Chapter 13
The Statement
of Cash Flows
Skyline College
Lecture Notes
Statement of Cash Flows
 Shows how a company’s activities have affected
cash during an accounting period
 Explains the net increase or decrease in cash
Statement of Cash Flows includes:
Cash
Cash equivalents (90 days or less)
 Money market accounts
 Commercial paper
 U.S. Treasury bills
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13–2
How Is the Statement of Cash
Flows Used?
Managers
Assess liquidity
Investors and creditors assess the
company’s ability to
Manage cash flows
Determine dividend policy Generate positive future cash
flows
Evaluate investment
decisions
Pay its liabilities
Evaluate financing
decisions
Pay dividends and interest
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13–3
Classification of Cash Flows
The statement of cash flows classifies cash
receipts and cash payments into categories
Operating
Activities
Investing
Activities
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Financing
Activities
13–4
Operating Activities
Involve the cash inflows and outflows from
activities that enter into the determination of
net income
Cash Inflows
 Receipts from sale of
goods and services
 Receipts from sale of
trading securities
 Interest and dividends
Cash Outflows
 Payments for wages,
inventory, taxes, other
operating expenses
 Payments for purchase
of trading securities
Trading securities are a type of marketable security that a company
buys and sells for the purpose of making a profit in the near term.
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13–5
Investing Activities
Involve the purchase and sale of PP&E, investments
(other than trading securities), and the issuing and
collecting of notes receivable
Cash Inflows
 Receipts from selling
marketable securities
and long-term assets
 Collections on loans
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Cash Outflows
 Expenditures on
purchase of securities
and assets
 Outflows of cash lent
to borrowers
13–6
Financing Activities
Issuing stock, paying dividends, and borrowing
and repaying creditors
Cash Inflows
Proceeds from
stock issues
borrowing
Cash Outflows
Repayments of loans
Sales of treasury stock
Purchases of treasury
stock
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Payments of dividends
13–7
Noncash Investing and Financing
Transactions
Significant transactions that involve only long-term
assets, long-term liabilities, or stockholders’ equity
Noncash examples:
 Exchange of long-term
asset for a long-term
liability
 Settle a debt by issuing
capital stock
 Take out a long-term
mortgage to purchase
real estate
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Not reflected on the
statement of cash flows;
no cash inflows or
outflows
Future cash flows are
affected, so disclose
these transactions in a
footnote to the statement
13–8
Format of the Statement of Cash Flows
1
Operating Activities section Indirect method begins with net
income and ends with cash flows
from operating activities
2
Investing Activities section Cash transactions involving
3
Financing Activities section
4
Reconciliation of beg. and
end. balances of cash
capital expenditures
Debt, cash stock transactions, dividends,
and treasury stock transactions
Ties to cash balances of the
balance sheet
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13–9
Discussion: Ethics on the Job
Boxcar Industries, a small upstart company, was
having cash flow difficulties. Payroll was due to
employees in one week, invoices were due to
vendors, and there was not enough cash to cover
both. The CEO considered telling employees that
payroll would be late or slowing down payments to
vendors. He also considered a more aggressive
collection effort on the company’s accounts
receivables.
Q. What do you think of the options? Do any of
the options strike you as more or less ethical
than others?
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13–10
Cash-Generating Efficiency (CGE)
Shows the company’s ability to generate cash
from its current or continuing operations
Ratios used to calculate
Cash flow yield
Cash flows to sales
Cash flows to assets
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13–11
Cash Flow Yield
Shows how much of net income actually results
in operating cash inflows
Net Cash Flows from Operating Activities
Cash Flow Yield 
Net Income
$891

 1.5 times
$594
Marriott’s operating activities were generating about 50
percent more cash flow than net income
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13–12
Cash Flows to Sales
Shows how much of net sales actually results in
cash inflows
Marriott 2004 Annual Report (in millions)
2004
2003
2002
Net Sales
Cash Flows to Sales 
$10,099
$9,014
$8,415
Net Cash Flows from Operating Activities
Net Sales
$891

 8.8%*
$10,099
* Rounded
Marriott generated positive cash flows to
sales of 8.8 percent.
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13–13
Cash Flows to Assets
Shows how much cash is being generated by
operations for each dollar of assets
Marriott 2004 Annual Report (in millions)
2004
2003
2002
Total Assets
Cash Flows to Assets 

8,668
8,177
8,296
Net Cash Flows from Operating Activities
Average Total Assets
$891
*
 10.6%
($8,668  $8,177)  2
*Rounded
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13–14
Free Cash Flow
Amount of cash that remains after deducting the
funds a company must commit to continue operating
at its planned level
Net Cash Flows from Operating Activities
– Dividends
– Purchases of Plant Assets
+ Sales of Plant Assets
Free Cash Flow
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13–15
Free Cash Flow Effects
• If free cash flow is positive, the company
– Has met all of its planned cash commitments
– Has cash available to reduce debt or expand
• If free cash flow is negative, the company
will have to..
– Sell investments
– Borrow money
– Issue stock in the short term
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13–16
Determining Cash Flows from
Operating Activities
There are two methods of converting the income
statement from an accrual basis to a cash basis:
1. The direct method
• Adjusts each item on the income statement to its
cash equivalent
• More easily understood by the average reader
2. The indirect method
• Lists only necessary adjustments to convert net
income to net cash flows
• Superior from an analyst’s perspective
• Used by most companies
Both methods produce the same net figure
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13–17
Depreciation
Depreciation expense appears on the income
statement, but involves no outlay of cash
Cash flows from operating activities
Adjustment:
Depreciation
expense added
back to net
income
for the period
Net income
Adjustments to reconcile net income to
net cash flows from operating activities
Depreciation
Gain on sale of investments
Loss on sale of plant assets
Changes in current assets and current
liabilities
Decrease in accounts receivable
Increase in inventory
Decrease in prepaid expenses
Increase in accounts payable
Increase in accrued liabilities
Decrease in income taxes payable
Net cash flows from operating activities
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$8,000
$18,500
(6,000)
1,500
4,000
(17,000)
2,000
3,500
1,500
(1,000)
7,000
$15,000
13–18
Gains and Losses
Do not affect cash flows from operating
activities; should be removed from net income
Cash flows from operating activities
Adjustments:
Gain/Losses
subtracted and
added to net
income
for the period
Net income
Adjustments to reconcile net income to
net cash flows from operating activities
Depreciation
Gain on sale of investments
Loss on sale of plant assets
Changes in current assets and current
liabilities
Decrease in accounts receivable
Increase in inventory
Decrease in prepaid expenses
Increase in accounts payable
Increase in accrued liabilities
Decrease in income taxes payable
Net cash flows from operating activities
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$8,000
$18,500
(6,000)
1,500
4,000
(17,000)
2,000
3,500
1,500
(1,000)
7,000
$15,000
13–19
Treatment of Noncash Items
Noncash Item
Depreciation Expense
Add to or Deduct
from Net Income
Add
Amortization Expense
Add
Depletion Expense
Add
Losses
Add
Gains
Deduct
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13–20
Changes in Current Assets
Example: Amir Corporation’s Accounts Receivable
decreased by $4,000 as illustrated below.
Accounts Receivable
Beg. Bal.
Sales to
Customers
27,500
353,000
Cash Receipts
from Customers
349,000
End. Bal.
23,500
The $4,000 decrease in Accounts Receivable
should be added to net income on the statement of cash flows.
 Decreases in current assets are added to net income
 Increases in current assets are deducted from net income
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13–21
Changes in Current Liabilities
Example: Amir Corporation’s accounts payable increased
by $3,500 as illustrated below.
Accounts Payable
Cash Payments to
Suppliers
273,500
Beg. Bal.
21,500
277,000
End. Bal.
Purchases
25,000
The $3,500 increase in Accounts Payable should
be added to net income on the statement of cash flows.
 Decreases in current liabilities are deducted from net income
 Increases in current liabilities are added to net income
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13–22
Net Income versus Cash Flows from
Operating Activities
Cash flows from operating activities
A net income of
$8,000, after
adjustments,
actually yielded
$15,000 in
positive cash
flows from
operating
activities
Net income
Adjustments to reconcile net income to
net cash flows from operating activities
Depreciation
Gain on sale of investments
Loss on sale of plant assets
Changes in current assets and current
liabilities
Decrease in accounts receivable
Increase in inventory
Decrease in prepaid expenses
Increase in accounts payable
Increase in accrued liabilities
Decrease in income taxes payable
Net cash flows from operating activities
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$8,000
$18,500
(6,000)
1,500
4,000
(17,000)
2,000
3,500
1,500
(1,000)
7,000
$15,000
13–23
Adjustments for Changes in Current
Assets and Liabilities
Add to
Net Income
Deduct from
Net Income
Accounts receivable
(net)
Decrease
Increase
Inventory
Decrease
Increase
Prepaid expenses
Decrease
Increase
Accounts payable
Increase
Decrease
Accrued liabilities
Increase
Decrease
Income taxes payable
Increase
Decrease
Current Assets:
Current Liabilities:
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13–24
Examining Investment Transactions
To determine cash flows from investing
activities, accounts involving cash receipts
and cash payments from investing activities
are examined individually
Long-term assets
Short-term investments
Investment gains and losses
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13–25
Investment Transactions
Cash Flows Illustrated
1. Amir Corporation’s purchases of investments totaled
$39,000 during 20x7. These transactions, caused a
$39,000 decrease in cash flows (cash paid).
2. Amir sold investments that cost $45,000 for $51,000.
This transaction resulted in a gain of $6,000 and caused
an increase in cash flows of $51,000 (cash received) .
Investing activities section, statement of cash flows:
Purchase of investments ($39,000)
Sale of investments
51,000
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13–26
Plant Asset Transactions Cash Flows
 Examine the Plant Assets account and the related
Accumulated Depreciation account
1. Amir Corporation purchased plant assets totaling
$60,000. These transactions, caused a $60,000 decrease
in cash flows (cash paid).
2. Amir sold plant assets that cost $5,000 and that had
accumulated depreciation of $1,000 for $2,500. This
transaction resulted in a loss of $1,500 and caused an
increase in cash flows of $2,500 (cash received) .
Investing activities section, statement of cash flows:
Purchase of plant assets ($60,000)
Sale of plant assets
2,500
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13–27
Cash Flows from Investing Activities
The transactions for Amir Corporation we have
examined are listed below on its statement of cash
flows in the investing activities section:
Cash flows from
investing activities
Purchase of investments
Sale of investments
Purchase of plant assets
Sale of plant assets
Net cash flows from
investing activities
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($39,000)
51,000
(60,000)
2,500
(45,500)
13–28
Examining Financing Transactions
To determine cash flows from financing
activities, accounts involving cash receipts
and cash payments from financing activities
are examined individually
Short-term borrowings
Long-term liabilities
Stockholders’ equity
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13–29
Bonds Payable Transactions
Cash Flows Illustrated
Amir Corporation repaid $25,000 of bonds at
face value at maturity. This transaction caused
a $25,000 decrease in cash flows (cash paid).
Financing activities section, statement of cash flows:
Repayment of bonds
($25,000)
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13–30
Common Stock Transactions
Cash Flows Illustrated
Amir Corporation issued 7,600 shares of $5 par value
common stock for $87,500. The Common Stock
account increased by $38,000, and the Additional Paidin Capital account increased by $49,500. This
transaction caused an $87,500 increase in cash flows
(cash received).
Financing activities section, statement of cash flows:
Issue of common stock
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$87,500
13–31
Dividend Transactions
Cash Flows Illustrated
Amir Corporation paid cash dividends of $4,000. This
amount decreased Retained Earnings causing a $4,000
decrease in cash flows (cash paid).
Only the payment of dividends appears on the statement of
cash flows, not the declaration of dividends.
Financing activities section, statement of cash flows:
Payment of dividends
($4,000)
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13–32
Treasury Stock Transactions
Cash Flows Illustrated
Amir Corporation purchased treasury stock for $12,500. This
transaction created a cash outflow of $12,500.
Financing activities section, statement of cash flows:
Purchase of treasury stock
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($12,500)
13–33
Cash Flows from Financing Activities
The transactions of Amir Corporation that we
have examined are presented in the financing
section of the statement of cash flows:
Cash flows from
financing activities
Repayment of bonds
Issue of common stock
Payment of dividends
Purchase of treasury stock
Net cash flows from
financing activities
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($25,000)
87,500
(4,000)
(12,500)
46,000
13–34
Noncash Transaction
Illustrated
Amir Corporation issued bonds at face
value ($50,000) for plant assets. There
are no cash inflows or outflows, but it is
a significant transaction.
Schedule of Noncash Investing and
Financing Transactions:
Issue of bonds payable for plant assets $50,000
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13–35
Statement of Cash Flows Summary
All three sections are presented in summary form
here, followed by the net increase or decrease in cash:
Amir Corporation
Statement of Cash Flows
For the Year Ended December 31, 20x7
Net cash flows from operating activities
Net cash flows from investing activities
Net cash flows from financing activities
Net increase (decrease) in cash
Cash at beginning of year
Cash at end of year
$15,000
(45,500)
46,000
$15,500
7,500
$23,000
Note: Issue of bonds payable for plant assets
$50,000
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13–36