Chapter 6
Statement of Cash Flows
Statement of Cash Flows--Purpose
• To provide information about
cash receipts,
cash payments, and the
net change in cash resulting from
 operating,
 investing, and
 financing activities
of a company during the period.
Statement of Cash Flows--Purpose
• Provides answers to the following:
Where did the cash come from during the period?
What was the cash used for during the period?
What was the change in the cash balance during the
period?
Composition
• Cash Flows from Operations
• Cash Flows from Investing Activities
• Cash Flows from Financial Activities
Cash From Operations
Cash From Investing
Cash From Financing
Material Non-cash Transactions
• Examples:
Issuance of common stock to purchase assets.
Conversion of bonds into common stock.
Issuance of debt to purchase assets.
Exchanges of plant assets.
• Reported at the bottom of the statement of cash flows or in a
separate note to the financial statements.
Direct & Indirect Method
Convert net income from an accrual basis to a
cash basis.
Use either indirect or direct format.
Both methods arrive at same totals.
Investing and financing activities are the same
for both methods.
99% of firms use the indirect method.
Preparing the Cash Flow Statement
(Indirect Method)
Preparing Cash From Operations-Example
• Krauss Company’s financial statements for the year ended
December 31, 2007, contained the following condensed
information.
Revenues from fees
Operating expenses
Depreciation expense
Loss on sale of equipment
Income before income tax
Income tax
Net income
Accounts receivable
Accounts payable
Income taxes payable
2007
$ 840,000
624,000
60,000
26,000
130,000
40,000
$ 90,000
$
37,000
41,000
4,000
2006
Change
$ 54,000
31,000
8,500
$ (17,000)
10,000
(4,500)
Cash From Operations—Example
(Indirect Method)
Cash flows from operating activities
Net income
Adjustment to reconcile net income
to net cash provided by operating activities:
Depreciation expense
Loss on sale of equipment
Decrease in accounts receivable
Increase in accounts payable
Decrease in income taxes payable
Net cash provided by operating activities
$ 90,000
60,000
26,000
17,000
10,000
(4,500)
198,500
Adjustments to Cash From Operations
Statement of Cash Flows
(Indirect Method)
Statement of Cash Flows
Cash flow from operating activities
Net income (loss)
Adjustment to reconcile net income to cash:
Depreciation expense
Loss on sale
Gain on sale
Cash from operations
$ (50,000)
22,000
2,700
(9,000)
(34,300)
Cash flow from investing activities
Sale of plant assets
Sale of land
Cash from investing activities
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
5,400
39,000
44,400
430,000
(47,000)
383,000
$ 393,100
Cash Flow Issues
• CFO trends, especially related to net income;
CFO is expected to be larger than net income
(e.g., depreciation increases CFO) & should
parallel net income over time
• The Dow 30 had an average CFO of $9.9
billion, 47% above net income
• Potential problem where net income is
positive and CFO is negative—this is a possible
indicator of manipulation (this was one of the
signals at Enron of problems)
Free Cash Flows (FCF)
• Free cash flows is a measure of cash available for
discretionary uses (that is; cash provided by
operations less expenditures that are considered
required):
• According to the book, the calculation is:
CFO-Capital Expenditures-Cash dividends
(in other words, cash available after fixed asset
investments and maintaining dividends.)
• Alternative definitions: FCF1 = CFO – Capital
Expenditures; FCF2 = CFO – CFI
• Cash flows can highlight certain problems such as
lagging cash collections
Free Cash Flows
• Amount of discretionary cash flow a company
has for purchasing additional investments,
retiring its debt, purchasing treasury stock, or
adding to its liquidity.
Current Cash Debt Coverage Ratio
Cash From Operations
Average Current Liabilities
Ratio indicates whether the company can pay
off its current liabilities from its operations. A
ratio near 1:1 is good.
A Liquidity measure (similar to operating cash
flow).
Cash Debt Coverage Ratio
Cash From Operations
Average Total Liabilities
• Ratio indicates a company’s ability to repay its
liabilities from net cash provided by operating
activities, without having to liquidate the assets
employed in its operations.
• A solvency (leverage) measure.
Corporate Life Cycle