The Statement of

Cash Flows
Purpose of The Statement
of
Cash Flows: Basic
Concepts

The statement of cash flows

reports the entity’s cash flows
(cash receipts and cash payments)
during the period.
 Purposes of the
Statement
of Cash Flows
• The statement of cash flows is designed to
fulfill the following:
– predict future cash flows
– evaluate management decisions
– determine the ability to pay dividends plus
interest and principal
– show the relationship of net income to
changes in the firm’s cash
 Components and
Relationships Between the
Financial Statements
It is important to understand that the income statement,
balance sheet and cash flow statement are all interrelated.

The income statement is a description of how the assets and

liabilities were utilized in the stated accounting period.

The cash flow statement explains cash inflows and outflows,

and will ultimately reveal the amount of cash the company has
on hand; this is reported in the balance sheet as well.

We will not explain the components of the balance sheet and
the income statement here since they were previously
reviewed.
 12/31/x1 For the Year Ended 12/31/x2 12/31/x2
(a point in time) (a period of time) (a point in time)

Income
Statement

Balance Statement Balance

Sheet of Retained Sheet
Earnings

Statement
of Cash
Flows
 Organization of the
Statement of Cash Flows

• A business may be evaluated in terms of three

types of business activities:
1Operating activities
2Investing activities
3Financing activities
 Preparing
Preparing the
the Statement
Statement of
of Cash
Cash Flows
Flows

Three Sources of Information:

1. Comparative balance sheets
2. Current income statement
3. Additional information
1. Cash Flow from Operating
Activities (CFO)

• CFO is cash flow that arises from normal operations such as

revenues and cash operating expenses net of taxes.
This includes:
Cash inflow (+)
• Revenue from sale of goods and services
• Interest (from debt instruments of other entities)
• Dividends (from equities of other entities)

• Cash outflow (-)

• Payments to suppliers
• Payments to employees
• Payments to government
• Payments to lenders
• Payments for other expense
 2. Cash Flow from Investing
Activities (CFI)

• CFI is cash flow that arises from investment activities such

as the acquisition or disposition of current and fixed assets.
This includes:

• Cash inflow (+)

• Sale of property, plant and equipment
• Sale of debt or equity securities (other entities)
• Collection of principal on loans to other entities
• Cash outflow (-)
• Purchase of property, plant and equipment
• Purchase of debt or equity securities (other entities)
• Lending to other entities
3. Cash flow from financing
activities (CFF)

• CFF is cash flow that arises from raising (or decreasing) cash
through the issuance (or retraction) of additional shares, short-
term or long-term debt for the company's operations. This
includes:

• Cash inflow (+)

• Sale of equity securities
• Issuance of debt securities

• Cash outflow (-)

• Dividends to shareholders
• Redemption of long-term debt
• Redemption of capital stock
 Format
Format of
of the
the Statement
Statement of
of Cash
Cash Flows
Flows

Illustration: Classify each of these

transactions by type of cash flow
activity.
1. Issued 100,000 shares of $5 par value
common stock for $800,000 cash. Financi
2. Borrowed $200,000, signing a 5-year ng
Financi
note bearing 8% interest.
3. Purchased two semi-trailer trucks for ng
$170,000 cash. Investin
4. Paid employees $12,000 for salaries and g
wages.
Operatin
5. Collected $20,000 cash for services g
Operatin
provided.
g
 Review
Review Question
Question

Which is an example of a cash flow from an

operating activity?
a. Payment of cash to lenders for interest.
b. Receipt of cash from the sale of capital
stock.
c. Payment of cash dividends to the
company’s stockholders.
d. None of the above.

SO 4 Prepare a statement of cash flows using the indirect method.

 Review
Review Question
Question

Which is an example of a cash flow from an

investing activity?
a. Receipt of cash from the issuance of bonds
payable.
b. Payment of cash to repurchase outstanding
capital stock.
c. Receipt of cash from the sale of equipment.
d. Payment of cash to suppliers for inventory.

SO 4 Prepare a statement of cash flows using the indirect method.

 Format of the SCF

• FASB Statement 95 approved two methods for

reporting cash flows from operating activities.

1Direct method (preferred)

2Indirect method
 The Direct Method
Cash Flow from Operations
Under the direct method, (net) cash
flows from operating activities are
determined by taking cash receipts from
sales, adding interest and dividends, and
deducting cash payments for purchases,
operating expenses, interest and income
taxes. We'll examine each of these
components below:
 The Direct Method

• Cash collections are the principle components of CFO.

These are the actual cash received during the
accounting period from customers.

They are defined as:

Cash Collections Receipts from Sales = Sales +
Decrease (or - increase) in Accounts Receivable
 The Direct Method

• Cash payment for purchases make up the most

important cash outflow component in CFO. It is the
actual cash dispersed for purchases from suppliers
during the accounting period.
It is defined as:
Cash payments for purchases = cost of goods sold +
increase (or - decrease) in inventory + decrease (or -
increase) in accounts payable
 The Direct Method

• cash payment for operating expenses is the cash

outflow related to selling general and administrative
(SG&A), research and development (R&A) and other
liabilities such as wage payable and accounts payable.
It is defined as:
Cash payments for operating expenses = operating
expenses + increase (or - decrease) in prepaid
expenses + decrease (or - increase) in accrued
liabilities
 The Direct Method

• Cash interest is the interest paid to debt holders in

cash.
It is defined as:

Cash interest = interest expense – increase (or +

decrease) interest payable + amortization of bond
premium (or – discount)
 The Direct Method

• Cash payment for income taxes is the actual cash

paid in the form of taxes.
It is defined as:
Cash payments for income taxes = income taxes +
decrease (or - increase) in income taxes
payable
Prepare SCF

1. The company purchased a truck

during the year at a cost of $30,000
that was financed in full by the
manufacturer.

2. A truck with a cost of $10,000 and a

net book value of $2,000 was sold
during the year for $7,000. There
were no other sales of depreciable
assets.
Statement of Cash Flows
(Direct Method)
 The Indirect Method

Current Assets

Add to Net Income if this account has decreased

Deduct from Net Income if this account has increased

 The Indirect Method

Current Liabilities

Add to Net Income if this account has increased

Deduct from Net Income if this account has decreased

Statement of Cash Flows
(Indirect Method)
 CLASS WORK -SCF
Menghai Pizza Dec 31, 2000
Cash payment (35,000) Retirement of (25,000)
of Dividend Common stock
Acquisition of (14,000) Purchase of (30,000)
Parahata Pizza equipment
Cash Payment (10,000) Cash payment (85,000)
for interest to suppliers
Cash payment (45,000) Cash collected 250,000
for Salaries from customers
Sale of 38,000 Cash at Dec 50,000
equipment 31,1999

Required:
Prepare SCF
CLASSWORK 1-Solution Menghai Pizza
Statement of Cash Flows
YearEnded December 31, 2

CF FROM OA
Cash collection 250,0
from customers 00
Cash payment to (85,0
Suppliers 00)
CF FROM FA
Cash payment for (45,0
Salaries 00) Retirement of (25,0
Common stock 00)
Cash payment for (10,0
interest 00) Payment of (35,0
dividend 00)
Net cash from OA 110,0
00 Net cash from (60,00
FA 0)

CF from IA
Net increase in 44,000
Sales of equipment 38,00 cash
0
Cash at 50,000
 End of
Chapter