Chapter-5

Statement of Cash Flow

Statement of Cash Flows
• Reports a company’s cash receipts and cash
payments during a particular period
• Classifies them as financing, investing, and
operating cash flows
• Shows the performance of a company over a
period of time
• Explains why balance sheet items change
• Explanation of changes in cash account
Statement of Cash Flows
Show performance of companies over a period of
time
Purposes of Cash Flow Statement
Cash Equivalents
Operating Decisions
• Affect the major day-to-day activities that
generate revenues and expenses
• Cash flows from operating activities
• First major section of the cash flow statement
• Helps users evaluate the cash impact of management’s
operating decisions
• Operating activities: Transactions affecting
purchase, processing, and selling of
products and services
Financing Decisions
• Decisions concerned with whether and how
to raise or repay cash
• Cash flows from financing activities
• Section of the statement of cash flows
that helps users understand financing
decisions
• Financing activities: Transactions that obtain
resources by either of the following methods
• Borrowing from creditors
• Selling shares of stock
• Use resources for either of the following
purposes
• Repay creditors
• Provide a return to shareholders
Investing Decisions
• Decisions that include the choices to:
• Acquire or dispose of plant, property,
equipment, and other long-term
productive assets
• Provide or collect cash as a lender or as an
owner of securities
Investing Decisions
• Cash flows from investing activities
• Section of the statement of cash flows that
helps understand management’s investing
decisions
• Investing activities: Transactions that acquire or
dispose of:
• Long-lived assets
• Securities that are not cash equivalents
Cash Flows from Financing
Activities
• Determining cash flows to and from
providers of capital involves:
• Examining changes in cash account in
balance sheet equation
• Identifying changes associated with
financing activities
Cash Flows from Financing
Activities
• Examples of financing activities
• Initial investment, $400,000
• Loan from bank, $100,000
• Cash flows from financing activities

Balance, Balance,
January 1, January 31, Increase
20xx 20xx (Decrease)
Notes payable $0 $100,000 $100,000
Paid-in capital 0 400,000 400,000
Cash Flows from Financing
Activities
Cash Flows from Investing
Activities
• Lists cash flows from the purchase or sale of:
• Plant, property, equipment and other
long-lived assets
• Determined by looking at transactions that
increase or decrease:
• Long-lived assets, loans, or securities that
are not considered cash equivalents.
Cash Flows from Investing
Activities
• Cash flows from transaction of long-lived
assets
• Change in assets = Acquisitions − Disposals −
Depreciation expense
• Asset acquisitions and disposals involve
cash
• Depreciation is a non-cash expense
• Examples of investing activity
• Acquire store equipment for cash, $15,000
• Sale of asset for cash, $1,000

Cash Flows from Investing Activities

Purchase of store equipment ($15,000)
Proceeds from sale of store equipment 1,000
Net cash used by investing activities ($14,000)
Cash Flows from Investing
Activities
Noncash Investing and Financing
Activities
• Listed in separate schedule
• Example of a company acquiring $8,000 of store
equipment by issuing common stock

Cash + Store Equipment = Liabilities + Paid-in Capital

0 +8,000 = +8,000
Cash Flows from Operating
Activities
• Shows cash transactions affecting income
statements
• Two approaches under U.S. GAAP
Cash Flows from Operations —
The Direct Method
• Consists of a listing of cash receipts
(inflows) and cash disbursements
(outflows)
• Constructed by examining cash column
of balance sheet equation
Cash Flows from Operations —
The Direct Method
• Example:

Cash Flows from Operating Activities

Cash payments for inventory ($120,000 + $10,000) ($130,000)
Cash payments to creditors for accounts payable (4,000)
Cash collections on accounts receivable 5,000
Cash payment for rent (6,000)
Net cash used by operating activities ($135,000)
Cash Flows from Operations —
The Indirect Method
• Used to understand how the cash flows from
operating activities differ from net income
• Operating statement:
• Starts with net income
• Adds or subtracts a series of adjustments
• Ends with cash provided by (used for)
operating activities
Cash Flows from Operations
• Highlights the differences between:
• Revenues and cash inflows
• Expenses and cash outflows
• Adjustments recognize the differences in
timing between:
• Revenues and cash inflows
• Expenses and cash outflows
• Line items are not cash flows they are
adjustments of net income
Cash Flows from Operations—The
Indirect Method
Adjustment for Depreciation
• Why add depreciation expense back to
net income?
• Depreciation is deducted when computing
net income
• There is no cash flow effect of
depreciation
• Adding it back simply cancels the
deduction
Adjustment for Revenues
Adjustment for Revenues
• Adjust to get increase or decrease in accounts
receivable
Beginning accounts receivable $0
Less: Ending accounts receivable 155,000
Decrease (increase) in accounts receivable $(155,000)

• Adjust to get cash collection from customers

Sales $ 160,000
Decrease (increase) in accounts receivable (155,000)
Cash collections from customers $ 5,000
Adjustment of COGS
we can adjust cost of goods sold to compute
cash outflow for payments to suppliers. To do
this, we use one income statement account,
Cost of Goods Sold, and two balance sheet
accounts, Inventory and Accounts Payable. We
adjust cost of goods sold to get cash payments
to suppliers in two steps:
Adjustment for Cost of Goods
Sold
• Adjusted to get purchases
Cost of goods sold in January $ 100,000
Add: Ending inventory, January 31 59,200
Inventory available in January $ 159,200
Less:Beginning inventory, January 1 0
Inventory purchased in January $ 159,200

• Adjusted to get payment to suppliers

Inventory purchased in January $ 159,200
Add: Beginning accounts payable, January 1 0
Total amount to be paid $ 159,200
Less: Ending accounts payable, January 31 (25,200)
Amount paid in cash during January $ 134,000
We can simplify these two steps into one line
each:
A General Approach to
Adjustments
• To adjust for noncash revenues and
expenses:
• Add back depreciation
• Add back other expenses that do not
require cash
• Deduct revenues that do not generate
cash
A General Approach to
Adjustments
• To adjust for changes in noncash assets
and liabilities relating to operating
activities:
• Add decreases in operating assets
• Deduct increases in operating assets
• Add increases in operating liabilities
• Deduct decreases in operating
liabilities
Example-1
Continue…
The president looked at the indirect-method
cash flow statement and suggested a way to
help the cash flow problem. He suggested
tripling the depreciation from $30,000 to $90,000
a year. That way, the cash flow will improve by
$60,000 annually. Explain why this reasoning is
faulty.
Example-2
Example-3
Reconciliation Statement
• Direct-method statements must include
supplementary schedule:
• To reconcile net income to net cash
provided by operations
• Which is effectively the operating section
of an indirect method cash flow statement
The Statement of Cash Flows and
the Balance Sheet Equation
• The balance sheet equation rearranged as
Assets = Liabilities + Stockholders' equity
Cash + Noncash assets = Liabilities + Stockholders' equity
Cash = Liabilities + Stockholders' equity – Noncash assets

• Any change in cash is accompanied by change(s) in

items on right
∆ Cash = ∆ Liabilities + ∆ Stockholders' equity – ∆ Noncash assets

Change in cash = Change in all noncash accounts

The Statement of Cash Flows and
the Balance Sheet Equation
• Statement of cash flows focuses on changes in the
noncash accounts to explain how and why level of
cash changed
• Changes in the accounts on the right side of the
equation appear in the statement of cash flows:
• When they involve the use or receipt of cash
• Left side of the equation measures the net
effect of the change in cash
The Importance of Cash Flow
• Statement of cash flows explains changes in cash
account
• Not changes in owners’ equity
• Measures firm’s performance in maintaining strong
cash position
• Free cash flow: Net cash flow from operations less
capital expenditures
• Some also subtract dividends