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Lecture 4: Statement of Cash Flows

Accounting for Business Decisions B (University of Technology Sydney)

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LEC 4: Statement of Cash Flows

• Describe the purpose and format of the statement of cash flows.

- The statement of cash flows reports the impact of a firm’s operating, investing and financing
activities on cash flows during the accounting period. Some would say that the statement of
cash flows is the most important of the four required financial statements.

Statement of cash flows:

- An important resource of any company is cash. If a company cannot generate sufficient cash,
its ability to continue operations is very limited.

- It is a financial statement that summarises a company’s inflows and outflows of cash over a
period of time.

- It informs users how and why a company’s cash changed during the period.

- Groups and reports cash flows in three major categories: operating, investing and financing.

The purpose of the statement of cash flows:

- provides information about cash inflows and cash outflows during a period

- provides information about cash changes between two balance sheet dates

- discloses items that affect the balance sheet but don’t show up in the income statement eg.
buying land (cash outflow)

The basic structure of the statement:

Cash flows provided (used) by operating activities

+/- Cash flows provided (used) buy investing activities

+/- Cash flows provided (used) by financing activities

Net increase (decrease) in cash

+ Cash, beginning of year

Cash, end of year

Disclosures for non-cash investing and financing activities:

Even though such transactions do not involve cash, they are important to help properly
understanding a company’s cash flows. Therefore, they must be disclosed either on the face of
the statement or in the notes to the financial statements.

• Preparing the statement.

The income statement, statement of changes in equity and balance sheet re prepared with
numbers from an adjusted trial balance. however the statement of cash flows is prepared with
information collected from a variety of sources, including the examination of the changes in all no-
cash accounts.

Preparing the statement of cash flows:

In order to explain a company’s change in cash, you just explain the changes in the company’s
non-cash accounts. To do that, you need the following items:

- a comparative statement of financial position (balance sheet)

- a statement of comprehensive income (income statement)

- additional information on changes in account balances

The Cash Change Equation*** how different accounts affect cash

Change in Cash Assets = Change in Liabilities + Change in Equity - Change in Non-Cash Assets

Direct and Indirect Method


The manner in which cash flows from investing and financing activities are reported is the same
for all companies. however, companies can report their cash flows from operating activities using
one of two methods:
- direct method (encouraged): under the direct method, a company calculates the reports its
cash inflows from operations followed by its cash outflows or disbursements for operations

- indirect method: under the indirect method, a company reports its cash flows from operating
activities by adjusting its profit or loss from an actual basis to a cash basis

Both the indirect and direct methods will yield the same net cash flows from operating activities.
When using the direct method, a reconciliation of cash flows from operating to profits is required.

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LEC 4: Statement of Cash Flows

• Direct Method.
The direct method is use by most reporting entities in Australia. Entities using this method need to
also prepare a reconciliation of cash flows from operations to profit or losses.

Reporting cash flows from operating activities: direct method

- when reporting operating cash flows under the direct method, companies calculate and report
cash receipts from operating activities.

- cash receipts are calculated by converting revenues from the income statement to cash
collections

- cash payments are calculated by converting expenses from the income statement to cash
payments

Other revenues and expenses in the operating activities section:

- Two additional items, depreciation expense and gain/loss on sale of equipment, are common in
the statement of cash flows.

- These items are ignored under the direct method, because depreciation expense is a non-cash
expense.

- However, depreciation expense is one of the reasons cash flow from operations and profits
differ. Therefore it will be shows in the reconciliation.

- A fain on the sale of equipment occurs when cash received from the sale exceeds the
equipment’s carrying amount.

- Sale of equipment is an investing activity, all cash received from the sale will be reported as a
cash inflow from investing activities.

- The gain or loss on the sale is not included in the operating activities section under the direct
method, but is included in the reconciliation.

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