Statement of Cash Flows

Cash Flow Statement

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?
Cash includes cash and cash
equivalents
Cash equivalents:
treasury bills maturing in 90 days or
less;
investment funds;
foreign currency on hand;
checking account and free savings
account

External Uses of CFS

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 companys 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 companys need for additional financing

Internal Uses of CFS

Along side with cash budget CFS is
used:
To assess liquidity
Determine if short-term financing is necessary

To determine dividend policy

Decide to distribute; or increase or decrease

To evaluate the investment and financing

decisions

Cash flow from operating activities

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:

cash payments to acquire property, plant, and

equipment (PPE), other tangible or intangible assets,
and other long-term assets; and sale of such assets

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 longterm 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

To wages salary
payments

From receipt of customer

advances

To suppliers for
purchases of inventories

Operating Activities

From receipt of interest

revenue or dividends or
rent revenue or similar
revenue items

To other operating
expenses
To interest payments
To tax payments
To advance payments to
suppliers

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 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

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
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
Increasein
innon-cash
non-cash Decrease
Decreasein
innon-cash
non-cash
assets
shows
that
cash
assets shows that cash
assets
assetsshows
showsthat
that
was
wasspent,
spent,
they
theyprovided
provided cash
cash
so
cash
outflow.
so cash outflow.
so
socash
cashinflow.
inflow.

Increase
Increasein
inliabilities
liabilities Decrease in liabilities
Liabilities
Decrease in liabilities
cash
cashsavings;
savings;
or
and
orSHE
SHEshows
shows
increase
in
SHE
cash
increase in SHE cash
cash
Shareholders
cashpaid;
paid;
received;
received;
so
cash
outflow
equity
so
cash
outflow
so
cash
inflow
so cash inflow

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

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

Effects of a Sale of
a Long-Term Assets on Cash Flows

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

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

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 longterm and consider that each is either good or poor.
A strong growing firm would show both good longterm 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 (shortterm) but poor net income (long-term)?
What about a firm with poor cash flows (short-term)
but good net income (long-term)?