Statement of Cash Flows-

Introduction to preparation of the Statement

of Cash Flows
Purpose of the Statement of
Cash Flows
 Provides information about the cash receipts and cash
payments of a business entity during the accounting period
Helps investors with questions about the company’s:
 Ability to generate positive cash flows.
 Ability to meet its obligations and to pay dividends.
 Need for external financing.
 Investing and financing transactions for the period.
 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.
 Classification of Cash Flows

Operations -- cash flows related to selling goods and services;

that is, the principle business of the firm.
Investing -- cash flows related to the acquisition or sale of
noncurrent assets.
Financing -- long term and short term cash flows related to
liabilities and owners’ equity; dividends are a financing
cash outflow.
Operating Activities
Inflows
Inflows from:
from:
 Sales to customers.
Sales to customers.
 Interest and dividends
Interest and dividends
received.
received. + Cash
Cash
Flows
Flows
Outflows
Outflows to:
to: from
from
 Suppliers of merchandise
Suppliers of merchandise Operating
Operating
and
andservices.
services.
 Employees.
Employees.
_ Activities
Activities
 Lenders for interest.
Lenders for interest.
 Governments for taxes.
Governments for taxes.
Cash flow from operating
activities
 Examples:
 cash received from customers through sale of goods or
services performed;
 cash received from non-operating activities such as
dividends from investments, interest revenue,
commissions, and fees;
 cash payments to suppliers or employees;
 cash payments for taxes and other expenses;

In effect, the income statement is changed from

accrual basis to cash basis
 Investing Activities
Inflows
Inflows from:
from:
 Selling
Sellinginvestments
investmentsand
andplant
plant
assets.
assets.
 Collecting
Collectingof
ofprincipal
principalon
onloans.
loans.
+ Cash
Cash
Flows
Flows
from
from
Outflows
Outflows to:
to:
 Payments
Investing
Investing
Paymentstotoacquire
acquire
investments
investmentsand
andplant
plantassets.
assets. _ Activities
Activities
 Purchase
Purchasedebt
debtor
orequity
equity
investments.
investments.
 Make
Makeloans.
loans.
Investing Activities
Examples of investing activities include:
 cash payments to acquire property, plant, and equipment
(PPE), other tangible or intangible assets, and other long-term
assets; and sale of such assets
 loans extended to other companies; and collection of such
loans;
 Financing Activities
Inflows
Inflows from:
from:
 Short-term
Short-termand
andlong-term
long-term
borrowing.
borrowing. + Cash
 Owners
Owners(for
(forexample,
example, from
from Cash
issuing
issuingstock).
stock). Flows
Flows
from
from
Outflows
Outflows to:
to: Financing
Financing
 Repayments
Repaymentsofofborrowed
borrowed _ Activities
funds.
funds. Activities
 Owners
Ownersfor
fordividends.
dividends.
 Purchase
Purchasetreasury
treasurystock.
stock.
Financing Activities
Examples of financing activities are :
 cash received from issuing share capital;
 cash proceeds from issuing bonds, loans, notes,
mortgages and other short or long-term borrowings;
 cash repayment of loans and other borrowings; and
 cash payments to shareholders as dividends.
What is Cash?
 Cash includes cash and cash equivalents
 Cash equivalents:
 treasury bills maturing in 90 days or less;
 investment funds;
 foreign currency on hand;
 checking account and free savings account
 Classification of Cash in-flows and outflows
From sales of goods and To wages salary
services to customers payments
From receipt of To suppliers for
customer advances purchases of inventories
Operating Activities
From receipt of interest To other operating
revenue or dividends or expenses
rent revenue or similar To interest payments
revenue items To tax payments
To advance payments to
suppliers
From sale of PPE and To purchase PPE and
other long-term assets other long-term assets
Investing Activities
From collection of loans To make loans and to
collect such loans

From sale of common or

preferred stock Financing Activities To repay debt
From issuance of short To pay dividends
or long term debt
 Format of the Cash Flow Statement

Name of the Company

Cash Flow Statement
For the period …

Cash from operating activities A

Cash from investing activities B
Cash from financing activities C
Net Change in Cash D = (A+B+C) increase or (decrease)
+ Beginning Cash balance CB, from the beginning balance sheet
Ending Cash balance =CB + D should equal to ending
cash
balance in the ending balance sheet
Non-cash Investing and Financing Activities
 Determination of Cash Flows From
Operating Activities
Direct Method
Income Statement items are converted to cash flows individually

Indirect Method
Net income or loss is adjusted for accruals such as accounts
receivable and payable, and for non-cash expenses such as
depreciation
reconciliation of the accrual based and cash based accounting

The
Theoperating
operatingcash
cashflows
flows
section
sectioncan
canbe
beprepared
prepared
using
usingeither
eitherthe
thedirect
direct
method
methodororthe
theindirect
indirect
method.
method.
 Comparison of Methods
 Direct method of presentation calculates cash flow from operations
by subtracting cash disbursements to supplies, employees, and
others from cash receipts from customers.

 The indirect method calculates cash flow from operations by

adjusting net income for non-cash revenues and expenses.
 Most firms present their cash flows using the indirect method.

Only operating activities section is different between the

methods, investing and financing sections are the same .
Direct Method
Cash Received from Customers
 Accrual basis revenue includes sales that did
not result in cash inflows.
 Can be computed as:

Decrease
Decreaseinin
+ receivables
receivables =

Cash
CashReceived
Receivedfrom
from
Net
NetSales
Sales Customers
Customers
Increase
Increasein
in
– receivables
receivables =
Direct Method
Cash Received from Customers
The
TheA/R
A/Rbalance
balancewas
was$80,000
$80,000onon12/31/02
12/31/02andand
$110,000
$110,000onon12/31/03.
12/31/03. IfIfaccrual
accrualsales
salesrevenue
revenue
for
for2003
2003was
was$900,000,
$900,000,what
whatwas
wascash
cashbasis
basis
revenue?
revenue?
Decrease
Decreaseinin
+ receivables
receivables =
Net
NetSales
Sales Cash
CashReceived
Receivedfrom
from
$900,000
$900,000 Customers
Customers
Increase
Increasein
in
– receivables
receivables =
Direct Method
Cash Received from Customers
The
TheA/R
A/Rbalance
balancewas
was$80,000
$80,000on on12/31/02
12/31/02and
and
$110,000
$110,000on
on12/31/03.
12/31/03. IfIfaccrual
accrualsales
salesrevenue
revenuefor
for
2003
2003was
was$900,000,
$900,000,what
whatwas wascash
cashbasis
basisrevenue?
revenue?

Decrease
Decreaseinin
receivables
receivables

Net
NetSales
Sales Cash
CashReceived
Receivedfrom
from
$900,000
$900,000 Customers
Customers==$870,000
$870,000
$30,000
$30,000
Increase
Increasein
in
– receivables
receivables =
Now that we understand the process, let’s
look at some simplified formulas for
computing direct method cash flows
Direct Method
Interest and Dividends Received
Direct Method
Cash Paid for Merchandise
Step 1

Step 2
Direct Method
Cash Paid for Merchandise
How much did Lug Lite pay for inventory
in 2003?
Inventory, 1/1/03 $ 130,000 A/P, 1/1/03 $ 23,000
Inventory, 12/31/03 $ 165,000 A/P, 12/31/03 $ 35,000
COGS, 12/31/03 $ 900,000

Purchases
Purchasesfor
for2003
2003were
were $935,000.
$935,000.
a. $900,000 Purchases
Purchases==$900,000
$900,000++$35,000
$35,000
b. $923,000 Cash
CashPaid
Paidfor
forMerchandise
Merchandisein
in2003
2003
c. $947,000 was
was$923,000.
$923,000.
d. $877,000 Cash
CashPaid
Paid== $935,000
$935,000--$12,000
$12,000
 Direct Method
Cash Payments for Expenses
After
Afterdeducting
deductingdepreciation
depreciationand
andother
othernoncash
noncash
expenses,
expenses,the
thecash
cashpaid
paidfor
forexpenses
expensesisisaffected
affectedby
by
(1)
(1)whether
whetherthe
theexpense
expensewas
wasprepaid,
prepaid,and
and
(2)
(2)whether
whetherthe
theexpense
expensewas
wasaccrued.
accrued.

{ {
+ Increase in + Decrease in
Cash Paid for prepaid expenses accrued liabilities
= Expenses
Expenses - Decrease in - Increase in
prepaid expenses accrued liabilities
Direct Method - Example
Grate Big Company
Comparative Balance Sheets - Assets

December 31,
2002 2003
Cash $ 60,000 $ 70,370
Accounts Receivable, net 27,000 35,000
Inventory 230,000 200,000
Trading Securities - 25,000
Equipment, net 500,000 425,000
Investment in Tiny Co. 100,000 130,000
Total Assets $ 917,000 $ 885,370
Direct Method - Example
Grate Big Company
Comparative Balance Sheets - Liabilities and Equity
December 31,
2002 2003
Accounts Payable $ 15,000 $ 12,000
Salaries Payable 7,000 5,000
Interest Payable 11,950 7,350
Income Tax Payable 20,000 17,000
Notes Payable, Bob's Bank 70,000 60,000
Bonds Payable 250,000 150,000
Premium on Bonds Payable 5,000 4,000

Common Stock 450,000 500,000

Retained Earnings 88,050 130,020
Total Liabilities and Equity $ 917,000 $ 885,370
Direct Method - Example
Grate Big Company
Income Statement Amounts
For the Year Ending December 31, 2003

Sales Revenues $ 800,000

Cost of Goods Sold 560,000
Depreciation Expense 5,000
Interest Expense 28,050
Income Tax Expense 27,980
Salary Expense 80,000
Other Expenses 71,000
Amortization of Bond Premium 1,000
Gain on Sale of Equipment 3,000
Extraordinary Loss 30,000
Equity in Investee Income 40,000
Net Income $ 41,970
Direct Method - Example
Additional Information
 Trading Securities were purchased during 2003 at a
cost of $25,000.
 Equipment with a book value of $40,000 was sold
during the year for $43,000.
 Equipment with a book value of $30,000 was
destroyed during a freak flood in 2003. There was no
insurance.
 Grate Big holds a 25% investment in Tiny Co. and
accounts for it using the Equity Method.
Direct Method - Example

Additional Information

 Grate Big’s tax rate is 40%.

 The Notes Payable to Bob’s Bank carry a 12% rate.
The payments are due on the first day of each month.

 The Bonds Payable carry a 9% rate. Interest is payable
semiannually on July 1 & Jan. 1.

 Grate Big sold stock during 2001 for $50,000.

 Grate Big received $10,000 dividends from Tiny Co.
Direct Method - Example
Cash Received from Customers

Sales
Sales Revenues
Revenues $$ 800,000
800,000
Less:
Less: Increase
Increase in
in A/R
A/R (8,000)
(8,000)
Cash
Cash Received
Received from
from Customers
Customers $$ 792,000
792,000

Cash Paid to Employees

Salary
Salary Expense
Expense $$ 80,000
2000
80,000
2000
Add:
Add: Decrease
Decrease in
in Salary
Salary Payable
Payable 2,000
2,000
Cash
Cash Paid
Paid to
to Employees
Employees $$ 82,000
82,000
Direct Method - Example
Cash Paid for Inventory
Cost
Cost of
of Goods
GoodsSold
Sold $$ 560,000
560,000
Add
Add :: Decrease
Decreaseinin A/P
A/P 3,000
3,000
Less:
Less: Decrease
Decreaseinin Inventory
Inventory (30,000)
(30,000)
Cash
Cash Paid
Paid for
forInventory
Inventory $$ 533,000
533,000

Cash Paid for Interest

Interest
Interest Expense
Expense $$ 28,050
2000
28,050
2000
Add:
Add: Decrease
Decrease in
in Interest
Interest Payable
Payable 4,600
4,600
Cash
Cash Paid
Paid for
for Interest
Interest $$ 32,650
32,650
Direct Method - Example
Cash Paid for Taxes
Income
Income Tax
Tax Expense
Expense $$ 27,980
2000
27,980
2000
Add:
Add: Decrease
Decrease in
in Taxes
Taxes Payable
Payable 3,000
3,000
Cash
Cash Paid
Paid for
for Taxes
Taxes $$ 30,980
30,980

Other Operating Cash Flows

Direct Method - Example
Cash Flows From Operating Activities
 Equipment
Equipmentwith
withaabook
bookvalue
valueof
of
$40,000
$40,000was
wassold
soldfor
for$43,000.
$43,000.

Bonds
BondsPayable
Payabledecreased
decreasedfrom
from
$250,000
$250,000toto$150,000
$150,000during
during2003.
2003.

Notes
NotesPayable
Payabledecreased
decreasedfrom
from
$70,000
$70,000to
to$60,000
$60,000during
during2003.
2003.
 Grate Big Company
Statement of Cash Flows
For the Period Ending December 31, 2003
Notice that
I. Operating Cash Notice
Flows that the
the Ending
Ending $ 27,370
Cash
Cash Balance
Balance per
per the
the
II. Investing Cash Flows
Statement
Statement of of Cash
Cash Flows
Flows
Proceeds from sale of Equipment 43,000
agrees with the 12/31/03
agrees with the 12/31/03
III. Financing Cash Cash
Flows balance on the
Cash balance on the
Proceeds from saleBalance
of Stock Sheet.
$ 50,000
Balance
Principal paid on Bonds
Sheet.
(100,000)
Principal paid on Notes (10,000) (60,000)
Net Cash Flows for the Period $ 10,370
Add: Beginning Cash Balance 60,000
Ending Cash Balance $ 70,370