Cash Flow Statement
Cash Flow Statement
Cash Flow Statement
An Overview
Operating Activities
Investing Activities
Financing Activities
6
10
Direct Method
10
Indirect Method
11
16
17
Checklist
18
Resources
18
Notes
19
what to expect
This Business Builder will introduce you to the cash flow statement and its importance
for financial management. Through the use of a worksheet, the Business Builder will
guide you through the construction of a cash flow statement for your business. The cash
flow statement is a complex financial statement and by necessity, this Business Builder
contains information on sophisticated accounting topics.
The cash flow statement reports the cash provided and used by the operating, investing, and financing
activities of a company during an accounting period. In 1987, the Financial Accounting Standards Board
issued Statement No. 95, which requires that a statement of cash flows accompany the income statement,
balance sheet and statement of retained earnings.
An Overview
The cash flow statement explains the change during the period in cash and cash equivalents.
Cash includes currency on hand and demand deposits. Cash equivalents are short-term, highly
liquid investments that are readily convertible to cash.
Statement No. 95 requires that cash receipts and payments be classified as operating, investing and
financing activities.
The cash flow statement will summarize the cash flows so that net cash provided or used by each of
the three types of activities is reported. Beginning and ending cash must be reconciled based on the net
effect of these activities. Here is an example of what a cash flow statement might look like.
$200
100
30
10
I ncrease in Inventory
(150)
(25)
165
(400)
A
ctivities Notes Payable
Net Change in Cash
30
(205)
Investing Activities
Investing activities include buying and selling noncurrent assets which will be used to generate
revenues over a long period of time; or buying and selling securities not classified as cash
equivalents.
Cash inflows generated by investing activities include sales of noncurrent assets such as property,
plant, and equipment. Investing activities can also include the purchase or sale of stock and securities.
Lending money and receiving loan payments would also be considered investing activities.
Financing Activities
Financing activities include borrowing and repaying money, issuing stock (equity) and paying
dividends.
For example, if you borrow funds to purchase equipment or pay off a loan, the cash flow statement will
enable you to determine how much cash was either generated or used as a result of those transactions.
The indirect method reconciles net income with net cash flow from operating activities by
adjusting net income for deferrals, accruals, and items that effect investing and financing
cash flows.
The first step in preparing the cash flow statement is to determine the net increase in cash and cash
equivalents for the period. This amount will be a control figure and the cash flow statement will reconcile
the inflows and outflows (sources and uses) to this figure.
The fictional company From the Roots Up will be used as the example throughout this booklet. The
current year income statement data is shown on Exhibit 1 and the balance sheets from the prior two years
have been combined on the cash flow worksheet as Exhibit 2. This is also referred to as the sources and
uses statement.
Begin with the balance sheet data by taking the cash balance of $223,000 from the most recent
balance sheet and subtracting the cash balance of $169,000 from the prior year, which results in an
increase in cash of $54,000. The cash flow statement must balance to this control number.
Next, determine the change in each balance sheet account. This is reflected in the Balance Change
column (Exhibit 2) of the worksheet. It is calculated by subtracting the prior year account balance from
the current year balance. For example, accounts receivable in 200Y was $884,000 compared to $705,000
in 200X, which resulted in a $179,000 increase in accounts receivable. This process is continued for each
of the balance sheet accounts.
After calculating the account balance change, it is necessary to determine if the balance change is
an inflow or an outflow of cash or a source or use of cash. To make this task simple use Table I as a guide
to determine the effect of each balance change. The table shows a decrease in an asset balance and an
increase in a liability or equity account are cash inflows. The opposite holds true for increases in an asset
balance or a decrease in a liability or equity account, which results in a cash outflow.
To complete the cash flow worksheet (Exhibit 2), determine if each account balance change is an
operating, investing or financing activity. Using Table II as your guide, beginning with the asset section of
the cash flow worksheet, review each account. Remember, the change in cash and cash equivalents is
the control number to which you reconcile your cash flow statement.
Accounts receivable would be categorized as an operating activity, because it is related to collections
from customers. The change in inventory is classified as an operating activity, because it is a component
of core operating activities. Plant and equipment transactions would be classified as investing, because
the sale or purchase of productive assets which are expected to generate revenues in the future are
defined as Investing Activities in Table II.
Exhibit 1
$8,158
(4,895)
Gross Profit
3,263
(367)
(188)
Operating Expense
(1,468)
Personnel Expense
(816)
(33)
Operating Profit
391
Interest Expense
Net Income
0
(122)
$269
Prior Year
Current Year
Balance
Cash Source/
Activity
200X
200Y
Change
(Cash Use)
Type
Assets
Cash
$169
$233
$54
Control
Cash
705
884
(179)
Use
Operating
(14)
(18)
(4)
Use
Operating
Inventories
983
1,160
(177)
Use
Operating
130
214
(84)
Use
Investing
512
552
(40)
Use
Investing
Accumulated Depreciation
(102)
(110)
Source
Operating
Noncurrent Assets
72
68
Source
Investing
$2,455
$2,973
Total Assets
$353
$442
$89
Source
Operating
Salaries Payable
40
50
10
Source
Operating
28
50
22
Source
Operating
200
231
31
Source
Financing
490
400
(90)
Use
Financing
Due to Shareholders
324
450
126
Source
Financing
Paid in Capital
500
698
198
Source
Financing
Retained Earnings
520
652
132
Source
Operating
$2,455
$2,973
9
Table I
Cash Outflow
Table II
Inflows of Cash
Operating Activities
Investing Activities
Financing Activities
Collection on Loans
Interest Income
Dividends Receipts
Outflows of Cash
Operating Activities
Investing Activities
Financing Activities
Payments to Suppliers
Payment of Dividends
Payments to Employees
Interest Payments
Acquisition of an Entitys
Own Equity Securities
Making Loans
Repayment of Amounts
Borrowed
10
The first method performed will be the direct method of calculating cash flow. This method
combines information from both the Income Statement and the Cash Flow worksheet we created
using the Balance Sheet.
The result is an accurate indication of exactly what funds were collected in the form of cash, paid
in the form of cash, and if the company actually generated cash. You can use Table III as a guide for
calculating the cash flow on a direct basis.
Table III
Other Income/Expense
Interest Expense
Dividends/Withdrawals
11
Exibit 3
Net Sales
$8,158
(175)
(33)
7,950
(4,895)
Change in Inventories
Income Statement
Income Statement
Balance Sheet
89
Balance Sheet
(4,983)
2,967
Change in Accruals
10
Balance Sheet
(177)
Income Statement
Balance Sheet
138
Income Statement
Balance Sheet
$142
The second method used to calculate the Cash Flows from Operating Activities is referred to as
the Indirect Method. Using the Indirect Method, cash flows from Operating Activities are reported
by adjusting net income for revenues, expenses, gains, and losses that appear on the income
statement but do not have an effect on cash.
Using Table IV as a guide, and Table I and Table V to determine if the change is an inflow or outflow,
extract data from the Income Statement (Exhibit 1) and Cash Flow Worksheet (Exhibit 2) to prepare the
Cash Flows from Operating Activities using the Indirect Method. (Exhibit 4).
12
Table V
Cash Outflow
Expense Accounts are Uses of Cash
Based on the formula provided in Table IV, reconcile From the Roots Up net income with net cash
provided by its Operating Activities (Exhibit 4).
13
Exhibit 4
Net Profit
$269
Non-Cash Changes
Depreciation, Amortization
188
4
461
Change in Inventory
89
Change in Salaries
10
22
(179)
(84)
(177)
$142
A comparison of the Direct Method with the Indirect Method indicates that either method will
generate the same results. The Operating Activities of From the Roots Up generated $142,000 in net cash
during 200Y.
Investing Activities
Cash flow from investing activities is the second part of both types of cash flow statements.
Investing activities are the changes to the cash position created by the buying or selling of
non-current assets. This includes selling and replacing equipment that wears out or acquiring a
new building or land to facilitate growth in a company.
Investing activities can also include the purchase or sale of stocks, bonds and securities. Lending
money and receiving loan payments are also considered investing activities. For a small business, the
investing activities section of a cash flow statement usually reports the following information:
For a given period, there may not be much in the way of investing activities. But over time, it is an
important consideration for assessing how to choose to use the cash generated by your business.
Financing Activities
Financing activities on a cash flow statement reflect borrowing money and repaying money,
issuing stock, and paying dividends. The financing activities section of the cash flow statement
can be reduced to the following formula:
- Repayment of Loans
- Dividends/Distributions/Withdrawals Paid
As you can see, this section of the cash flow statement is registering inflows of cash from
loans received and loans repaid, and other cash inflows from outsiders and owners. If you have paid
dividends or taken money from the business, it should be reported here.
Our actual Cash Flow Statement can now be created by summarizing the results as follows:
14
15
Description
Net Sales
Change in Account / Notes Rec-Trade (Net)
12 Month Period
$8,158
(208)
7,950
(4,895)
Change in Inventories
Change in Accounts Payable-Trade
Cash Paid to Suppliers
CASH FROM TRADING ACTIVITIES
General and Administrative Expenses (Less Non-Cash Expenses)
Change in Accruals and Other Pay
Cash Paid for Operating Costs
CASH AFTER OPERATIONS
(177)
89
(4,983)
2,967
(2,839)
10
(2,829)
138
4
142
Interest Expense
(122)
(137)
(259)
(117)
(117)
(32)
(84)
(116)
(233)
53
(90)
126
Change in Capital
198
287
54
169
$223**
16
Investing Activities
The cash flow statement puts investing activities into perspective. At one glance, you can see
whether or not a surplus in operations is being used to grow the company.
A lack of investing activities, which is few purchases of new equipment or other assets, may indicate
stagnant growth or a diversion of funds away from the company.
Financing Activities
The financing activities section of the cash flow statement will show repayments of debt, borrowing
of funds, as well as injections of capital and the payment of dividends. As a company expands, this
area of the cash flow statement will become increasingly important. It will tell outsiders how the
company has grown and the financial strategies of management.
Together, the three sections of the cash flow statement show the net change in cash during the
period being examined. A comparison between past periods will give owners and managers a good
idea of the trend of their business. Positive trends in cash flow may encourage owners to consider
long-term financing as an aid to growth and increase their comfort level concerning the companys ability
to generate cash for repayment. Strong cash flow will also make it easier to acquire financing and to
negotiate with lenders from a position of strength. Preparation of a cash flow statement is the first step
toward financial management for long-term success.
17
Description
Net Sales
Change in Account / Notes Rec-Trade (Net)
Cash Collected From Sales
Cost of Sales / Revenues
Change in Inventories
Change in Accounts Payable-Trade
Cash Paid to Suppliers
CASH FROM TRADING ACTIVITIES
General and Administrative Expenses (Less Non-Cash Expenses)
Change in Accruals and Other Pay
Cash Paid for Operating Costs
CASH AFTER OPERATIONS
Change in Other Assets / Liabilities
Other Income (Expense) and Taxes Paid
Net Cash After Operations
Interest Expense
Dividends - Paid in Cash
Cash Paid for Dividends and Interest
NET CASH INCOME
Current Portion Long-Term Debt
CASH AFTER DEBT AMORTIZATION
Change in Net Fixed Assets
Change in Investments
Cash Paid for Plant and Investments
FINANCING SURPLUS (REQUIREMENTS)
Change in Short-Term Loans / Other Payables
Change in Long-Term and Sub Debt
Change in Other Non-Current Liabilities
Change in Capital
Total External Financing
CASH AFTER FINANCING*
Add: Beginning Cash & Equivalents
Ending Cash Equivalents
12 Month Period
18
checklist
Operating Activities
___ When you prepared the operating activities portion of the cash flow statement by the direct
method, did you also prepare it by the indirect method to reconcile net income to cash flow from
operating activities?
___ Has net income been adjusted for changes in accounts receivable, inventory, accounts
payable, wages payable, and income taxes?
Investing Activities
___ Is every cash transaction to purchase equipment or other assets represented?
___ If any loans were made by the company, are they reflected?
Financing Activities
___ Are all loan payments reported?
___ Have all cash dividends been reported?
___ Are there any unreported cash inflows from owners or investors?
resources
Books
Cash Flow Analysis, Financial Proformas, Inc., Fifth Edition, September 1995
Healthy Business Guide, Zions First National Bank
Websites
The Trade Creditors Guide to the Statement of Cash Flows,
www.crfonline.org/orc/cro/cro-10.html
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notes
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b-4
resources@zionsbank. com
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