1.Purpose of the Statement of Cash Flows

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Power Notes
Chapter 15
Statement of Cash Flows
Learning Objectives

• 1. Purpose of the Statement of Cash Flows
• 2. Reporting Cash Flows
• 3. Statement of Cash Flows The Indirect Method
• 4. Statement of Cash Flows The Direct Method
• 5. Financial Analysis and Interpretation

C15
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Transparency Master 15-1
WRITING EXERCISE Review the following financial
data from two companies in the same industry.
Comment on any strengths or weaknesses you
notice.   Income statements Company
A Company B   Sales 500,000
500,000 Expenses 425,000 425,000 Net
income 75,000 75,000   Cash
held Beginning of year 25,000
25,000 End of year 25,000
25,000 Increase in cash 0 0   A
detailed analysis of the cash account reveals the
following cash receipts and payments   Cash
received from customers 450,000 350,000
from sale of fixed assets 5,000
60,000 Total cash received 455,000
410,000 Cash paid to suppliers 380,000
400,000 for purchase of fixed
assets 70,000 10,000 for purchase of
investments 5,000 0 Total cash
paid 455,000 410,000 Increase in
cash 0 0
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Transparency Master 15-2
WHY ARE CASH FLOWSIMPORTANT? Cash is what pays
the bills.   You must sell your product and
collect cash from your customers in time
to   1. Pay suppliers for merchandise
purchases.   2. Pay the bank on any
loans.   3. Pay employees their wages.   4. Pay
taxes.   5. Purchase new equipment as
needed.   Analyzing where a companys cash is
coming from and where it is being spent may
assist in detecting future profit potential
and/or future financial problems.  
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Reporting Cash Flows
The statement of cash flows reports a firms
major cash inflows and outflows for a period.
Cash flows are reported by three types of
activities.

• 1. Operating activities transactions that
  affect net income.
• 2. Investing activities transactions that
  affect noncurrent assets.
• 3. Financing activities transactions that
  affect equity and debt of the entity.

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Transparency Master 15-3
SSECTIONS OF THE STATEMENT OF CASH FLOWS
Cash Flows from Operating ActivitiesReport cash
received and paid in the daily operations of the
business, including 1. Cash received from
customers 2. Cash paid to suppliers Cash
Flows from Investing ActivitiesReport cash
received and paid as a result of the sale and
purchase of investments. The investments reported
in this section can be divided into two
categories 1. Investments in YOURSELF, for
example a. Purchase of fixed assets b.
Sale of fixed assets (Continued)
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SECTIONS OF THE STATEMENT OF CASH FLOWS

• Investments in OTHERS, for example
• Purchase of equity or debt securities of another
  corporation
• Sale of equity or debt securities held as
  investments
• Making of a loan to another company
• Collection of principal payments on a loan made
  to another company

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Transparency Master 15-4 SECTIONS OF THE
STATEMENT OF CASH FLOWS
(Concluded) Cash Flows from Financing
ActivitiesReport cash received and paid as a
result of the activities to obtain and repay
funds used to finance the operations of a
company. Financing activities can be divided into
two categories   1. EQUITY financing a. Issui
ng shares of stock b. Retiring shares of
stock c. Purchasing shares of treasury
stock d. Selling shares of treasury
stock e. Paying cash dividends on
stock 2. DEBT financing a. Borrowing
cash b. Repaying principal on a loan  
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Transparency Master 15-5 STATEMENT OF CASH FLOWS
Schedule of Noncash Investing andFinancing
Activities Used to report transactions that are
investing and/or financing activities but do not
bring in or use up any cash. These transactions
need to be reported because they will affect cash
flows in the future. Examples include the
following   1. Purchasing fixed assets by
signing a note payable   2. Purchasing a
building through a mortgage loan   3. Exchanging
stock for fixed assets   4. Issuing stock to
retire debt   5. Converting preferred stock to
common stock  
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Transparency Master 15-6 STATEMENT OF CASH FLOWS
Three "Foolers" The following transactions are
reported in the operating activities section of
the statement of cash flows   1. Interest paid
on debt   Justification The decision to
finance the business through debt is a financing
activity. Once that decision has been made, the
cash to pay for the interest on debt must come
from operating activities.   2. Interest
received on investments   3. Dividends received
on investments   Justification The decision to
use cash to purchase equity or debt securities is
an investment decision. Once that decision has
been made, the cash received from interest or
dividends is used to operate the business.  
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Transparency Master 15-7 CASH FLOWS FROM
OPERATING ACTIVITIESINDIRECT METHOD
(Also Known as the "Reconciliation
Method") Net income (from income
statement) XXX Noncash expenses
(depreciation, amortization, and
depletion) XXX / Losses or gains on
investing or financing activities XXX /
Changes in current asset and current
liability accounts related to operating
activities XXX Net cash flows from
operating activities XXX  
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Statement of Cash Flows
The statement of cash flows is invaluable in
assessing the capacity of a firm to achieve goals
such as

• 1. Generate cash flow from operations.
• 2. Maintain and expand operating capacity.
• 3. Pay dividends.
• 4. Pay debts, including interest, when due.
• 5. Generate future profits.
• The primary attention is the flow of cash rather
  than net income.

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Financial Analysis and Interpretation
Free Cash Flow
Cash flow from operations 1,400,000 Less Cash
invested in fixed assets to maintain
capacity (450,000) Less Cash used for
dividends (100,000) Free cash flow 850,000
Use To measure operating cash flow available for
corporate purposes after providing sufficient
fixed asset additions to maintain current
productive capacity and dividends.