Statement of Cash Flows- First
Approach
Appendix 6- Introduction to preparation of the
Statement of Cash Flows
Cash Flow Statement
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Flow statement
Periodic
Provides information regarding the liquidity of a firm
explains the reasons for increase or decrease in cash balance
from one balance sheet date to the next
classifies the reasons for the change as an operating, investing
or financing activity.
amount of net income in a period is usually different than the
amount of increase in cash in the same period
reconciles net income with cash flow from operations.
Classification of Cash Flows
Operations -- cash flows related to selling goods and
services; that is, the principle business of the firm.
Investing -- cash flows related to the acquisition or sale of
noncurrent assets.
Financing -- long term and short term cash flows related
to liabilities and owners’ equity; dividends are a
financing cash outflow.
What is Cash?
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Cash includes cash and cash equivalents
Cash equivalents:
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treasury bills maturing in 90 days or less;
investment funds;
foreign currency on hand;
checking account and free savings account
External Uses of CFS
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To assess the ability of a firm to manage cash flows
To assess the ability of a firm to generate cash
through its operations
To assess the company’s ability to meet its
obligations and its dividend policy
To provide information about the effectiveness of the
firm to convert its revenues to cash
To provide information to estimate or anticipate the
company’s need for additional financing
Internal Uses of CFS
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Along side with cash budget CFS is used:
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To assess liquidity
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To determine dividend policy
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Determine if short-term financing is necessary
Decide to distribute; or increase or decrease
To evaluate the investment and financing
decisions
Cash flow from operating
activities
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Examples (IAS No.7):
cash received from customers through sale of
goods or services performed;
cash received from non-operating activities such
as dividends from investments, interest revenue,
commissions, and fees;
cash payments to suppliers or employees;
cash payments for taxes and other expenses;
In effect, the income statement is changed from
accrual basis to cash basis
Investing Activities
Examples of investing activities include:
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cash payments to acquire property, plant, and equipment
(PPE), other tangible or intangible assets, and other long-term
assets; and sale of such assets
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loans extended to other companies; and collection of such
loans;
Financing Activities
Examples of financing activities are :
 cash received from issuing share capital;
 cash proceeds from issuing bonds, loans, notes,
mortgages and other short or long-term borrowings;
 cash repayment of loans and other borrowings; and
 cash payments to shareholders as dividends.
Classification of Cash in-flows and outflows
From sales of goods and
services to customers
From receipt of customer
advances
Operating Activities
From receipt of interest
revenue or dividends or
rent revenue or similar
revenue items
From sale of PPE and other
long-term assets
From collection of loans
From sale of common or
preferred stock
From issuance of short
or long term debt
Investing Activities
Financing Activities
To wages salary
payments
To suppliers for
purchases of inventories
To other operating
expenses
To interest payments
To tax payments
To advance payments to
suppliers
To purchase PPE and
other long-term assets
To make loans and to
collect such loans
To repay debt
To pay dividends
Format of the Cash Flow Statement
Name of the Company
Cash Flow Statement
For the period …
Cash from operating activities
A
Cash from investing activities
B
Cash from financing activities
C
Net Change in Cash
D = (A+B+C) increase or (decrease)
+ Beginning Cash balance
CB, from the beginning balance sheet
Ending Cash balance
=CB + D should equal to ending cash
balance in the ending balance sheet
Non-cash Investing and Financing Activities
Determination of Cash Flows From
Operating Activities
Direct Method
Income Statement items are converted to cash flows
individually
Indirect Method
Net income or loss is adjusted for accruals such as
accounts receivable and payable, and for non-cash
expenses such as depreciation
reconciliation of the accrual based and cash based
accounting
Comparison of Methods
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Direct method of presentation calculates cash flow from
operations by subtracting cash disbursements to supplies,
employees, and others from cash receipts from customers.
The indirect method calculates cash flow from operations by
adjusting net income for non-cash revenues and expenses.
Most firms present their cash flows using the indirect method.
Only operating activities section is different between the
methods, investing and financing sections are the same.
How to prepare cash flow
statement
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Firms could prepare their own cash flow
statement directly from the cash account.
however, we need two consecutive balance
sheets and the income statement that covers
the period between the two balance sheets
Algebraic Formulation*
Assets = Liabilities + Shareholders’ Equity
or A = L + SHE
Assets are either cash (C) or not (Non-Cash)
Thus reorganizing
C + Non Cash Assets (NCA) = L + SE
 C +  NCA =  L +  SE
Where  means the change in the balance of the item
from the previous period.
Solving for change in cash:
 C =  L +  SE -  NCA
Based on Stickney and Weil, 10th ed. Financial Accounting Slides http://www.swlearning.com/accounting/stickney/tenth_edition/stickney.html
Algebraic Formulation (Cont.)
 C =  L +  SE -  NCA
The change in cash,  C, is the increase or decrease
in the cash account.
This amount must equal changes in liabilities plus
changes in shareholders’ equity minus changes in
assets other than cash.
Thus, we can identify the causes in the change in the
cash account by studying the changes in non-cash
accounts.
Indirect Method – cash flow from operations
Adjusting Net Income of the period (accrual) to cash
basis income
INCREASE
Assets
DECREASE
Increase in non-cash Decrease in non-cash
assets shows that cash
assets shows that
was spent,
they provided cash
so cash outflow.
so cash inflow.
Increase in liabilities
Liabilities
cash savings;
and
increase in SHE cash
Shareholders’
received;
equity
so cash inflow
Decrease in liabilities
or SHE shows
cash paid;
so cash outflow
Indirect Method- operating activitiesAdjustments to net income
Net income
+ noncash expenses: depreciation, amortization,
uncollectible account expense,etc
+ loss on sale of asset
+ increases in current liabilities
+ decreases in current assets
- gain on sale of asset
- decrease in current liabilities
- increase in current assets
= Cashflow from operating activities
Noncash Expenses
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Noncash expenses, such as depreciation expense,
are added back – because they were deducted to
measure net income but did not require any cash
payment in the current period
They are not truly sources of cash, even though
they are associated with cash inflows but reversal
of an accrued expense
Portakal Company
Prepare Cash Flow Statement
Accounts with Debit Balances
Cash
Notes Receivable (from loans to other companies)
Accounts Receivable
Merchandise Inventory
Prepaid Operating Expenses
Interest Receivable
Land
Property,Plant and Equipment-PPE-net
Accounts with Credit Balances
Accounts Payable
Accrued Wages Payable
Income Taxes Payable
Unearned Revenues
Bank Notes Payable - long term
Common Stock; TL 15 par value
Additional Paid in Capital
Retained Earnings
2008
2007
37.500
69.000
53.700
158.000
2.100
1.400
110.000
377.000
808.700
39.250
50.000
39.900
120.000
1.800
600
65.000
380.000
696.550
45.000
3.000
6.000
2.500
215.000
405.000
70.000
62.200
808.700
38.000
2.400
4.500
1.250
200.000
375.000
50.000
25.400
696.550
increase
(decrease)
(1.750)
19.000
13.800
38.000
300
800
45.000
(3.000)
112.150
7.000
600
1.500
1.250
15.000
30.000
20.000
36.800
112.150
Portakal Company
Income Statement
Sales Revenue
Cost of Goods Sold
Depreciation Expense
Salary and Wages Expense
Administrative Expenses
Loss on Sale of Equipment
Other Operating Expenses
Interest Revenue
Interest Expense
Income Tax Expense
Net Income
0
2008
750.000
(375.000)
(43.000)
(125.000)
(80.000)
(4.000)
(5.000)
4.000
(20.000)
(28.000)
74.000
The company paid TL 50.000 of Bank Notes and borrowed new bank loan.
The company declared and paid cash dividends.
The company sold equipment with a cost of TL 12000 and accumulated depreciation of TL
6000 for TL 2000 receving a note in return to be collected in 2009.
The company purchased equipment for TL 46.000; paid TL 44.000 in 2008 and gave a
note for Jan. 2009.
The company issued common stock during the year .
Portakal Company
Cash Flow Statement
Cashflow from Operating Activities
Net Income
Add back noncash:
Depreciation Expense
Loss on Sale of Equipment
2008
74000
43.000
4.000
121.000
adjustments that increase cash:
increase in Acct.Payable
Increase in Acc.Wages Payable
increase in Income Taxes payable
increase in unearned revenued
adjustments that decrease cash:
increase in Accts Rec.
increase in Merch. Inv.
Increase in Prepaid Expense
increase in interest recev.
Cashflow from operations
7.000
600
1.500
1.250
10.350
(13.800)
(38.000)
(300)
(800)
(52.900)
78.450
Cashflow from investing
Sale of PPE (note will be received in 2009)
Purchase of PPE
(44.000)
Loans extended( to other companies) (19.000)
Purchase of land
(45.000)
Cashflow from investing
(108.000)
Cashflow from financing
Bank Notes Payable - long term
65.000
Common Stock; TL 15 par value
30.000
Additional Paid in Capital
20.000
Payment of Bank loan
(50.000)
Payment of Dividends
(37.200)
Cashflow from financing
27.800
Net Change in Cash
(1.750)
Effects of a Sale of
a Long-Term Assets on Cash Flows
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A few transactions complicate the derivation of a cash
flow statement from a comparative balance sheet, for
example, the sale of a long-term (or fixed) asset.
Recall the journal entry for the sale of an asset:
Cash
Accumulated Depreciation
Asset
Gain (or loss) on sale
nnnn
nnnn
nnnn
nnnn
Sale of an Asset
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Each of the four parts of the above journal entry require
an adjustment in the cash flow statement.
The first line, cash, adds a line to the investing section.
The second line, a debit to accumulated depreciation,
increases the depreciation expense above the change
in the change in the accumulated depreciation account.
The third line, a credit to the asset, increases the
amount of cash invested in long-lived assets above the
change in the fixed asset accounts.
The fourth line, a gain or loss, is reversed out in the
operating sections since this is not a cash flow.
Comparison of Cash Flow to Net
Income
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Net income is an accrual based concept and purports to
show the long-term.
Cash flows purport to show the short term.
Consider the outlook for both short-term and long-term and
consider that each is either good or poor.
A strong growing firm would show both good long-term and
good short-term outlooks.
A failing firm would show both poor long-term and poor
short term outlooks.
What about a firm with good cash flows (short-term) but
poor net income (long-term)?
What about a firm with poor cash flows (short-term) but
good net income (long-term)?