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Chapter 14

Statement of Cash Flows

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The Statement of Cash Flows
Summary of company’s transactions that involve cash over a period of
time. Transactions are classified as:
 Operations
 Investments
 Financing

Figure 14-1 Sample statement of cash flows

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 Required for financial statements by SFAS 95 (1987).
Statement of Cash Flows

Primary purpose is to provide relevant information

about cash receipts and cash disbursements of the
company during the period.

Serves to complement the other financial statements.

Focus is on cash flows, not income.

Reconciles the balance sheet and the income

statement.
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Definition of Cash
 Cash consists of coin, currency, and available
funds on deposit at the bank. Negotiable
instruments such as money orders, certified
checks, cashier’s checks, personal checks, and
bank drafts are also considered cash.

 Also certain cash equivalents, which include

commercial paper and other debt investments
with maturities of less than three months are
included in the statement of cash flows.

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Content of Statement of Cash Flows
Explains change in cash and cash equivalents.

Cash equivalents are defined as short-term, highly liquid

investments near to maturity.

Examples of cash equivalents are Treasury bills and money

market funds.

Format of SCF includes the following three sections:

cash flow from operating activities.
cash flow from investing activities.
cash flow from financing activities.

Like US GAAP, IFRS requires the presentation of a SCF, and

the format is largely the same.
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General Description of the Statement of Cash Flows

Figure 14-2
Standard
statement
of cash
flows 
7
Cash Provided (Used) by Operating Activities
Cash Flows from operating activities is based on
the income statement, and converts income activity
to a cash basis.
There are two formats for the presentation of CF
from operating activity:
Direct Method: this technique shows cash
received from customers and cash paid to various
entities for operating activities.

Indirect Method: this technique starts with net

income and makes adjustments to net income to
convert it to a cash basis.

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Cash Provided (Used) by Operating Activities
If the direct method is used, the indirect method must
be presented in a supplementary schedule.

FASB recommends companies use the direct method

including the supplementary schedule.

The direct method is more straight-forward and

provides more information with the supplementary
disclosure, but the vast majority of companies
present only the indirect method.

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Cash Provided (Used) by Investing Activities
Cash Flows from investing activities explain the changes in cash
from the purchase or sale of the company’s (primarily) long-term
assets.
Examples of investing activity includes:
Cash paid for purchase of equipment, land, buildings,
marketable securities (available-for-sale and equity), intangible
assets, and most other long term assets.

Cash received from sale of equipment, land, buildings,

marketable securities (available-for-sale and equity), intangible
assets, and most other long term assets.

Cash paid for issue of non-trade notes receivable (both short-

term and long-term).

Cash received for repayment on non-trade notes receivable

(both short-term and long-term).  10
Cash Provided (Used) by Financing Activities
Cash Flows from financing activities explain the changes in cash from the
issue or retirement of the company’s (primarily) long-term liabilities and
contributed capital (equity).
Examples of financing activity includes:
cash received from issue of bonds, mortgages and other long-term debt,

cash received from issue of common stock and preferred stock,

cash paid for the retirement of long-term debt,

cash paid for the repurchase of treasury stock,

cash paid for dividends,

cash received for issue of non-trade notes payable (both short-term and
long-term), and

cash paid for retirement or repayment on non-trade notes payable (both

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Cash Provided (Used) by Financing Activities
Note that cash paid for dividends is
classified as a financing activity, but cash
paid for interest is classified as an operating
activity.

Note that cash received for dividends and

cash received for interest are both classified
as operating activities.

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The Importance of Cash from Operating Activities
Cash from Operating Activities has special importance
to a business and those outside the company:

The sale of services and/or inventory is a prerequisite for

a successful business.

Investing and Financing cash flows can vary greatly year

to year

Operating cash flows should be more consistent, and,

expected to reoccur making them essential for
predicting future outcomes

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The Importance of Significant Noncash
Transactions
Significant non-cash transactions such as issuing
stock or a note for an asset must be disclosed in
the footnotes of the financial statements

For example MCI acquired Satellite Business Systems (SBS) for

common stock and a note payable and required disclosure

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Deriving Cash Flow from Accrual Financial Statements
Operating – Sales and Bad Debt Expense
Cash inflow from sales can be determined by analyzing changes
in accounts receivable and the allowance for doubtful accounts.

Figure 14-6
Determining
cash inflow
from sales

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Deriving Cash Flow from Accrual Financial Statements
Operating – Fees Earned
Cash inflow related to fees earned can be determined by looking
at changes in the advance account

Figure 14-7
Determining
cash inflow
from fees
earned

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Deriving Cash Flow from Accrual Financial Statements
Operating – Cost of Goods Sold
Cash outflow associated with goods sold can be determined
with changes in inventory and accounts payable.

Figure 14-8
Determining
cash outflow
from inventory
purchases
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Deriving Cash Flow from Accrual Financial Statements
Operating – Miscellaneous Expenses
Cash outflow related to miscellaneous expense can be
determined by analyzing changes in accrued payables

Figure 14-8
Determining
cash outflow
from
miscellaneous
expenses
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Deriving Cash Flow from Accrual Financial Statements
Operating – Insurance Expense
Cash outflow related to insurance expense can be
determined by looking at changes to the prepaid
insurance account

Figure 14-10
Determining
cash outflow
related to
insurance
expense

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Deriving Cash Flow from Accrual Financial Statements
Operating – Depreciation, Amortization, and Losses on
Sales
There is no operating cash effect with these
items

Note : They are a part of net income and

therefore the operating section of the statements
of cash flows must be adjusted for these items
under the indirect method of preparing the
statements of cash flows.

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Deriving Cash Flow from Accrual Financial Statements
Operating – Interest Expense
Cash outflow related to interest expense can be
determined by looking at changes in the discounts on
note payable account

Figure 14-11
Determining
cash outflow
related to
interest expense

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Deriving Cash Flow from Accrual Financial Statements
Operating – Income Tax Expense
Cash outflow related to income tax expense can be
determined by looking at changes in the income tax
payable account
Figure 14-12
Determining
cash outflow
related to income
taxes

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Deriving Cash Flow from Accrual Financial Statements
Investing
Cash inflows and outflows associated with investing
activities are analyzed by looking at changes in the long-
lived asset accounts.

Outflows occur when assets are acquired.

Figure 14-13
Determining
cash outflow
for land
purchases

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Deriving Cash Flow from Accrual Financial Statements
Investing (cont’d)
 Cash inflows and outflows associated with investing activities are analyzed by
looking at changes in the long-lived asset accounts.

 Inflows occur when assets are sold.

Figure 14-14
Determining
cash inflow
from sale of
machinery

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Deriving Cash Flow from Accrual Financial Statements
Financing – Payment on Notes Payable
A pay down on a note payable would be do to the
payment of cash unless another transaction is indicated.

Figure 14-15
Determining
cash outflow
from payments on
notes

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Deriving Cash Flow from Accrual Financial Statements
Financing – Issuance of Common Stock and Treasury Stock

Cash inflows from the issuance of common stock

and treasury stock can be determined by looking
at changes in the common stock, additional paid-
in capital and treasury stock accounts.

(See Next Slide)

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Figure 14-16
Determining
cash inflow
from stock
issuances
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Deriving Cash Flow from Accrual Financial Statements
Financing – Cash Dividends
The cash dividend payment can be determined by
looking at changes in the dividend payable account.

Figure 14-15
Determining
cash outflow
from dividend
payments

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The Direct Method Figure 14-18
Statement
of cash
flows
for ABC
Enterprises:
Direct
Method

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The Indirect Method
 To understand the adjustments to get from net income to Cash Flow from
operations, we can classify the adjustments into various categories:
 Noncash Changes to non current accounts
 Changes in current noncash accounts

Figure 14-19
Statement
of cash
Flows: Indirect
Method

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The Indirect Method

Figure 14-20 Explaining current adjustments to net income in the

calculation of net cash provided (used) by operating activities

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Analyzing the Statement of Cash Flows:
An Application
 Operating Activities may provide positive or negative cash
flows regardless of net income (see ABC Enterprises Inc.
in previous slides) Remember that Operating Activities
and the cash in this section are considered more
sustainable.

 Cash must be evaluated over some time as any one

period may mislead investors about longer term cash flow
based on management’s decisions during that period –
but manipulation of cash for long periods of time is very
difficult

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