B.A.

(H) BUSINESS ECONOMICS

SEMESTER I
ACCOUNTING FOR MANAGERS

CASH FLOW STATEMENT

UNIT IV- FINANCIAL STATEMENT

ANALYSIS
PART III
 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.
C1 Purpose of the Statement
of Cash Flows

How
Howdoes
doesaacompany
company Where
Wheredoes
doesaacompany
company
obtain
obtainits
itscash?
cash? spend
spendits
itscash?
cash?

What
Whatexplains
explainsthe
the
change
changein
inthe
thecash
cash
balance?
balance?
C1

Importance of Cash Flows

Does
Doesthe thebusiness
businesshave
have
How
Howdid
didthe
thebusiness
business sufficient
sufficientcash
cashtotopay
pay
fund
fundits
itsoperations?
operations? its
itsdebts
debtsas
asthey
they
mature?
mature?

Did
Didthe
thebusiness
businessmake
make Did
Didthe
thebusiness
business
any
anydividend
dividend borrow
borrowany
anyfunds
fundsor
or
payments?
payments? repay
repayany
anyloans?
loans?
 Measurement of Cash Flows

Cash Equivalents Cash

Cash Currency

 Short-term,
Short-term,highly
highlyliquid
liquidinvestments.
investments.
 Readily
Readilyconvertible
convertibleinto
intocash.
cash.
 What is Cash?
• Cash includes cash and cash equivalents
• Cash equivalents:
– treasury bills maturing in 90 days or less;
– investment funds;
– foreign currency in hand;
– checking account and free savings account
 Objectives of this Chapter
• Identify business activities which can
generate or use cash and differentiate
between income flows (i.e., accrual basis)
and cash flows from operating activities.

• The Importance and the usefulness of the

statement of cash flows.

• Learn how to prepare the statement of

cash flows.
Statement of Cash Flows 7
Learning Objective 1

Identify the purpose the statement of

cash flows

SOURCE: Pearson Prentice Hall

 Cash Flow Statement
• Shows cash receipts and payments during
a period
• Purposes:
– Predicts future cash flows
– Evaluates management decisions
– Determines ability to pay dividends and
interest
– Shows relationship of net income to cash
flows

SOURCE: Pearson Prentice Hall

 Importance of Cash Flow
A company needs
both net income
and strong cash
flow to succeed

SOURCE: Pearson Prentice Hall

 The Importance and Usefulness of the
Statement of Cash Flows
 Possible earnings managements may result in
unreliable accrual earnings

 Accrual accounting relies on many subjective

judgments that may introduce measurement
error and uncertainty into reported earnings.

 One-time write-offs and restructuring charges

can reduce the quality of reported earnings

 For these reasons, analysts scrutinize a firm’s

cash flows—not just its accrual earnings—to
evaluate performance and creditworthiness .
 The Importance and Usefulness of the
Statement of Cash Flows (cont.)
 In order to show cash flows of a company,
cash flows of all three activities should be
reported:

 Operating,
 Investing and
 Financing
….activities of a company.

Statement of Cash Flows 12

 The following questions can also be
answered:
1. What is the relationship between net
income and cash provided by operations?
2. Why did cash decreased when net income
increased?
3. What expansion (investment) activities
took place and how were they financed?

Statement of Cash Flows 13

The following questions can also be answered:…
contd.

4. How much is the cash provided by operating

activities?
5. What happened to the proceeds received
from issuance of bonds or common stock?

All of these cannot be answered from either

the income statement or the balance sheet
statement.
Statement of Cash Flows 14
 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 company’s 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 company’s

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
 Learning Objective 2
Distinguish among operating, investing and
financing cash flows

SOURCE: Pearson Prentice Hall

 Cash Flow Categories

• Operating activities
– Related to the transactions that result in net income
– Most important as they reflect core of the business

• Investing activities
– Related to long-term assets
– How a company uses its resources in the long-term

• Financing activities
– Related to long-term debt and equity
– How a company obtains resources
SOURCE: Pearson Prentice Hall
 FORMATS FOR OPERATING CASH
FLOWS
• Indirect
– Reconciles net income to cash provided by
operating activities
– Easier to prepare

• Direct
– Shows cash inflows and outflows by type
– Easier to interpret

SOURCE: Pearson Prentice Hall

I. Activities which can either generate cash or use
cash for a business entity
– A. Operating activities.
– B. Investing activities.
– C. Financing activities.

Statement of Cash Flows 20

 A. Operating Activities (i.e., sales revenue,
expenses)

 All these activities are reported in the I/S (income

statement).
 However, I/S only provides the accrual-basis net
income (revenue –expense + gains – losses ) which
very often is not the change in cash.

 Therefore, we need to adjust from net income flows to

cash flows in order to report the net cash provided by
(or used in) operating activities.
Statement of Cash Flows 21
 A. Operating Activities (contd.)
 There are two approaches to reconcile
net income to net cash provided by (or
used in) operating activities:
– 1. Indirect Method
– ==> Lump-Sum Adjustment
– 2. Direct Method
– ==> Individual Account Adjustment
Statement of Cash Flows 22
 1. Indirect Method
 Adjust net income (the lump sum
amount of all revenues and
expenses) for all differences
between income flows and cash
flows.

Statement of Cash Flows 23

 2. Direct Method
 Adjust each revenue account to cash
collection and adjust each expense
account to cash payment

 Subtract total cash payments from total

cash collections to derive net cash flows
of the operation activities

Statement of Cash Flows 24

 CASH FLOWS FROM OPERATING
ACTIVITIES
 Cash Inflows:
1. Collections from customers including
cash received from sales (or services)
and collections of A/R.
2. Cash receipts of interests or dividends
(for a finance company)
3. Collections of other operating receipts
(i.e., unearned revenue, rent revenue).

Statement of Cash Flows 25

 Cash Flows from
Operating Activities (contd.)
 Cash Outflows:

1. Payments to suppliers.

2. Payments to employees.

3. Payments for interest expense.

4. Payments for income taxes.

5. Payments for other expenses(i.e., Prepaid

expenses; rent expenses).
Statement of Cash Flows 26
Activities which can either generate cash or use cash
for a business entity
– A. Operating activities.
– B. Investing activities.
– C. Financing activities.

Statement of Cash Flows 27

 B. Investing Activities
 In addition to generate cash from or
use cash in the operating activities,
companies can also generate cash
from (or use cash in) investing
activities.

Statement of Cash Flows 28

 Cash Flows from
Investing Activities
 Transactions involving acquiring
(Investing (Cash outflows)) and selling
(Disinvesting (Cash inflows)) :
a. Property, Plant and Equipment.
b. Investments (non-current).
c. Notes Receivable (current and non-
current).
Statement of Cash Flows 29
 Notes Receivable
 Notes Receivable (current and non-
current), including:
 Lending money (N/R , cash outflow);
 Collecting of loan (N/R , cash inflow);
 Selling of N/R (N/R, discounting N/R,
cash inflow)
Statement of Cash Flows 30
Activities which can either generate cash or use cash
for a business entity
– A. Operating activities.
– B. Investing activities.
– C. Financing activities.

Statement of Cash Flows 31

 C. Financing Activities
 Companies can also generate cash or
use cash through financing activities:

Statement of Cash Flows 32

 Cash Flows from
Financing Activities

 Obtaining resources from owners and creditors (cash

inflows) and repaying the amount borrowed (cash outflows).

 Cash inflows:
 Cash received from issuance of common stock.

 Cash received from issuance of bonds.

 Cash received from issuance of N/P (short-term or long

term).

Statement of Cash Flows 33

 Cash Flows from
Financing Activities (contd.)

 Cash Outflows:
 Retirement of bonds.
 Retirement of stock.
 Payments of N/P.
 Payments of dividends.

Statement of Cash Flows 34

 EXERCISE
Identify cash flow from operating activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds

35
 SOLUTION
Identify cash flow from operating activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds

36
 EXERCISE
Identify cash flow from investing activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds

37
 SOLUTION
Identify cash flow from investing activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds

38
 EXERCISE
Identify cash flow from financing activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds

39
 SOLUTION
Identify cash flow from financing activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds

40
 Exercise
Item O I or F + or -
a. Net Income
b. Cash dividend
c. Sale of LT investment
d. Loss on sale of equip.
e. Amortization
f. Issuance of LTNP
g. Depreciation expense
h. Issuance of stock
SOURCE: Pearson Prentice Hall
 Solution
Item O I or F + or -
a. Net Income O +
b. Cash dividend F -
c. Sale of LT investment I +
d. Loss on sale of equip. O +
e. Amortization O +
f. Issuance of LTNP F +
g. Depreciation expense O What type+ of
account is stock?
h. Issuance of stock ___ +
SOURCE: Pearson Prentice Hall
 Exercise
Item O I or F + or -
j. Increase in accts pay
k. Purchase of equipment with
note payable
l. Payment of long-term
debt
m. Purchase building
n. Accrual of salary expense
o. Purchase of long-term
investment
SOURCE: Pearson Prentice Hall
 Solution
Item O I or F + or -
j. Increase in accts pay O +
k. Purchase of equipment with NIF
note payable
l. Payment of long-term F -
debt
m. Purchase building I -
n. Accrual of salary expense N
o. Purchase of long-term I -
investment
SOURCE: Pearson Prentice Hall
 Exercise
Item O I or F + or -
p. Decrease in inventory O +
q. Increase in prepaid O -
expenses
r. Sale of land I +
s. Decrease in accrued O -
liabilities

SOURCE: Pearson Prentice Hall

 Solution
Item O I or F + or -
p. Decrease in inventory O +
q. Increase in prepaid O -
expenses
r. Sale of land I +
s. Decrease in accrued O -
liabilities

SOURCE: Pearson Prentice Hall

 Learning Objective 3
Prepare a statement of cash flows by the
indirect method

SOURCE: Pearson Prentice Hall

Data needed to prepare statement of cash
flows
1. Comparative balance sheet statements.
2. The income statement.
3. The retained earnings statement.
4.Other supplemental information
concerning the reasons for the changes
in the B/S accounts (other than cash).
Statement of Cash Flows 48
Procedures for Preparation of the Statement of
Cash Flows
1. Operating Cash Flows (indirect
method).
2. Investing Cash Flows.
3. Financing Cash Flows.

Statement of Cash Flows 49

 1. Operating Cash Flows
(Indirect Method; Reconciliation Method)
•Net Income
–  Adjustments
– + Any increase in current Liabilities (except for
N/P)
– + Any decrease in current assets (except for
cash and N/R)
– - Any decrease in current liabilities (except for
N/P)
– - Any increase in current assets (except for cash
and N/R)
Statement of Cash Flows 50
 Reconciling Items
• Goal: To convert accrual net income to
operating cash flow
• Start with net income and adjust for non-
cash items
– Add back non-cash expenses
– Subtract gains and add losses
• These amounts do not reflect cash flows
– Add or subtract changes in current assets and
current liabilities

SOURCE: Pearson Prentice Hall

 Current Assets and Current
Liabilities
• Each account relates to an income statement
item
– Accounts receivable Sales
– Salaries payable Salaries expense
• The change in each account is computed
– Change = Current year balance – prior year balance
• Current assets inverse relationship
– Subtract increases from net income; add decreases
• Current liabilities direct relationship
– Add increases to net income; subtract decreases

SOURCE: Pearson Prentice Hall

 Preparing the Operating Section –
Indirect Method
• Use current year income statement for the
following amounts
– Net Income
– Depreciation, depletion and amortization
expense
– Gains or losses on sales of assets
• Use comparative balance sheets to
compute the changes in current assets
and current liabilities

SOURCE: Pearson Prentice Hall

 2. Investing Cash Flows
• Inflows: decrease in non-current
assets (i.e., long-term investments,
P.P.E.) and certain current assets
(i.e., trading securities, N/R).

• Outflows: increases in noncurrent

assets
Statement of Cash Flows 54
 3. Financing Cash Flows
• Inflows: increases in noncurrent
liabilities (i.e., B/P, N/P), stockholders’
equity and certain current liability (i.e.,
N/P).

• Outflows: decreases in noncurrent

liabilities, stockholders’ equity, certain
current liability and dividend payment.
Statement of Cash Flows 55
 The Indirect Method
Income Statement
Revenues $ 100,000
Cost of Goods Sold 40,000
Gross Profit 60,000
Operating expenses:
Salaries expense 20,000
Add back to net
Depreciation expense 10,000 income
Other expenses 5,000
Total operating expenses 35,000 Subtract from
Other income: net income

Gain on sale of plant assets 3,000 Use as first line

Net Income $ 38,000 in operating
section
SOURCE: Pearson Prentice Hall
 Comparative Balance Sheets
December 31, 2009 and 2008
12-31-09 12-31-08 Change
Cash $ 20,000 $ 18,000 Added to
net income
Accounts Receivable 25,000 30,000 (5,000)
Inventory 42,000 30,000 12,000 Subtracted
Long-term assets 150,000 162,000 from net
income
Total assets $ 237,000 $ 240,000
Subtracted
Accounts payable 15,000 18,000 (3,000) from net
Salaries payable 10,000 6,000 4,000 income
Long-term liabilities 98,000 105,000 Added to
Stockholders' equity 114,000 111,000 net income
Total liabilities & equity $ 237,000 $ 240,000

SOURCE: Pearson Prentice Hall

 Investing Activities
• Affect long-term assets:
– Plant assets Purchases = outflows
– Investments Sales = inflows

– Notes receivable

Loans made = outflows

Collections = inflows

SOURCE: Pearson Prentice Hall

 Computing Purchases and Sales of
Plant Assets
From Balance
Plant assets, net, beginning balance Sheet

+ Acquisitions
From Income
- Depreciation Statement

- Book value of assets sold

= Plant assets, net, ending balance From Balance

Sheet

SOURCE: Pearson Prentice Hall

 Proceeds from Sales of Plant Assets

• Compare book value of assets sold to gain

or loss
– Gain or loss located on income statement

Book value + Gain on sale

Cash
Proceeds
Book value – Loss on sale

SOURCE: Pearson Prentice Hall

 Computing Purchases and Sales of
Investments
Investments, beginning balance
+ Purchases
- Cost of investments sold
= Investments, ending balance

To compute cash proceeds of investments sold:

Cost + Gain on sale

Cash
Proceeds
Cost – Loss on sale

SOURCE: Pearson Prentice Hall

Computing Loans Made and Collections
on Notes
Notes receivable, beginning balance
+ Loans made
- Collections
= Notes receivable, ending balance

SOURCE: Pearson Prentice Hall

 Financing Activities
• Affect long-term liabilities & equity:
– Long-term Debt Payments = outflows
• Notes payable Borrowings = inflows

• Bonds payable
– Common stock and Paid-in Capital
– Retained earnings

Issuance of new shares =

Cash dividends = outflows
inflows
SOURCE: Pearson Prentice Hall
 Computing Issuance and Payments of
Long-Term Debt
Long-term debt, beginning balance
+ Issuance of new debt
- Payments of debt
= Long-term debt, ending balance

SOURCE: Pearson Prentice Hall

 Computing Issuance of Stock and
Purchases of Treasury Stock
Common stock, beginning balance
+ Issuance of new stock Inflow of cash
= Common stock, ending balance

Treasury stock, beginning balance

+ Purchase of treasury stock Outflow of cash
= Treasury stock, ending balance

SOURCE: Pearson Prentice Hall

 Computing Dividend Payments

Retained earnings, beginning balance

+ Net Income From income statement

- Dividends declared
= Retained earnings, ending balance

SOURCE: Pearson Prentice Hall

 Noncash Investing and Financing
Activities
• Transactions that involve long-term
assets, long-term debt and/or equity
– But do not increase or decrease cash
• Examples:
– Purchasing plant assets by signing a note
payable
– Issuing stock for land
– Stock dividends

SOURCE: Pearson Prentice Hall

 Statement of Cash Flows
Cash flows from operating activities:
Net Income
Reconciling adjustments:
+ Depreciation/depletion/amortization
+ Losses on sales of long-term assets
- Gains on sales of long-term assets
+ or - changes in current assets & current liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of plant assets & investments
Sale of plant assets & investments
Net cash provided by investing activities
Cash flows from financing activities:
Issuance of stock
Payment of dividends
Issuance of long-term note payable
Purchase of treasury stock
Net cash provided by financing activities
Net increase (decrease) in cash
Cash balance, beginning of year Proves that cash flow
Cash balance, end of year statement “works”

SOURCE: Pearson Prentice Hall

COMPREHENSIVE
QUESTION
QUESTION 1:
Prepare Cash Flow Statement of Suryan Ltd. from the following:

• During 2006, the business of a sole trader was purchased by issuing shares for
Rs. 2, 00,000. The assets acquired from him were: Goodwill Rs. 20,000,
Machinery Rs. 1, 00,000, Stock Rs. 50,000 and Debtors Rs. 30,000
• Provision for tax charged in 2006 was Rs. 35,000.
• The debentures were issued at a premium of 5% which is included in the retained
earnings.
• Depreciation charged on machinery was Rs. 30,000
QUESTION 2:
From the following Balance Sheets of Exe Ltd. make a Cash Flow
Statement:

• Depreciation of Rs. 10,000 and Rs. 20,000 have been charged on Plant and Land and
Buildings in 2004.

• An interim dividend of Rs. 20,000 has been paid in 2004.

• Rs. 35,000 Income tax was paid during 2004

Question 3:
Solution to Question 3:
Solution to Question 3:…contd.