings to Net Cash Provided
(Used) by Operating Activities
Noncash Items on Statement of Earnings
Amortization expense
Loss on sale of asset
Gain on sale of asset
Earnings from long-term equity investment
Add
Add
Deduct
Deduct
Net Cash Provided (Used) by
Operating Activities
Indirect Method –Sample Format
ANY CORPORATION
Cash Flow Statement (Partial) — Indirect Method
Year Ended December 31, 2004
Operating activities
Net earnings
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Amortization expense
Loss on sale of equipment
Decrease in accounts receivable
Increase in prepaid expenses
Increase in accrued expenses payable
Net cash provided by operating activities
$139,000
$15,000
3,000
10,000
(4,000)
55,000
79,000
$218,000
Cash Receipts and Cash Payments
(Direct Method)
Illustration 13-17
Cash Receipts from Customers
• The relationship among cash receipts from
customers, revenues from sales, and
changes in accounts receivable is:
Cash receipts
from
customers
=
Sales
revenue
{
+ Decrease in accounts receivable
or
– Increase in accounts receivable
Cash Payments to Suppliers
• The relationship among cash payments to
suppliers, cost of goods sold, changes in
inventory, and changes in accounts payable is:
Cash
payments to
suppliers
=
Cost of
goods sold
{
{
+ Increase in inventory
or
– Decrease in inventory
+ Decrease in accounts payable
or
– Increase in accounts payable
Cash Payments for Operating
Expenses
• The relationship among cash payments for operating
expenses, changes in prepaid expenses, and changes
in accrued expenses payable is:
Cash payments for operating
expenses
=
Operating
expenses
{
{
+ Increase in prepaid expenses
or
– Decrease in prepaid expenses
+ Decrease in accrued expenses
payable
or
– Increase in accrued expenses payable
Cash Payments for Income Taxes
• The relationship among cash payments for
income taxes, income tax expense, and
changes in income taxes payable is:
Cash
payments for
income taxes
=
Income
tax
expense
{
+ Decrease in income tax payable
or
– Increase in income tax payable
Net Cash Provided (Used) by
Operating Activities
Direct Method –Sample Format
ANY CORPORATION
Cash Flow Statement (Partial) — Direct Method
Year Ended December 31, 2004
Operating activities
Cash receipts from customers
Cash payments:
For operating expenses
For income taxes
Net cash provided by operating activities
$517,000
$(210,000)
(89,000)
(299,000)
218,000
Preparing Cash Flow Statement:
Step 3
Net Cash Provided (Used) by Investing
Activities
• Study the balance sheet to determine changes in
investments and long-term assets
• Changes in each short-term investment (unless
incorporated as part of cash definition) and longterm account are analysed using selected
transaction data to determine the effect, if any,
the changes had on cash
Net Cash Provided (Used) By Financing
Activities
• Examine the balance sheet to determine
changes in noncurrent liabilities and
shareholders’ equity
• Changes in each noncurrent account are
analysed using selected transaction data to
determine the effect, if any, the changes had
on cash
ANY CORPORATION
Cash Flow Statement (Partial)
Year Ended December 31, 2004
(Sample Format)
Net cash provided by operating
activities (Continued)
Investing activities
Purchase of building
Purchase of equipment
Sale of equipment
Net cash used by investing activities
Financing activities
Payment of cash dividends
Net cash used by financing activities
Net increase in cash
Cash, January 1
Cash, December 31
$218,000
$(160,000)
(25,000)
4,000
(181,000)
$15,000
(15,000)
22,000
34,000
$ 56,000
Using Cash Flows to Evaluate a
Company
– Cash provided by operating activities does
not consider that a company must invest in
new assets
– Free cash flow is a solvency-based measure
that helps to evaluate a company’s
discretionary cash flow
– This ratio is cash-based instead of accrualbased
Free Cash Flow
Cash
Provided
by
Operating
Activities
-
Capital
Expenditures
-
Dividends
Paid
= Free
Cash
Flow