CHAPTER 8
THE CASH FLOW
STATEMENT: ITS
CONTENT AND USE
1
Chapter Overview
 Why is a company’s cash flow statement
important?
 What are the types of transactions that
may cause cash inflows and cash
outflows for a company?
 What do users need to know about a
company’s cash flow statement?
 How does a company report the cash
flows from its operating activities on its
cash flow statement under the direct
method?
2
Chapter Overview
 How do users combine the changes in a
company’s current assets and current
liabilities with its revenues and expenses for
the accounting period to determine the
company’s operating cash flows?
 Why do internal and external users study a
company’s cash flow statement in
conjunction with its income statement and
balance sheet?
 What cash flow ratios are used to evaluate
a company’s performance?
3
Why the Cash Flow Statement
is Important
 A company’s cash flow statement shows the
changes in a company’s cash during an
accounting period from operating, investing,
and financing activities.
 It primarily provides information about a
company’s ability to remain solvent (meet its
obligations) and to grow.
4
Why the Cash Flow Statement
is Important
 A cash flow statement can help users
answer questions such as , “How much
cash was provided or used by the
company’s operating activities?”, or “What
are the reasons that cash increased or
decreased during an accounting period?”
 A company cannot survive without cash to
operate day-to-day; and thus, studying the
cash flow statement provides important
information on a company’s financial
stability.
5
Cash Inflows and Outflows
 A company’s cash flow statement shows the
inflows (receipts) and outflows (payments)
during an accounting period.
 The cash flow statement reconciles the
beginning balance of cash from the balance
sheet to the ending balance of cash on the
balance sheet.
6
Cash Account
and Cash Flows
7
Balance Sheet Accounts and
Cash Flows
8
Inflows (Receipts) of Cash

A decrease in an asset (other than cash)
causes an inflow (increase) of cash when
cash is received in exchange for the asset.

This occurs when a company collects $200 on
an accounts receivable from a customer.
Assets = Liabilities + Owners' Equity
Cash
A/R
Beg. Bal. $ 2,000 $ 800
When cash is collected,
$ 200 $ (200)
the asset accounts
receivable decreases
End. Bal. $ 2,200 $ 600
9
Inflows (Receipts) of Cash

An increase in a liability may also cause an
inflow (increase) of cash when a company
receives cash in exchange for the liability.

This occurs when a company borrows $4,000
from a bank and signs a note payable.
Assets
Cash
Beg. Bal. $ 2,200
$ 4,000
End. Bal. $ 6,200
= Liabilities + Owners' Equity
N/P
When a company borrows
$ 1,500
money in exchange for a
$ 4,000
note payable, the liability
$ 5,500
notes payable increases.
10
Inflows (Receipts) of Cash

An increase in owners’ equity may also cause
an inflow (increase) of cash when additional
investments are made in the business.

This occurs when a company’s owner invests
an additional $1,000 into the business.
Assets
= Liabilities + Owners' Equity
Cash
Owners' Capital
Beg. Bal. $ 6,200
$
50,000
$ 1,000
$
1,000
End. Bal. $ 7,200
$
51,000
When an owner invests additional cash into
the business, owners’ capital increases.
11
Outflows (Payments) of Cash

An increase in an asset (other than cash)
causes an outflow (decrease) of cash when a
company pays cash for the asset.

This occurs when a company pays $50 for
purchased supplies.
Assets = Liabilities + Owners' Equity
Cash Supplies
Beg. Bal. $ 7,200 $ 2,200
When cash is paid, the
$
(50) $
50
asset store supplies
increases.
End. Bal. $ 7,150 $ 2,250
12
Outflows (Payments) of Cash

A decrease in a liability causes an outflow
(decrease) of cash when a company pays
cash for outstanding debts.

This occurs when a company pays $500 to
reduce its notes payable.
Assets
Cash
Beg. Bal. $ 7,150
$ (500)
End. Bal. $ 6,650
= Liabilities + Owners' Equity
N/P
When a company pay a
$ 4,000
portion of its outstanding
$ (500)
notes payable, the liability
notes payable decreases.
$ 3,500
13
Outflows (Payments) of Cash
 An decrease in owners’ equity may also
cause an outflow (decrease) of cash for
owners’ withdrawals from the business.
 This occurs when an owner withdraws $300
from the company.
Assets
Cash
Beg. Bal. $ 6,650
$ (300)
End. Bal. $ 6,350
= Liabilities + Owners' Equity
Owners' Capital
$
51,000
$
(300)
$
50,700
When an owner withdraws cash from the
business, owners’ capital decreases.
14
Organization of the Cash
Flow Statement
 The cash flow statement shows a company’s
cash flows in three sections according to the
type of activity that caused the increase or
decrease in cash.
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
15
The Nature of Operating
Cash Flows
Cash flow from operating activities
 Operating cash flows include cash inflows
and outflows related to the profit-making
activities of a company.
 Collections from customers, payments for
merchandise purchases, payments to
employees and for other operating expenses
are included in this category.
16
The Nature of Investing
Cash Flows
Cash flow from investing activities
 Investing cash flows include cash inflows and
outflows related to lending activities, investing
in other companies and long-term operating
assets.
 Purchases and sales of property and
equipment are included in this category.
17
The Nature of Financing
Cash Flows
Cash flow from financing activities
 Financing cash flows include cash inflows
and outflows related to acquiring owner’s
capital, rewarding owners by returning profits,
and non-operating debt activities.
 Investments and withdrawals by owners and
acquiring or repaying loans are included in
this category.
18
Examples of Cash Flows
Exhibit 8-4
19
Net Cash Flows from Operating
Activities: Direct Method
Cash Flows from Operating Activities
Cash inflows:
Collections from customers
Collection of interest
Other operating receipts
Cash inflows from operating activities
Cash outflows:
Payments to supplies
Payments to employees
Payments of interest
Other operating payments
Cash outflows from operating activities
Net cash provided by operating activities
Under the direct method,
a company identifies the
underlying reasons for
cash inflows and
outflows, which provides
a detailed picture of cash
flow activity. Examples
include collections from
customers (cash inflows)
or payments of interest
(cash outflows).
20
Net Cash Flows from Operating
Activities: Indirect Method
Cash Flows from Operating Activities
Net income
Adjustments for differences between net income
and cash flows from operating activities:
Add:
Depreciation expense
[Net] decrease in accounts receivable
Less:
[Net] decrease in accounts payable
[Net] decrease in salaries payable
Net cash provided by operating activities
Under the indirect method, a
company starts with net
income, adjusting this for
non cash items (such as
depreciation) and net
changes in non-cash current
assets and liabilities during
the period.This provides less
detail but an important
reconciliation between net
income on the income
statement and cash flows
from operations.
21
Net Cash Flows from Operating
Activities: Direct Method
Sweet Temptations Cash Account: January 2004
Jan 1 Bal
7,300
+300 Cash sales
-1,620 Payments for inventory purchases
Detailed
+400
Receipts
– saleinofthe
equipment
 By carefully
analyzing
all
of
the
changes
cash
cash
-50 Owner
withdrawal
account,
we
can
summarize
the
detail
transactions that
transactions
-200 Payment
for consulting
bill
cause
Sweet
Temptations’
cash
to
increase
from
occurring
-300 January
Payment2004
for advertising bill
$7,300
to $11,030 during
during
-200 Payment for equipment purchases
January
-2,050 Payments for salaries
2004
-60 Payment for telephone bill
-190 Payment for utility bill
+7,700 Cash sales
Jan 31 Bal 11,030
22
Net Cash Flows from Operating
Activities: Direct Method
Sweet Temptations Cash Account: January 2004
Jan 1 Bal
After identifying
the cash
transactions,
operating cash
flows can be
segregated.
Jan 31 Bal
7,300
+300
-1,620
+400
-50
-200
-300
-200
-2,050
-60
-190
+7,700
11,030
Cash sales
Payments for inventory purchases
Receipts – sale of equipment
Owner withdrawal
Payment for consulting bill
Payment for advertising bill
Payment for equipment purchases
Payments for salaries
Payment for telephone bill
Payment for utility bill
Cash sales
23
Net Cash Flows from Investing
Activities
Sweet Temptations Cash Account: January 2004
Jan 1 Bal
After identifying
the operating
cash flows,
investing cash
flows can be
segregated.
Jan 31 Bal
7,300
+300
-1,620
+400
-50
-200
-300
-200
-2,050
-60
-190
+7,700
11,030
Cash sales
Payments for inventory purchases
Receipts – sale of equipment
Owner withdrawal
Payment for consulting bill
Payment for advertising bill
Payment for equipment purchases
Payments for salaries
Payment for telephone bill
Payment for utility bill
Cash sales
24
Net Cash Flows from Financing
Activities
Sweet Temptations Cash Account: January 2004
Jan 1 Bal
After identifying
operating and
investing cash
flows, financing
cash flows can
be segregated.
Jan 31 Bal
7,300
+300
-1,620
+400
-50
-200
-300
-200
-2,050
-60
-190
+7,700
11,030
Cash sales
Payments for inventory purchases
Receipts – sale of equipment
Owner withdrawal
Payment for consulting bill
Payment for advertising bill
Payment for equipment purchases
Payments for salaries
Payment for telephone bill
Payment for utility bill
Cash sales
25
Sweet Temptations’ Cash
Flow Statement
26
Expanding Calculations under
the Direct Method
 While a company can analyze every
transaction in its cash account, this would
be a time consuming process given the
thousands of transactions recorded during
an accounting period.
 Instead, under accrual-basis accounting,
changes in non-cash current assets and
liabilities can be defined in terms of
operating cash inflows and outflows.
27
Cash Collections
from Customers
 Sales revenues on the income statement arise
from cash and credit sales to customers.
 By understanding the changes in the current
asset accounts receivable during the year,
sales revenues can be converted to cash
collections from customers.
 When accounts receivable increases, a credit
sale is made (but no cash is received). When
it decreases, cash is collected (but no revenue
is recorded).
28
Cash Collections
from Customers
 Assume a company reports $500,000 in sales
revenues on its income statement, and the
following activity is recorded in accounts
receivable during the year:
Beg. Bal., Jan 1
Credit sales to customers
Cash collections from customers
End. Bal., Dec. 31
$ 31,000
$ 350,000
$ (352,500)
$ 28,500
 How can this be analyzed to determine the
cash collections from customers on the cash
flow statement?
29
Cash Collections from Customers
1. Accounts receivable (A/R) shows a net decrease during
the year – what does it mean when A/R decreases?
Beg. Bal., Jan 1
$ 31,000
Credit sales to customers
$ 350,000
3. This is true; credit sales were $350,000 and cash collections were
$352,500. From a cash flow perspective, sales on the income
statement are understated when A/R decreases during the year.
Cash collections from customers $ (352,500)
End. Bal., Dec. 31
4. The net
decrease
of $2,500
must be
added to
net sales to
obtain cash
collections
from
customers
$ 28,500
2. It means the company collected more cash
from customers than it recorded in credit sales.
30
Cash Collections
from Customers
 After we complete the analysis of the net
changes in accounts receivable, cash
collections from customers (under the direct
method) is computed as follows:
Net sales (income statement)
$ 500,000
Add: net decrease in A/R during year $ 2,500
Cash collections from customers
$ 502,500
Cash inflow from operating activities
31
Cash Payments
to Employees
 Salary expense on the income statement
arises when employees perform services and
a company recognizes the expense in the
period the services are performed.
 By understanding the changes in the current
liability salaries payable during the year, salary
expense can be converted to cash payments
to employees.
 When salaries payable increases, expense is
being recorded (but no cash is paid). When it
decreases, cash is paid (but no expense is
recorded).
32
Cash Payments
to Employees
 Assume a company reports $25,000 in salaries
expense on its income statement, and the
following activity is recorded in salaries
payable during the year:
Beg. Bal., Jan 1
Salary expense recorded
Salaries paid to employees
End. Bal., Dec. 31
$
$
$
$
10,000
25,000
(15,000)
20,000
 How can this be analyzed to determine the
cash payments to employees on the cash flow
statement?
33
Cash Payments to Employees
1. Salaries Payable (S/P) shows a net increase during
the year – what does it mean when S/P increases?
Beg. Bal., Jan 1
$ 10,000
Salary expense recorded
$ 25,000
3. This is true; salary expense was $25,000 and cash payments to
employees were $15,000. From a cash flow perspective, salary expense
on the income statement is overstated when S/P increases during the year.
4.
Salaries paid to employees
$ (15,000)
End. Bal., Dec. 31
$ 20,000
The net increase of $10,000 must be subtracted from
salary expense to obtain cash payments to employees
2. It means the
company
recorded more
salary expense
than cash paid
to employees.
34
Cash Payments
to Employees
 After we complete the analysis of the net
changes in salaries payable, cash payments to
employees (under the direct method) is
computed as follows:
Salary expense (income statement)
$ 25,000
Less: net increase in S/P during year $ (10,000)
Cash payments to employees
$ 15,000
Cash outflow from operating activities
35
Calculation of Operating Cash Flows
36
Cash Flow Statement Usefulness
A measure of a company’s
liquidity - how much net cash is
generated from each dollar of net
sales generated by a company.
A measure of how well
a company uses its
total resources to
generate net cash from
operating activities.
A measure of how well a
company uses its owners’
capital to generate net cash
from operating activities.
37
Operating Cash
Flow Margin
 Operating cash flow margin describes how
much net cash a company generates from
each dollar of net sales, providing an
additional measure of a company’s
liquidity.
Net Cash Flow Provided by Operating Activities
Net Sales
38
Cash Return
on Total Assets
 Cash return on total assets measures how
well a company is using its resources to
generate net cash from operating activities.
[Net cash flow provided by operating
activities + Interest paid]
Average Total Assets
39
Cash Return
on Owners’ Equity
 A company’s cash return on owners’ equity
measures how much net cash from
operating activities the company generates
with each dollar of owners’ capital.
Net Cash Flow Provided by Operating Activities
Average Owners’ Equity
40