Statement of Cash Flows

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Statement of Cash Flows
Revised by Judy Beebe, Western Oregon University

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The statement of cash flows reports a firms
major cash inflows and outflows for a period. It
provides useful information about a firms
ability to generate cash from operations,
maintain and expand its operating capacity, meet
its financial obligations, and pay dividends.
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Reporting Cash Flows
The statement of cash flows reports cash flows
from three types of activities
1. Cash flows from operating activities are cash
flows from transactions that affect net
income. 2. Cash flows from investing activities
are cash flows from transactions that affect the
investments in noncurrent assets. 3. Cash flows
from financing activities are cash flows from
transactions that affect the equity and debt of
the business.
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Cash Flows
Sources (increases) of Cash
Uses (decreases) of Cash
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Cash Flows from Operating Activities
The direct method reports the sources of
operating cash and the uses of operating cash.
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The indirect method reports the operating cash
flows by beginning with net income and adjusting
it for revenues and expenses that do not involve
the receipt or payment of cash.
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A primary advantage of the direct method is that
it reports the sources and uses of operating cash
flows in the statement of cash flow.
A primary disadvantage of the direct method is
that the necessary data may not be readily
available and may be costly to gather.
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A primary advantage of the indirect method is
that it focuses on the differences between net
income and cash flows from operations.
Because the data are readily available, another
advantage of the indirect method is that it is
normally less costly to use than the direct
method.
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Cash Flows from Operations Direct and
Indirect Methods NetSolutions
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same amount
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Noncash Investing and Financing Activities
Noncash investing and financing activities are
transactions that do not involve cash. The
effect of such transactions is recorded in a
separate schedule that appears at the bottom of
the statement of cash flows.
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c. Investing

• Investing

f. Operating
b. Financing

• Operating

e. Financing
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• For each of the following, identify whether it
  would be disclosed as an operating, financing, or
  investing activity on the statement of cash flows
  under the indirect method.
• a. Purchase Patent d. Net Income
• Pay cash dividend e. Purchase treasury stock
• Disposal of f. Depreciation expense
• Equipment

For Practice PE 14-1A, PE 14-1B
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An efficient approach to preparing the statement
of cash flows is to analyze the changes in the
noncash balance sheet accounts. The logic of
this approach is that a change in any balance
sheet account (including Cash) can be analyzed in
terms of changes in the other balance sheet
accounts.
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The analysis of Retained Earnings provides a good
starting point for determining the cash flows
from operating activities, which is the first
section of the statement of cash flows.
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Comparative Balance Sheet
(Continued)
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Comparative Balance Sheet
(Concluded)
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Indirect Method
Use this table when adjusting Net Incometo Cash
Flow form Operations.
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Retained Earnings
The Retained Earnings account for Rundell Inc.
reveals that the balance increased 80,000 during
the year.
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The net income of 108,000 is entered on the
statement (or working papers).
To statement
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Operating Activities Rundell Inc.
Cash flows from operating activities
Net income 108,000 Adjustments to reconcile
net income
to net cash flow from operating activities
This phrase is added to indicate that accrual
basis net income is being adjusted to arrive at
cash flows from operations.
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Depreciation
Next, we need to determine depreciation expense
for the year. If it isnt given in the income
statement, sometimes it can be found by analyzing
the various accumulated depreciation accounts.
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The comparative balance sheet (Exhibit 4 Slides
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DepreciationBuilding increased by 7,000. By
analyzing the account we can see that the
increase is the result of the year-end adjusting
entry.
to statement
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The offsetting 7,000 debit is to an expense for
depreciation. The effect on the income statement
was to reduced net income however, this expense
did not require an outflow of cash. Therefore,
the 7,000 is added back to net income in
determining cash flows from operating activities.
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Operating ActivitiesRundell Inc.
Cash flows from operating activities
Net income 108,000 Adjustments to reconcile
net income to net cash flow from operating
activities Depreciation 7,000
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Gain on Sale of Land
The ledger or income statement of Rundell Inc.
indicates that the sale of land resulted in a
gain of 12,000. This gain increased net income
by 12,000, yet cash flows was provided by an
investing activity (selling land) rather than an
operating activity, so the gain is deducted from
net income on the statement of cash flows.
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Operating ActivitiesRundell Inc.
Cash flows from operating activities
Net income 108,000 Adjustments to reconcile
net income to net cash flow from operating
activities Depreciation 7,000 Gain on
sale of land (12,000)
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Omni Corporations accumulated depreciation
increased by 12,000, while patents decreased by
3,400 between balance sheet dates. There were
no purchases or sales of depreciable or
intangible assets during the year. In addition,
the income statement showed a gain of 4,100 from
sale of land. Reconcile a net income of 50,000
to net cash flow from operating activities.
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Net income 50,000 Adjustments to reconcile net
income from operating
activities Depreciation 12,000 Amortization 3,4
00 Gain on sale of land (4,100) Net cash flow
from operating activities 61,300
For Practice PE 14-2A, PE 14-2B
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Changes in Current Operating Assets and
Liabilities
Next, select current assets and current
liabilities that impact cash flows and determine
their increases and decreases. Exhibit 5 in
(Slide 28) may prove to be helpful in determining
how to treat increases and decreases in noncash
current operating assets and current operating
liabilities.
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Adjustments to Net Income (Loss) Using the
Indirect Method
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Changes in Current Accounts
December 31
Increase
Accounts
2007
Decrease
2008
Accounts receivable (net) 74,000
65,000 Inventories 172,000 180,000 Accounts
payable (mdse.) 43,500 46,700 Accrued expenses
payable 26,500 24,300 Income taxes
payable 7,900 8,400
9,000 8,000 3,200 2,200 500
Note that Cash and Dividends Payable are not
included in this analysis.
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Operating ActivitiesIndirect Method
Cash flows from operating activities
Net income 108,000 Adjustments to reconcile
net income to net cash flow from operating
activities Depreciation 7,000 Gain on
sale of land (12,000) Changes in current
operating assets and liabilities Increase in
accounts receivable (9,000) Decrease in
inventory 8,000 Decrease in accounts
payable (3,200) Increase in accrued
expenses 2,200 Decrease in income taxes
payable (500)
You will notice that increases actually decrease
cash flows from operating activities, and
decreases do just the opposite.
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Statement of Cash FlowsIndirect Method for
Rundell Inc. (Operating Activities Section)
Same information as Slide 30, only in final form.
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Victor Corporations comparative balance sheet
for current assets and current liabilities was as
follows
Dec. 31, 2009
Dec. 31, 2008
Accounts receivable 6,500
4,900 Inventory 12,300 15,000 Accounts
payable 4,800 5,200 Dividends payable 5,000 4,000
Adjust net income of 70,000 for changes in
operating assets and liabilities.
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Net income 70,000 Adjustments to reconcile net
income to net cash from from
operating activities Increase in accounts
receivable (1,600) Decrease in
inventory 2,700 Decrease in accounts payable
(400) Net cash flow from operating activities
70,700
For Practice PE 14-3A, PE 14-3B
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Omicron, Inc. reported the following data
Net income 120,000 Depreciation
expense 12,000 Loss on disposal of
equipment 15,000 Increase in Accounts
receivable 5,000 Decrease in Accounts
payable (2,000)
Prepare the cash flow for operating activities
section of the statement of cash flows using the
indirect method.
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Cash flows from operating activities Net
income 120,000 Adjustments
to reconcile net income
to net cash flow from operating
activities Depreciation 12,000 Loss from
disposal of equipment 15,000 Changes in current
operating assets
and liabilities Increase in accounts
receivable (5,000) Decrease in accounts
payable (2,000) Net cash flow from operating
activities 140,000
For Practice PE 14-4A, PE 14-4B
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Cash Flows Used for Payment of Dividends
ACCOUNT Dividends Payable
ACCOUNT NO.


Balance Date Item
Debit Credit Debit
Credit
2008
Jan. 1 Balance 10,000 10 Cash
paid 10,000 June 20 Dividends
declared 14,000 14,000 July 10 Cash
paid 14,000 Dec. 20 Dividends
declared 14,000 14,000
Note that while 28,000 in dividends were
declared, only 24,000 were paid during the year.
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Because paying of dividends affects equity and is
an outflow of cash, it is a negative 24,000 cash
flows from financing activities transaction.
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Common Stock
Common Stock increased by 8,000.
ACCOUNT Common Stock
ACCOUNT NO.


Balance Date Item
Debit Credit Debit
Credit
2008
Jan. 1 Balance 16,000 Nov. 1 4,000 shares
issued/cash 8,000 24,000
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Analyzing the two accounts together, we can
determine that the 4,000 shares were sold for
48,000.
ACCOUNT Paid-in Capital in Excess of ParCommon
Stock


Balance Date Item
Debit Credit Debit
Credit
2008
Jan. 1 Balance 80,000 Nov. 1 4,000 shares
issued/cash 40,000 120,000
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Issuing common stock affects equity therefore,
we have a positive 48,000 cash flows from
financing activities item.
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Bonds Payable
Bonds Payable decreased by 50,000.
ACCOUNT Bonds Payable
ACCOUNT NO.


Balance Date Item
Debit Credit Debit
Credit
2008
Jan. 1 Balance 150,000 June 30 Retired by
payment of cash at face amount 50,000 100,000

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Retiring bonds is a cash outflow reported as a
negative item under cash flows from financing
activities.
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Building
By examining the Building account, we can
determine that Rundell Inc. bought a building for
60,000 cash.
ACCOUNT Building
ACCOUNT NO.


Balance Date Item
Debit Credit Debit
Credit
2008
Jan. 1 Balance 200,000 Dec. 27 Purchased for
cash 60,000 260,000
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Purchasing a building involves a noncurrent
asset, so this is a negative cash flows from
investing activity.
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Land
The 45,000 decline in the Land account resulted
from two separate transactions a sale and a
purchase.
ACCOUNT Land
ACCOUNT NO.


Balance Date Item
Debit Credit Debit
Credit
2008
Jan. 1 Balance 125,000 June 8 Sold for 72,000
cash 60,000 65,000 Oct. 12 Purchased for
15,000 cash 15,000 80,000
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The first transaction, the sale of land, is
classified as a positive cash flows from
investing activity because land is a noncash
asset.
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The 12,000 gain was recorded earlier on Slide 24
as an operating activity. The purchase of land
also is an investing activity.
Click the button to view Slide 24. To return to
this slide, type 47 and press the Enter key.
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The second transaction is the purchase of land
for cash of 15,000. This transaction is
reported as an outflow of cash in the cash flows
from investing activities section.
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Statement of Cash FlowsIndirect Method for
Rundell Inc. (Partial Statement)
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Statement of Cash FlowsIndirect Method for
Rundell Inc. (Partial Statement)
The ending balance in the Cash account should
match this amount.
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Alpha Corporation purchased land for 125,000.
Later in the year the company sold land with a
book value of 165,000 for 200,000. How are the
effects of these transactions are reported on the
statement of cash flows?
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For Practice PE 14-5A, PE 14-5B
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The Direct Method
The final amount for cash flows from operating
activities will be the same whether the direct or
indirect approach is used. The methods differ in
how the data are obtained, analyzed, and
reported.
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Statement of Cash FlowsDirect Method (Operating
Activities Section)
(Continued)
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Statement of Cash FlowsDirect Method
(Reconciliation)
A reconciliation is required when the direct
method is used.
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Financial Analysis and Interpretation
Free cash flow is a measure of operating cash
flow available for corporate purposes after
providing sufficient fixed asset additions to
maintain current productive capacity and
dividends.
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Free Cash Flow
Cash flow from operations Less Investments in
fixed assets to maintain current
production Free cash flow
Positive free cash flow is considered favorable.
A company that has free cash flow is able to fund
internal growth, retire debt, pay dividends, and
enjoy financial flexibility.
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Cash Flow Patterns and the Financial Health of a
Company
Operating Cash Flows are Positive Investing Cash
Flows are Negative Financing Cash Flows are
Positive
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Cash Flow Patterns and the Financial Health of a
Company
Operating Cash Flows are Negative Investing Cash
Flows are Positive Financing Cash Flows are
Positive
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Cash Flow Patterns and the Financial Health of a
Company
Operating Cash Flows are Positive Investing Cash
Flows are Positive or Negative Financing Cash
Flows are Negative
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Cash Flow Patterns and the Financial Health of a
Company
Operating Cash Flows are Positive or
Negative Investing Cash Flows are
Positive Financing Cash Flows are Negative