Importance

Importance

Generally Accepted Accounting Principles (GAAP)

call for three principal financial statements from
all firms.

These are
$ Balance Sheet
$ Income Statement or P & L Account
$ Statement of Cash Flows
 Importance
Importance

The Statement of Cash Flows

- translates earnings in the Income Statement

into cash inflows.
 Importance
Importance

The Statement of Cash Flows

- translates earnings in the Income Statement

into cash inflows.

- shows how good is the firm in realizing

adequate cash from its main operating
business.
 Importance
Importance
The Statement of Cash Flows

- translates earnings in the Income Statement

into cash inflows.
- shows how good is the firm in realizing
adequate cash from its main operating
business.
- reveals if firm needs to look outside for other
sources of finance.
 Importance
Importance
In the Statement of Cash Flows

- definition of cash includes both

cash ( currency and bank account
balances).
AND
- cash equivalents.
 Importance
Importance
In the Statement of Cash Flows
- definition of cash includes both
cash AND
- cash equivalents. Which are

$ Short term highly liquid instruments maturing in not

more than 90 days.
$ Treasury Bills ( T-Bills)
$ Short Term Certificates of Deposits (CDs)
$ Commercial Paper (CPs)
 Categories
Categories

The Statement of Cash Flows reports cash flows, in

the following categories :

- Operating activities: transactions that affect

the net income
 Categories
Categories

The Statement of Cash Flows reports cash flows, in

the following categories :
$ Operating Activities.

Investing Activities : Transactions which

affect investments in fixed assets like
property, plant etc.
 Categories
Categories

The Statement of Cash Flows reports cash flows, in

the following categories :
$ Operating Activities.
$ Investing Activities.

Financing Activities : Transactions which

affect equity and debt of the business.
 Categories
Categories

The Statement of Cash Flows reports cash flows, in

the following three categories :

$ Operating Activities.
$ Investing Activities.
$ Financing Activities.
 Uses
Uses
The Statement of Cash Flows is used by investors
and creditors to :

$ Evaluate management’s abilities to manage

cash now and in the future.
 Uses
Uses
The Statement of Cash Flows is used by investors
and creditors to :

$ Evaluate management’s abilities to manage

cash now and in the future.
$ Assess the company’s ability to pay dividends
and to pay creditors.
 Uses
Uses
The Statement of Cash Flows is used by investors
and creditors to :

$ Evaluate management’s abilities to manage

cash now and in the future.
$ Assess the company’s ability to pay dividends
and to pay creditors.
$ Convert actual net income reported on income
statement to a cash basis figure.
 Methods
Methods

The Statement of Cash Flows is prepared by using

$ Direct Method.

$ Indirect Method.
 Methods
Methods

The Statement of Cash Flows is prepared by using

$ Direct Method.

$ Indirect Method.
The vast majority of publicly traded firms
use indirect method .
 Methods
Methods

The Statement of Cash Flows is prepared by using

$ Direct Method.
$ Indirect Method.

” The only difference between the two

methods is, how cash flows from
operating activities are calculated.”
 Methods
Methods

The Statement of Cash Flows is prepared by using

$ Direct Method.
$ Indirect Method.
” The only difference between the two methods is, how cash flows
from operating activities are calculated.”

“Cash flows from investing and

financing activities are
calculated identically in both methods.”
 Methods
Methods

The Statement of Cash Flows is prepared by using

$ Direct Method.
$ Indirect Method.
” The only difference between the two methods is, how cash flows
from operating activities are calculated.”
“Cash flows from investing and financing activities are calculated
identically in both methods.”

The net cash inflow from operating activities is the same

whether statement prepared by direct or indirect method.
 Methods
Methods

Direct Method.

Converts each item on the income

statement to a cash flow
i.e. sales are converted to
cash receipts from
sales etc.
 Methods
Methods

Indirect Method.
Step # 01

Begin with Net Income as reported on the income

statement.
 Methods
Methods

Indirect Method.
$ Begin with Net Income as reported on the income
statement.
Step # 02

Add back Depreciation, Depletion and Amortization.

( as these are non cash expenses added back to income )
 Methods
Methods
Indirect Method.
$ Begin with Net Income as reported on the income
statement.
$ Add back Depreciation, Depletion and
Amortization.

Step # 03
Subtract gain on disposal of fixed assets.
( These are reported in investing section of the statement)
 Methods
Methods
Indirect Method.

$ Begin with Net Income as reported on the income statement.

$ Add back Depreciation, Depletion and Amortization.
$ Subtract gain on disposal of fixed assets.
Step # 04

Add back Loss on Disposal of Fixed Assets.

( These are reported in investing section of the statement)
 Methods
Methods
Indirect Method.

$ Begin with Net Income as reported on the income statement.

$ Add back Depreciation, Depletion and Amortization.
$ Subtract gain on disposal of fixed assets.
$ Add back Loss on disposal of fixed assets.
Step # 05
Adjust for changes in current asset and current
liability.
 Methods
Methods
Indirect Method.
Step # 05
Adjust for changes in current asset and current
liability as under :

1. An increase in current assets is deducted from net

income.
2. An increase in current liabilities is added to net income.
3. A decrease in current assets is added to net income.
4. A decrease in current liabilities is deducted from net
income.
 Methods
Methods
Indirect Method.

$ Begin with Net Income as reported on the income statement.

$ Add back Depreciation, Depletion and Amortization.
$ Subtract gain on disposal of fixed assets.
$ Add back Loss on disposal of fixed assets.
$ Adjust for changes in current asset and current liability.
Last Step !
Arrive at Net Cash Inflow ( or Outflow) from Operating
Activities.
 Methods
Methods

It is important to observe that the cash flow

compares Balance Sheets as on two dates and
determines the cash flow.

It is, therefore , more convenient to plot the Balance

Sheets on two dates in a vertical form.
Profit & Loss Account of a firm may show robust
topline and bottomline,

It is the Cash Flow Statement that reveals

liquidity so necessary for survival and
growth of an organization!