Chapter-5

Statement of Cash Flow

Statement of Cash Flows
• Reports a company’s cash receipts and cash
payments during a particular period
• Classifies them as financing, investing, and
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
Statement of Cash Flows
Show performance of companies over a period of
time
Purposes of Cash Flow Statement
Cash Equivalents
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
Financing Decisions
• Decisions concerned with whether and how
to raise or repay cash
• Cash flows from financing activities
• Section of the statement of cash flows
that helps users understand financing
decisions
• Financing activities: Transactions that obtain
resources by either of the following methods
• Borrowing from creditors
• Selling shares of stock
• Use resources to for either of the
following purposes
• Repay creditors
• Provide a return to shareholders
Investing Decisions
• Decisions that include the choices to:
• Acquire or dispose of plant, property,
equipment, and other long-term
productive assets
• Provide or collect cash as a lender or as an
owner of securities
Investing Decisions
• Cash flows from investing activities
• Section of the statement of cash flows that
helps understand management’s investing
decisions
• Investing activities: Transactions that acquire or
dispose of:
• Long-lived assets
• Securities that are not cash equivalents
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
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
Cash Flows from Financing
Activities
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-lived assets, loans, or securities that
are not considered cash equivalents.
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
• 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)
Cash Flows from Investing
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
Cash Flows from Operating
Activities
• Shows cash transactions affecting income
statements
• Two approaches under U.S. GAAP
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
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)
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
• Adds or subtracts a series of adjustments
• Ends with cash provided by (used for)
operating activities
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
• Line items are not cash flows they are
adjustments of net income
Cash Flows from Operations—The
Indirect Method
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
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
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
A General Approach to
Adjustments
• To adjust for noncash revenues and
expenses:
• Add back depreciation
• Add back other expenses that do not
require cash
• Deduct revenues that do not generate
cash
A General Approach to
Adjustments
• To adjust for changes in noncash assets
and liabilities relating to operating
activities:
• Add decreases in operating assets
• Deduct increases in operating assets
• Add increases in operating liabilities
• Deduct decreases in operating
liabilities
Reconciliation Statement
• Direct-method statements must include
supplementary schedule:
• To reconcile net income to net cash
provided by operations
• Which is effectively the operating section
of an indirect method cash flow statement
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

The Statement of Cash Flows and
the Balance Sheet Equation
• Statement of cash flows focuses on changes in the
noncash accounts to explain how and why level of
cash changed
• Changes in the accounts on the right side of the
equation appear in the statement of cash flows:
• When they involve the use or receipt of cash
• Left side of the equation measures the net
effect of the change in cash
The Importance of Cash Flow
• Statement of cash flows explains changes in cash
account
• Not changes in owners’ equity
• Measures firm’s performance in maintaining strong
cash position
• Free cash flow: Net cash flow from operations less
capital expenditures
• Some also subtract dividends