FINANCIAL MANAGEMENT

CASH FLOW ANALYSIS

LEARNING OBJECTIVES:

At the end of this topic, the student should be able to:

1) Describe the nature and purpose of the statement of cash flows
2) Define cash and cash equivalent
3) State the general rules for determining whether transactions should be classified as operating activities; investing activities or
financing activities
4) Describe the content and form of the Statement of Cash flows
5) Explain the differences between the direct method and indirect method of determining the net cash flow provided by operating
activities
6) Compute the net cash flow provided by operating activities using the direct and indirect method

CASH FLOW STATEMENT – a basic component of the financial statements which summarizes the operating, investing and financing
activities of an entity. It provides information about the cash receipts and cash payments of an entity during a period.

PAS 7 provides that an entity shall prepare a cash flow statement and shall present it as an INTEGRAL PART of its financial
statements for each period for which financial statements are presented.

Purpose of cash flow statement: TO PROVIDE RELEVANT INFORMATION ABOUT CASH RECEIPTS AND CASH
PAYMENTS OF AN ENTITY DURING A PERIOD

Cash flow statement:

1. Provides information that enables users to evaluate the changes in net assets of an entity, its financial structure, liquidity and
solvency
2. Is useful in assessing the ability of the entity to generate cash and cash equivalents
3. Also enhances the comparability of operating performance by different entities

CASH EQUIVALENTS – short-term highly liquid investments that are readily convertible to known amounts of cash and which are
subject to an insignificant risk of changes in value.

PAS 7 provides that an investment normally qualifies as cash equivalent only when it has a short maturity of THREE
MONTHS or less from the date of acquisition. The investment must be acquired three months or less BEFORE MATURITY

Examples of cash equivalents:

1) 3-month BSP treasury bill 3) 3-month time deposit
2) 3-year BSP treasury bill purchased THREE MONTHS 4) 3-month market instrument
BEFORE MATURITY

Note: Equity securities CANNOT qualify as cash equivalent because shares of stock do not have maturity date. However,
preferred shares with SPECIFIED REDEMPTION DATE and acquired three months before the redemption date can qualify
as cash equivalent.

CLASSIFICATION OF CASH FLOWS:

1. Operating activities – derived primarily from the principal revenue producing activities of the entity. It generally result from the cash
effects of transactions and other events that enter into the determination of net income or loss.

Examples of operating activities:

a) Cash receipts from:
1) Sales of goods and rendering of services 2) Royalties, rental, fees, commissions and other
revenue
b) Cash payments to:
1) Supplier for goods and services 2) For selling, administrative and other expenses
c) Cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits
d) Cash payments/ refunds of income taxes unless they can be specifically identified with financing and investing activities
e) Cash receipts and payments for securities held for dealing (trading) purposes

Note: An entity may hold securities and loans for dealing or trading purposes, in which case they are similar to inventory
acquired specifically for resale. Therefore, cash flows arising from the purchase and sale of DEALING (TRADING)
SECURITIES are classified as operating activities. Similarly, cash advances and loans made by a FINANCIAL
INSTITUTION are usually classified as operating activities since they relate to the main revenue producing activities of that
entity.

2. Investing activities – derived from the acquisition and disposal of long-term assets and other investments not included in cash
equivalents. These are the cash effects of transactions involving nonoperating assets, such as investments, property plant and
equipment, intangible assets and other noncurrent assets.

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Examples of investing activities:

1) Cash payments to:
a) Acquire property, plant and equipment
b) Acquire equity or debt instruments of other enterprises and interest in joint venture (current and long-term investments)
2) Cash receipts from:
a) Sales of property, plant and equipment, intangibles and other longterm assets
b) Sales of equity or debt instruments and interest in joint venture
c) Repayment of advances and loans made to other parties
3) Cash receipts/payments from/for future contracts, forward contract, option contract and swap contract
4) Cash advances and loans to other parties (other than advances and loans made by financial institutions)

3. Financing activities – derived from the equity capital and borrowings of the entity. These are cash flows that result from transactions
between the entity and its owners (equity financing) and between entity and its creditors (debt financing).

Examples of financing activities:

1) Cash receipts from:
a) Issuing shares or other equity instruments (e.g. common and preferred stock)
b) Issuing debentures, loans, notes, bonds, mortgages and other short or longterm borrowings
2) Cash payments to owners to acquire/redeem the enterprise’s shares (e.g. payment for treasury stock)
3) Cash payments for amounts borrowed
4) Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease

Treatment of non-cash transactions in the cash flow statement:

Investing and financing transactions that do not require use of cash or cash equivalents shall be excluded from the
cash flow statement. Such transactions shall be disclosed elsewhere in the financial statements either in the notes to financial
statements or in a separate schedule.

Examples of non-cash transactions:

a) Acquisition of noncurrent asset either by assuming directly related liability or by means of a finance lease
b) Acquisition of noncurrent asset by means of issuing capital stock or bonds payable
c) Conversion of debt to equity (e.g. conversion of bonds payable to common stock)
d) Conversion of preferred stock to common stock

Treatment of interest paid and interest received in the cash flow statement:
INTEREST PAID INTEREST RECEIVED
BENCHMARK TREATMENT: • Classified as operating cash flow • Classified as operating cash flow
ALTERNATIVE TREATMENT: • Financing cash flow • Investing cash flow

Treatment of dividend paid and dividend received in the cash flow statement:
DIVIDEND PAID DIVIDEND RECEIVED
BENCHMARK TREATMENT: • Classified as financing cash flow • Classified as operating cash flow
ALTERNATIVE TREATMENT: • Operating cash flow • Investing cash flow

METHODS USED IN DETERMING NET CASH FLOW FROM OPERATING ACTIVITIES:

 Direct method – shows in detail/ itemizes the major classes of gross cash receipts and gross cash payments.
 Indirect method – begins with the accrual basis net income and applies a series of adjustments to convert the income to cash basis.

Guidelines to be used in adjusting the accrual basis net income to cash basis net income under the indirect method:
1) With regards to trade noncash current assets and noncash current liabilities:
INCREASE DECREASE
TRADE NON-CASH CURRENT ASSETS • Deduct • Added back
TRADE NONCASH CURRENT LIABILITIES • Added back • Deduct
2) Depreciation, amortization and other noncash expenses are ADDED BACK to net income
3) Gains on disposal of property are previously included in net income but they are nonoperating items. Thus, they are deducted from
net income
4) Losses on disposal of property are previously deducted from net income but they are nonoperating items. Thus they are added back to
net income

END OF LECTURE

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EXERCISES ON CASH FLOW STATEMENT ANALYSIS

THEORIES:
1) Identify the following as financing or investing by putting an “X” mark on the appropriate column:
INVESTING FINANCING
A) Repayment of debt principal X
B) Gain on sale of land X
C) Payment of cash dividends
D) Purchase of common stock of another firm
E) Purchase of land X
F) Issuance of common stock
G) Increase in short-term debt
H) Resale of treasury stock
I) Sale of building
J) Reduction of long-term debt
K) Purchase of treasury stock
L) Purchase of equipment X

2) The following are based on the direct method of presenting cashflow from operating activities. Indicate whether the following items
would be added or subtracted to/from the relevant revenue or expense item in the calculation of cash flow from operating activities by
putting an “X” on the appropriate column:
ADD DEDUCT
a) Decrease in accounts receivable to calculate cash collections from sale
b) Decrease in inventories to calculate cash paid to supplier
c) Increase in accounts payable to calculate cash paid to supplier
d) Decrease in accrued salaries payable to calculate cash paid to employees
e) Depreciation expense for the period to calculate cash paid for operating expenses
f) Increase in prepaid expenses to calculate cash paid for operating expenses
g) Decrease in accrued interest payable to calculate cash paid for interest expense
h) Increase in deferred tax liability to calculate cash paid for tax expense

3) Below are certain events that took place at GLIZZARD inc. last year. Indicate how each of them would be classified on a statement of
cash flows by placing an “X” in the appropriate activity and also an “X” in the source or use column as appropriate.
Operating Investing Financing Source Use
1) Short-term investment securities were purchased
2) Equipment was purchased
3) Accounts payable increase
4) Deferred taxes decrease
5) Long-term bonds were issued
6) Common stock was sold
7) Interest was paid to long-term creditors
8) Long-term mortgage was entirely paid off
9) Cash dividends was declared and paid
10) Inventories decreased
11) Accounts receivable increased
12) Depreciation charges totalled P200,000 for the year

PROBLEMS

1. (CASH RECEIPTS FROM CUSTOMERS) Fill in the blanks in the following schedule:
CASE A CASE B CASE C CASE D
Sales for 2010 P 800,000 $ 1,000,000 P ___________ P 650,000
Accounts receivable:
• Beginning of 2010 42,000 37,000 28,000 31,000
• Ending of 2010 25,000 45,000 45,000 P __________
Cash collected from customers P __________ P ___________ P 853,000 P 625,000

2. (CASH PAYMENTS TO MERCHANDISE SUPPLIERS) Fill in the blanks in the following schedule
CASE A CASE B CASE C
Cost of goods sold in 2010 P 649,000 P 621,000 P _______________
Merchandise inventory:
• Beginning of 2010 P 91,000 P 57,000 P 262,000
• End of 2010 84,000 71,000 245,000
Accounts payable:
• Beginning of 2010 P 42,000 P 68,000 P 93,000
• Ending of 2010 51,000 P __________ 85,000
Cash paid to merchandise suppliers in 2010 P ___________ P 623,000 P 2,824,000

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3. (CASH FLOW – OPERATING ACTIVITIES USING THE INDIRECT METHOD) Burtis Company’s net income last year
was $77,000. Changes in the company’s balance sheet accounts for the year appear below:
Debit balances Increase (decrease) Credit balances Increase (decrease)
Cash $ 12,000 Accumulated depreciation $ 32,000
Accounts receivable (16,000) Accounts payable 26,000
Inventory 18,000 Accrued liabilities (4,000)
Prepaid expenses 7,000 Taxes payable (7,000)
Long-term investments 20,000 Bonds payable (20,000)
Plant and equipment 70,000 Deferred taxes 14,000
Common stock 30,000
Retained earnings 40,000
The company declared and paid cash dividends of $ 37,000 last year.
Required: Construct in good form the following sections of the company’s statement of cash flows for the year:
• operating activities section using the indirect • financing activities section
method
• investing activities section

4. (CASH FLOW – OPERATING ACTIVITIES USING THE INDIRECT METHOD) Buntis Company’s net income last year
was P 98,000. Changes in the company’s balance sheet accounts for the year appear below:
Debit balances Increase (decrease) Credit balances Increase (decrease)
Cash P 24,000 Accumulated depreciation P 32,000
Accounts receivable 15,000 Accounts payable (14,000)
Inventory (18,000) Accrued liabilities 11,000
Prepaid expenses (6,000) Taxes payable (8,000)
Long-term investments 10,000 Bonds payable (40,000)
Plant and equipment 40,000 Deferred taxes 12,000
Common stock 10,000
Retained earnings 62,000
The company declared and paid cash dividends of P 36,000 last year.
Required: Construct in good form the following sections of the company’s statement of cash flow for the year:
• Operating activities section using the indirect • Financing section
method
• Investing activities section

5. (CASH FLOW FOR OPERATING ACTIVITIES USING THE DIRECT METHOD) Perval’s income statement for last year
appears below:
Perval Company
Income statement
Sales P 100,000
Cost of goods sold (60,000) P 40,000
Operating expenses (25,000)
Income before income taxes P 15,000
Income taxes (6,000)
Net income P 9,000
The beginning and ending balances for last year are available for the following selected accounts:
Ending balance Beginning balance Ending balance Beginning balance
Accounts receivable P 15,000 P 10,000 Inventory P 29,000 P 25,000
Prepaid expenses 6,000 9,000 Accumulated depreciation (35,000) (30,000)
Accounts payable 27,000 20,000 Accrued liabilities 3,000 5,000
Income tax payable 4,000 1,000
Required: using the direct method, prepare in good form the operating activities section of the statement of cash flows:

6. (CASH FLOWS FOR OPERATING ACTIVITIES USING THE DIRECT METHOD) Carney Company’s comparative balance
sheet and income statement for last year appear below:

Statement of Financial Position

Ending Beginning Ending Beginning

balance balance balance balance
Cash P 59,000 P 36,000 Accounts payable P 19,000 P 33,000
Accounts receivable 45,000 27,000 Accrued liabilities 37,000 20,000
Inventory 29,000 41,000 Taxes payable 4,000 13,000
Prepaid expenses 5,000 11,000 Bonds payable 90,000 130,000
Long-term investments 280,000 230,000 Deferred taxes 23,000 17,000
Plant and equipment 535,000 520,000 Common stock 130,000 100,000
Accumulated depreciation (297,000) (271,000) Retained earnings 353,000 281,000
Total assets P 656,000 P 594,000 Total liabilities and SHE P 656,000 P 594,000

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Income statement

Sales P 900,000
Cost of goods sold (500,000) P 400,000
Operating expenses (260,000)
Net operating income P 140,000
Income taxes (42,000)
Net income P 98,000

The company declared and paid P 26,000 in cash dividends during the year.
Required: prepare in good form the operating activities section of the company’s statement of cash flows for the year using the direct
method.

7. (STATEMENT OF CASH FLOW) Comparative financial statements for Passaic Company follow:

Passaic Company
Statement of Financial Position

As of December 31, Year 1 and Year 2

Assets Year 1 Year 2 Liabilities and SHE Year 1 Year 2

Current assets: Current liabilities
Cash P 18,000 P 15,000 Accounts payable P 8,000 P 6,000
Accounts receivable 25,000 22,000 Accrued liabilities 15,000 6,400
Inventory 22,000 20,000 Total current liabilities P 23,000 P 12,400
Prepaid expenses 10,000 14,000 Bonds payable P 18,000 P 12,000
Total current assets P 75,000 P 71,000 Deferred income taxes 15,000 4,000
Long term investments P 25,000 P 7,000 Total liabilities P 56,000 P 28,400
Plant and equipment P 80,000 P 77,000 Stockholders’ equity:
Accumulated depreciation (64,000) (61,000) Common stock P 20,000 P 30,000
Plant and equipment (net) P 16,000 P 16,000 Retained earnings 40,000 35,600
Total assets P 116,000 P 94,000 Total stockholders’ equity P 60,000 P 65,600
Total liabilities and stockholders’ equity P 116,000 P 94,000

Passaic Company
Statement of Financial Performance
For the Year ended December 31, Year 2

Sales P 70,000
Cost of goods sold (40,000)
Gross margin P 30,000
Operating expenses (including depreciation expense of P 5,000) (20,000)
Net operating income P 10,000
Non-operating income:
Loss on sale of investment (4,000)
Income before taxes P 6,000
Income taxes (2,400)
Net income P 3,600
Additional data on activities during Year 2 are as follows:
a) During Year 2, Passaic Company sold some equipment for P 3,000 that had cost P 15,000 and on which there was accumulated
depreciation of P 8,000.
b) Equipment was purchased for P 12,000 cash
c) Long-term investments that had cost P18,000 when purchased were sold for P 18,000
d) Common stock was issued for P 10,000
Required:
1) Determine the net cash provided by operating activities for year 2 using the:
a. Indirect method
b. Direct method
2) Prepare the statement of cash flows

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8. (CASH FLOWS) Daschner Company’s comparative balance sheet and income statement for last year appear below:

Statement of financial position

Ending Beginning Ending Beginning

balance balance balance balance
Cash P 60,000 P 25,000 Accounts payable P 59,000 P 36,000
Accounts receivable 48,000 61,000 Accrued liabilities 42,000 24,000
Inventory 56,000 48,000 Taxes payable 7,000 14,000
Prepaid expenses 13,000 19,000 Bonds payable 80,000 140,000
Long-term investments 300,000 210,000 Deferred taxes 38,000 23,000
Plant and equipment 470,000 470,000 Common stock 110,000 70,000
Accumulated depreciation (222,000) (188,000) Retained earnings 389,000 338,000
Total assets P 725,000 P 645,000 Total liabilities and SHE P 725,000 P 645,000

Income statement

Sales P 540,000
Cost of goods sold (300,000) P 240,000
Operating expenses (150,000)
Net operating income P 90,000
Income taxes (27,000)
Net income P 63,000

The company declared and paid P 12,000 in cash dividends during the year.
Required: Construct in good form the following sections of the company’s statement of cash flows for the year:
1) Operating activities using the: 2) Investing activities
a) Indirect method 3) Financing activities
b) Direct method

END OF EXERCISES

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