Chapter 5
Statement of Cash Flows
Learning Objectives
1. Identify the purposes of the statement of cash
flows.
2. Classify activities affecting cash as operating,
investing, or financing activities.
3. Compute and interpret cash flows from
financing activities, investing activities and cash
flows from operations.
4. Use the indirect method to explain the difference
between net income and net cash provided by
(used for) operating activities.
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Bankruptcy
Declared by companies that lose too much
cash.
Companies seek court protection from its
creditors under federal law
Allows a firm to delay paying certain
obligations while it negotiates with its
creditors to reorganize its business and settle
its debts.
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Statement of Cash Flows
Reports a company’s cash receipts and cash
payments during a particular period
Classifies them as
1. Financing,
2. Investing, and
3. 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
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Statement of Cash Flows
Show performance of companies over a
period of time
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Purposes of Cash Flow Statement
Helps understand the relationship of net
income to changes in cash balances.
Reports past cash flows for:
Predicting future cash flows
Evaluating how management generates and uses
cash
Determining firm’s ability to pay interest,
dividends, and debts when due
Identifies changes in assets of a firm 5-6
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Cash Equivalents
Highly liquid short-term investments that
a company can easily and quickly convert
into cash.
Examples include money market funds and
Treasury bills.
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1. 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
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Typical Activities Affecting Cash
Typical operating activities
Cash inflows Cash outflows
• Collections from customers • Cash payments to suppliers
• Interest and dividend collected • Cash payments to employees
• Other operating receipts • Interest and tax payments
• Other operating cash payments
2. Financing Decisions
Decisions are concerned with whether and how
to raise or repay cash.
Financing activities: Transactions that
Obtain resources by either of the following
methods
Borrowing from banks
Selling shares, bonds, debentures
Use resources for either of the following purposes
Repay banks and other lenders
Provide a return to shareholders
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Typical Activities Affecting Cash
Typical financing activities
Cash inflows Cash outflows
• Borrowing cash from banks/ • Repayment of amounts
other entities borrowed
• Issuing equity/ preference • Repurchase of equity /
shares preference shares
• Issuing debt securities such • Payment of dividends
as bonds and debentures
3. Investing Decisions
Decisions that include the choices to:
Acquire or dispose off plant, property,
equipment, and other long-term productive
assets.
Provide or collect cash as a lender or as an
owner of securities/shares.
Investing activities: Transactions that acquire
or dispose of:
Long-lived assets
Securities that are not cash equivalents
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Typical Activities Affecting Cash
Typical investing activities
Cash inflows Cash outflows
• Sale of property, plant, and • Purchase of property, plant, and
equipment equipment
• Sale of securities that are not • Purchase of securities that are not
cash equivalents
cash equivalents
• Receipt of loan repayments
• Making loans
Effect of Exchange Rates on Cash
Applicable for companies with international
operations.
Appears on the cash flow statement after the
operating, investing, and financing activities.
Not a cash flow but appears on the cash flow
statement because it is:
Necessary for reconciliation of cash balances
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Compute and Interpret Cash Flows
from Financing Activities
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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
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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
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Cash Flows from Financing Activities
Two general rules for financing activities
In liabilities or paid-in In liabilities or paid-in
capital capital
In cash In cash
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Compute and Interpret Cash Flows
from Investing Activities
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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-term assets/ fixed assets, loans, or
securities that are not considered cash
equivalents.
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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
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Cash Flows from Investing Activities
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)
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Cash Flows from Investing Activities
Two general rules for financing activities
Sale of long-lived assets, Purchase of long-lived
collecting loans, and sales assets, granting loans, and
of investments purchases of investments
In cash In cash
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Cash flow from Financing Activities
Cash flow from Investing Activities
Cash flow from Investing and Financing 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
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Cash Flows from Operating Activities
Shows cash transactions affecting income
statements.
Two approaches under U.S. GAAP
Direct method Indirect method
Operating cash collections Adjusts net income
(−) to reflect actual cash receipts
Operating cash disbursement and cash disbursements
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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.
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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)
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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/ profit after tax
Adds or subtracts a series of adjustments
Ends with cash provided by (used for)
operating activities
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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
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Cash Flows from Operations—The Indirect
Method
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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
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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
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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
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A General Approach to Adjustments
Profit After Tax needs to be adjusted for
noncash revenues and expenses as follows:
Add back depreciation
Add back other expenses/ losses that do not require
cash
Deduct revenues/ profit that do not generate cash
Add decreases in operating/current assets
Deduct increases in operating/ current assets
Add increases in operating/current liabilities
Deduct decreases in operating/ current liabilities 5-37
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Cash Flow Statement- Direct Method (Biwheels)
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Cash Flow Statement- Indirect Method (Biwheels)
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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
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