Statement of Cash Flows- First
Appendix 6- Introduction to preparation of the
Statement of Cash Flows
Cash Flow Statement
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
Financing -- long term and short term cash flows related
to liabilities and owners’ equity; dividends are a
financing cash outflow.
What is Cash?
Cash includes cash and cash equivalents
treasury bills maturing in 90 days or less;
foreign currency on hand;
checking account and free savings account
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
Cash flow from operating
Examples (IAS No.7):
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
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
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.
Classification of Cash in-flows and outflows
From sales of goods and To wages salary
services to customers payments
From receipt of customer To suppliers for
advances purchases of inventories
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
From sale of PPE and other To purchase PPE and
long-term assets other long-term assets
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
Income Statement items are converted to cash flows
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
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.
How to prepare cash flow
Firms could prepare their own cash flow
statement directly from the cash account.
however, we need two consecutive balance
sheets and the income statement that covers
the period between the two balance sheets
Assets = Liabilities + Shareholders’ Equity
or A = L + SHE
Assets are either cash (C) or not (Non-Cash)
C + Non Cash Assets (NCA) = L + SE
C + NCA = L + SE
Where means the change in the balance of the item
from the previous period.
Solving for change in cash:
C = L + SE - NCA
Based on Stickney and Weil, 10th ed. Financial Accounting Slides http://www.swlearning.com/accounting/stickney/tenth_edition/stickney.html
Algebraic Formulation (Cont.)
C = L + SE - NCA
The change in cash, C, is the increase or decrease
in the cash account.
This amount must equal changes in liabilities plus
changes in shareholders’ equity minus changes in
assets other than cash.
Thus, we can identify the causes in the change in the
cash account by studying the changes in non-cash
Indirect Method – cash flow from operations
Adjusting Net Income of the period (accrual) to cash
Increase in non-cash Decrease in non-cash
assets shows that cash assets shows that
Assets was spent, they provided cash
so cash outflow. so cash inflow.
Increase in liabilities
Liabilities Decrease in liabilities
and or SHE shows
increase in SHE cash
equity so cash outflow
so cash inflow
Indirect Method- operating activities-
Adjustments to net income
+ noncash expenses: depreciation, amortization,
uncollectible account expense,etc
+ loss on sale of asset
+ increases in current liabilities
+ decreases in current assets
- gain on sale of asset
- decrease in current liabilities
- increase in current assets
= Cashflow from operating activities
Noncash expenses, such as depreciation expense,
are added back – because they were deducted to
measure net income but did not require any cash
payment in the current period
They are not truly sources of cash, even though
they are associated with cash inflows but reversal
of an accrued expense
Prepare Cash Flow Statement
Accounts with Debit Balances 2008 2007 (decrease)
Cash 37.500 39.250 (1.750)
Notes Receivable (from loans to other companies) 69.000 50.000 19.000
Accounts Receivable 53.700 39.900 13.800
Merchandise Inventory 158.000 120.000 38.000
Prepaid Operating Expenses 2.100 1.800 300
Interest Receivable 1.400 600 800
Land 110.000 65.000 45.000
Property,Plant and Equipment-PPE-net 377.000 380.000 (3.000)
808.700 696.550 112.150
Accounts with Credit Balances
Accounts Payable 45.000 38.000 7.000
Accrued Wages Payable 3.000 2.400 600
Income Taxes Payable 6.000 4.500 1.500
Unearned Revenues 2.500 1.250 1.250
Bank Notes Payable - long term 215.000 200.000 15.000
Common Stock; TL 15 par value 405.000 375.000 30.000
Additional Paid in Capital 70.000 50.000 20.000
Retained Earnings 62.200 25.400 36.800
808.700 696.550 112.150
Portakal Company 0
Income Statement 2008
Sales Revenue 750.000
Cost of Goods Sold (375.000)
Depreciation Expense (43.000)
Salary and Wages Expense (125.000)
Administrative Expenses (80.000)
Loss on Sale of Equipment (4.000)
Other Operating Expenses (5.000)
Interest Revenue 4.000
Interest Expense (20.000)
Income Tax Expense (28.000)
Net Income 74.000
The company paid TL 50.000 of Bank Notes and borrowed new bank loan.
The company declared and paid cash dividends.
The company sold equipment with a cost of TL 12000 and accumulated depreciation of TL
6000 for TL 2000 receving a note in return to be collected in 2009.
The company purchased equipment for TL 46.000; paid TL 44.000 in 2008 and gave a
note for Jan. 2009.
The company issued common stock during the year .
Portakal Company 2008
Cash Flow Statement
Cashflow from Operating Activities
Net Income 74000
Add back noncash:
Depreciation Expense 43.000
Loss on Sale of Equipment 4.000
adjustments that increase cash:
increase in Acct.Payable 7.000
Increase in Acc.Wages Payable 600
increase in Income Taxes payable 1.500
increase in unearned revenued 1.250
adjustments that decrease cash:
increase in Accts Rec. (13.800)
increase in Merch. Inv. (38.000)
Increase in Prepaid Expense (300)
increase in interest recev. (800)
Cashflow from operations 78.450
Cashflow from investing
Sale of PPE (note will be received in 2009)
Purchase of PPE (44.000)
Loans extended( to other companies) (19.000)
Purchase of land (45.000)
Cashflow from investing (108.000)
Cashflow from financing
Bank Notes Payable - long term 65.000
Common Stock; TL 15 par value 30.000
Additional Paid in Capital 20.000
Payment of Bank loan (50.000)
Payment of Dividends (37.200)
Cashflow from financing 27.800
Net Change in Cash (1.750)
Effects of a Sale of
a Long-Term Assets on Cash Flows
A few transactions complicate the derivation of a cash
flow statement from a comparative balance sheet, for
example, the sale of a long-term (or fixed) asset.
Recall the journal entry for the sale of an asset:
Accumulated Depreciation nnnn
Gain (or loss) on sale nnnn
Sale of an Asset
Each of the four parts of the above journal entry require
an adjustment in the cash flow statement.
The first line, cash, adds a line to the investing section.
The second line, a debit to accumulated depreciation,
increases the depreciation expense above the change
in the change in the accumulated depreciation account.
The third line, a credit to the asset, increases the
amount of cash invested in long-lived assets above the
change in the fixed asset accounts.
The fourth line, a gain or loss, is reversed out in the
operating sections since this is not a cash flow.
Comparison of Cash Flow to Net
Net income is an accrual based concept and purports to
show the long-term.
Cash flows purport to show the short term.
Consider the outlook for both short-term and long-term and
consider that each is either good or poor.
A strong growing firm would show both good long-term and
good short-term outlooks.
A failing firm would show both poor long-term and poor
short term outlooks.
What about a firm with good cash flows (short-term) but
poor net income (long-term)?
What about a firm with poor cash flows (short-term) but
good net income (long-term)?