THE STATEMENT OF

CASH FLOWS

1
 THE PURPOSE OF THE
STATEMENT OF CASH FLOWS
• The statement of cash flows (SCF)
explains how a company’s cash is
generated during a period and how
that cash is used

2
INFORMATION REPORTED
ON THE SCF
• The SCF explains the changes in
cash and cash equivalents during
a period
– Cash equivalents are short-term,
highly liquid investments such as
treasury bills, commercial paper, and
money market funds

3
 THREE CATEGORIES OF
CASH FLOWS
• Cash receipts and disbursements
are classified into three main
categories:
– Operating activities
– Investing activities
– Financing activities

4
 OPERATING ACTIVITIES
CATEGORY
• Includes all transactions relating to
a company delivering or producing
its goods for sale and providing its
services

5
 MAJOR CASH FLOWS FROM
OPERATING ACTIVITIES
Cash receipts Cash payments for:
from: – Inventory purchases
– Sale of goods or – Wages and salaries
services – Taxes
– Sale of trading – Interest expense
securities
– Other expenses (e.g.,
– Interest revenue utilities, rent)
– Dividend revenue – Purchase of trading
securities 6
 INVESTING ACTIVITIES
CATEGORY
• Includes cash inflows and outflows
from changes in noncurrent assets

7
 MAJOR CASH FLOWS FROM
INVESTING ACTIVITIES
Cash receipts from: Cash payments for:
– Sale of plant assets – Purchase plant assets
– Sale of a business – Purchase of
segment nontrading securities
– Sale of nontrading – Making loans to other
securities entities
– Collection of
principal on loans

8
 FINANCING ACTIVITIES
CATEGORY
• Includes obtaining resources from
owners and providing them a
return on their investment
• Includes obtaining resources from
creditors and repaying those
borrowings

9
 MAJOR CASH FLOWS FROM
FINANCING ACTIVITIES
Cash receipts from: Cash payments for:
– Issuance of stock – Cash dividends
– Borrowing (e.g., – Repayment of loans
bonds, notes, – Repurchase of
mortgages) stock (treasury
stock)

10
 HOW THE SCF RELATES
TO THE BALANCE SHEET
AND INCOME STATEMENT
Balance Sheet Statement of
Cash Flows
Current Assets Operating
Investing
Long-term Assets Financing
Net Change in Cash
Current Liabilities Accrual
Adjustments
Income
Long-term Liabilities Statement
Revenue
Stockholders’ Equity
Expenses
Net Income 11
 CASH FLOW PATTERN
• The normal pattern of cash inflows
(positive) or cash outflows
(negative) is as follows:
– Cash from operating activities +
– Cash from investing activities -
– Cash from financing activities + or -

12
NONCASH INVESTING AND
FINANCING ACTIVITIES
• These activities affect a company’s
financial position but do not result
in cash flows
• Example: Land acquired by
issuing stock
• These activities should be
disclosed separately in a schedule
or in the notes to the financial
statements 13
PREPARING A STATEMENT
OF CASH FLOWS
A SIMPLE EXAMPLE: Starting with
the following balance sheet dated
January 1, 2002, for Simaril Inc.

14
(in millions of dollars) LIABILITIES
ACCOUNT ASSETS AND EQUITY

Cash $ 300
Accounts receivable 2,500
Inventory 1,900
Property, plant and equipment 4,000
Accumulated depreciation (1,200)
Long-term receivable 0
Goodwill 0
Accounts payable $1,700
Current portion of long-term debt 0
Taxes payable 40
Unearned revenue 0
Other current liabilities 0
Long-term debt 2,200
Other long-term liabilities 0
Common stock 1,000
Retained earnings 2,560

TOTALS $7,500 $7,500

 SIMARIL Sales
Balance Sheet
December 31, 2002

ASSETS LIABILITIES
Cash 1,430 Accounts payable $1,500
Accounts receivable 2,000 Interest Payable 20
Inventory 1,800 Taxes payable 50
PP&E 4,500
Accumulated depreciation (900) Long-term debt 2,000

STOCKHOLDERS’ EQUITY
Common stock 1,450
______ Retained earnings 3,810

TOTAL $8,830 TOTAL $8,830

SIMARIL Sales
Income Statement
For the Year Ended December 31, 2004

Sales $13,500
Gain on Sale of Equipment 100
Expenses:
Cost of goods sold $8,000
Miscellaneous Expense 3,200
Depreciation & amortization 500
Interest expense 200
Restructuring charge 0 11,900

Income before taxes $1,700

Income Tax Expense 450

Net Income $1,250

 PREPARING A STATEMENT
OF CASH FLOWS
A summary of the cash
transactions is presented below:
Trans Cash Flow Relating to Type of Amount of Amount of
# Activity Cash Inflow Cash Outflow
2 Collections on account Operating $14,000
5 Paid for inventory Operating $8,100
6 Paid for PP&E Investing 1,700
7 Sold PP&E Investing 500
8 Repaid long-term debt Financing 200
9 Issued stock Financing 450
11 Paid interest on debt Operating 180
13 Paid miscellaneous operating Operating 3,200
and administrative expenses
15 Paid income taxes Operating 440
PREPARING A STATEMENT
OF CASH FLOWS
Grouping these items by
operating, investing, and financing
activities helps prepare the
statement of cash flows ...

18
 SIMARIL Sales
Statement of Cash Flows
For the Year Ended December 31, 2002

Transaction
Number
CASH FLOWS FROM OPERATING ACTIVITIES:
Collections on account 2 $14,000
Payments for Inventory 5 (8,100)
Payment for Misc operating and admin expenses 13 (3,200)
Payment for interest 11 (180)
Payment for income taxes 15 (440)
Net cash provided by operating activities 2,080

CASH FLOWS FROM INVESTING ACTIVITIES:

Sold PP&E 7 500
Purchased PP&E 6 (1,700)
Net cash used by investing activities (1,200)

CASH FLOWS FROM FINANCING ACTIVITIES:

Issued stock 9 450
Repaid long-term debt 8 (200)
Net cash used by financing activities 250

Net increase in cash $ 1,130

Beginning cash balance 300
Ending cash balance $ 1,430
PREPARING A STATEMENT
OF CASH FLOWS
AN ALTERNATE APPROACH:
ANALYZING THE OTHER
PRIMARY FINANCIAL
STATEMENTS
20
PREPARING A STATEMENT
OF CASH FLOWS
• Cash inflows and outflows can be
determined by analyzing changes
in the individual accounts in the
income statement and balance
sheet during an accounting period

21
 A SIX-STEP PROCESS TO
PREPARING THE SCF
1 Compute how much the cash
balance changed during the year
2 Convert the income statement
from an accrual-basis to a cash-
basis summary of operations
a Add noncash expenses (e.g., deprec.)
b Eliminate gains and losses from
investing and financing activities
c Adjust for changes in the balances of
current assets and current liabilities
 A SIX-STEP PROCESS TO
PREPARING THE SCF
3 Analyze the long-term assets to
identify the cash flow effects of
investing activities
4 Analyze the long-term debt and
stockholders’ equity to identify the
cash flow effects of financing
activities

23
 A SIX-STEP PROCESS TO
PREPARING THE SCF
5 Prepare the formal SCF by
classifying all cash inflows and
outflows according to operating,
investing, and financing activities
6 Disclose any significant noncash
investing and financing activities

24
 INDIRECT METHOD
Net income (loss)
+ Depreciation and other noncash expenses
+ Changes in balance sheet accounts
involving operating activities (generally
current assets and current liabilities other
than cash and cash equivalents)
+ Other accounting items
= Net cash provided (used) by operating
activities
25
 INDIRECT METHOD FOR
SIMARIL INC
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,250
Add depreciation and amortization expense $500
Subtract Gain on Sale of PP&E (100)
Decrease in accounts receivable 500
Decrease in inventory 100
Decrease in accounts payable (200)
Increase in interest payable 20
Increase in taxes payable 10

830

Net cash provided by operating activities $ 2,080

26
 INDIRECT METHOD FOR
SIMARIL INC
For an excel worksheet showing how to calculate the indirect method:

http://my.fit.edu/~bpierce/bus_5430/Module6_ppt_indirectmethod.xls

27
 SOME RULES OF THUMB
FOR THE INDIRECT METHOD

DIRECTION OF NECESSARY
ACCOUNT CHANGE ADJUSTMENT
Current asset Increase Subtract the increase
Current asset Decrease Add the decrease
Current liability Increase Add the increase
Current liability Decrease Subtract the decrease

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 DIRECT METHOD
Cash received from operating
activities (generally from sales of
goods and services)
- Cash paid for operating activities
- Taxes and interest paid (required to
be separately disclosed)
= Net cash provided (used) by
operating activities
29
 DIRECT METHOD FOR
SIMARIL INC
CASH FLOWS FROM OPERATING ACTIVITIES:

Collections from customers $14,000

Payments for inventory (8,100)
Payments for misc operating and admin expenses (3,200)
Payment for interest (180)
Payment for income taxes (440)

Net cash provided by operating activities $2,080

30
 PREPARING THE FORMAL
STATEMENT OF CASH FLOWS
SIMARIL INC’s statement of cash
flows is presented next using the
indirect method ...

31
 SIMARIL INC
Statement of Cash Flows
For the Year Ended December 31, 2002

CASH FLOWS FROM OPERATING ACTIVITIES:

Net Income $ 1,250
Add depreciation and amortization expense $500
Subtract Gain on Sale of PP&E (100)
Decrease in accounts receivable 500
Decrease in inventory 100
Decrease in accounts payable (200)
Increase in interest payable 20
Increase in taxes payable 10

830

Net cash provided by operating activities $ 2,080

CASH FLOWS FROM INVESTING ACTIVITIES:

Sold PP&E 7 500
Purchased PP&E 6 (1,700)
Net cash used by investing activities (1,200)

CASH FLOWS FROM FINANCING ACTIVITIES:

Issued stock 9 450
Repaid long-term debt 8 (200)
Net cash used by financing activities 250

Net increase in cash $ 1,130

Beginning cash balance 300
Ending cash balance $ 1,430