Statement of Cash Flows Explained

Statement of Cash
Flows
C15 - 1
Reporting Cash Flows
The statement of cash flows reports a firm’s 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.
C15 - 2
Cash Flows
Increases in Cash Decreases in Cash
Cash
C15 - 3
Cash Flows
Operating
(receipts from
revenues)
Cash
C15 - 4
Cash Flows
Operating Operating
(receipts from (payments for
revenues) expenses)
Cash
C15 - 5
Cash Flows
Operating Operating
revenues) expenses)
Investing
Cash
(receipts from sales of
noncurrent assets)
C15 - 6
Cash Flows
Operating Operating
revenues) expenses)
Investing
Cash Investing
(receipts from sales of (payments for aquiring
noncurrent assets) noncurrent assets)
C15 - 7
Cash Flows
Operating Operating
revenues) expenses)
Investing
Cash Investing
Financing
(receipts from issuing
equity and debt securities)
C15 - 8
Cash Flows
Operating Operating
revenues) expenses)
Investing
Cash Investing
Financing Financing
(receipts from issuing (payments for dividends, and
equity and debt securities) redemption of debt securities)
C15 - 9
Cash Flows – Operating Activities
Typical cash inflows Typical cash outflows
What are some

of the typical
cash inflows
from operating
activities?
C15 - 10
Sales of goods
and services What are some
of the typical
Interest Revenue cash outflows
from operating
Dividend Revenue activities?
C15 - 11
Sales of goods Merchandise

and services purchases
Interest Revenue Payments of

wages & other
Dividend Revenue expenses
Tax payments
C15 - 12
Cash Flows – Investing Activities
What are some

of the typical
cash inflows
from investing
activities?
C15 - 13
Sales of fixed assets

and other long-term What are some
investments
of the typical
cash outflows
Sale of marketable
from investing
securities and
activities?
investments
C15 - 14
Sales of fixed assets Purchase of fixed

and other long-term assets and other long-
investments term investments
Sale of marketable Purchase of

securities and marketable securities
investments and investments
C15 - 15
Cash Flows – Financing Activities
What are some

of the typical
cash inflows
from financing
activities?
C15 - 16
Sales (issuance)
of stock What are some
of the typical
Sale (issuance) of
cash outflows
bonds and other
money market debt from financing
activities?
Borrowing from banks
and other lending
institutions
C15 - 17
Sales (issuance) Purchase of

of stock treasury stock
Sale (issuance) of Repayment and

bonds and other redemption of debt
money market debt (bonds, notes, other)
Borrowing from banks Payment of cash

and other lending dividends
institutions
C15 - 18
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.
C15 - 19
Preparing the Statement of Cash Flows
Direct Method
Net cash flows from operating activities will be
the difference between the operating cash
receipts and operating cash payments.
Indirect Method
Net cash flows from operating activities is
determined by adjusting the accrual net income
from operations to reflect a cash-based net income
from operations.
C15 - 20
Advantages of Using the Direct Method
1. Reports the sources and uses of operating

cash receipts and payments.
2. Is easier to understand for many investors.
3. Recommended by the Financial Accounting
Standards Board (FASB).
Note: The total amount of net cash flow from
operating activities will be the same for both
direct and indirect methods.
Investing and Financing activities sections will
be identical for both methods.
C15 - 21
Advantages of Using the Indirect Method
1. Focuses on the differences between net

income and net cash flow from operations.
2. Reveals the relationship between the income
statement, the balance sheet, and the
statement of cash flows.
3. Less costly to prepare.
4. Must be prepared as a supplemental report
even if the direct method is used.
5. 98 percent of companies surveyed use the
indirect method.
C15 - 22
NetSolutions
Statement of Cash Flows – Direct Method
For the Month Ended November 30, 2015
Cash flows from operating activities:

Cash received from customers $ 7,500
Deduct cash payments for expenses
and payment to creditors 4,600
Net cash flow from operating activities $ 2,900
Cash flows from investing activities:
Cash payments for acquiring land (10,000)
Cash flows from financing activities:
Cash received as owner’s investment $15,000
Deduct cash withdrawal by owner 2,000
Net cash flow from financing activities 13,000
Net cash flow and ending cash balance $ 5,900
C15 - 23
NetSolutions
Statement of Cash Flows – Indirect Method

Net income, per income statement $ 3,050
Add increase in accounts payable 400
Deduct increase in supplies (550)
Cash flows from investing activities:
Cash payments for acquiring of land (10,000)
Cash flows from financing activities:
Cash received as owner’s investment $15,000
Deduct cash withdrawal by owner 2,000
Net cash flow from financing activities 13,000
Net cash flow and ending cash balance $ 5,900
C15 - 24
NetSolutions
NetSolutions
C15 - 25
NetSolutions
NetSolutions
C15 - 26
Cash Relationships and Cash Flows
Balance Sheet
Cash
Liabilities
Noncash
Assets Stockholders’
Equity
Assets = Liabilities + Stockholders’ Equity

Cash + Noncash Assets = Liabilities + Stockholders’ Equity
Cash = Liabilities + Stockholders’ Equity – Noncash Assets
C15 - 27
Balance Sheet
Cash
Liabilities
Noncash
Assets Stockholders’
Equity

C15 - 28
Balance Sheet
Cash
1 Liabilities
Noncash
3 Assets Stockholders’
2 Equity

1 2 3
The cash flows are determined by analyzing
liabilities, stockholders’ equity, and noncash assets.
C15 - 29
Changes in Current Accounts
Change
Accounts 2014 2015 Debit Credit
Trade receivables (net) $74,000 $65,000 9,000
Inventories 172,000 180,000 8,000
Accounts payable (mdse.) 43,500 46,700 3,200
Accrued expenses payable 26,500 24,300 2,200
Income taxes payable 7,900 8,400 500
Determine the debit or credit change of each item above.
C15 - 30
Change
Inventories 172,000 180,000 8,000
These debit changes are subtracted from net income in the

operating activities section of the statement of cash flows.
Think of these debits as deductions from net income in arriving
at net cash flow from operations.
C15 - 31
Change
Inventories 172,000 180,000 8,000
These credit changes are added to net income in the operating

activities section of the statement of cash flows.
Think of these credits as additions to net income in arriving at
net cash flow from operations.
C15 - 32
Operating Activities – Indirect Method
Net income, per income statement $108,000
Add: Depreciation $ 7,000
Decrease in inventories 8,000
Increase in accrued expenses 2,200 17,200
$125,200
Increase in accounts receivables
Deduct: $ 9,000
Decrease in accounts payable 3,200
Decrease in income taxes payable 500
Gain on sale of land 12,000 24,700
Net cash flow from operating activities $100,500
Start with the accrual basis net income

shown on the income statement.
C15 - 33
$125,200
Deduct: Increase in accounts receivables $ 9,000
Because depreciation expense reduced net income but did not

require an outflow of cash, it is added back to net income.
C15 - 34
$125,200
These represent credit changes in the current accounts. Think

of these credits as additional income from a cash perspective.
Why do these represent an increased cash flow?
C15 - 35
$125,200
These represent debit changes in the current accounts. Think

of these debits as additional expense from a cash perspective.
Why do these represent a reduced cash flow?
C15 - 36
$125,200
This gain was included in net income but did not represent an
operating cash flow. The related cash inflow from the sale is
reported in the cash flows from investing activities section.
C15 - 37
Change
Inventories 172,000 180,000 8,000
These changes in current accounts were used to prepare

the statement of cash flows with the indirect method.
They will also be used for the direct method that follows.
C15 - 38
Rundell Inc.
Income Statement
For the Year Ended December 31, 2014 Cash Basis
Sales $1,180,000
Cost of merchandise sold 790,000
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000
Other operating expenses 196,000
Total operating expenses 203,000
Income from operations $ 187,000
Other income:
Gain on sale of land $12,000
Other expense:
Interest expense 8,000 4,000
Income before income tax $ 191,000
Income taxaccrual basis income statement.83,000
This is an
Net
Theincome
direct method of reporting cash flows$ 108,000
will
essentially convert this to a cash basis statement.
C15 - 39
Rundell Inc.
Income Statement
Sales $960,000
Gross profit Cash collected $380,000
from customers Changes
Operating expenses:
Debit Credit
Sales 960,000
Receivables
Note:
Total operating All income9,000
expenses statement account
278,000
Cash
balances are zero at the
Income from operations beginning
$102,000
Other income: of a period. Therefore, the balance
shown represents
Gain on sale of investments the amount of
$30,000
Other expense: change during the period.
Income before income tax $118,000
Income tax 27,500
Net income $ 90,500
C15 - 40
Rundell Inc.
Income Statement
Sales $1,180,000
Operating expenses:
Debit Credit
Sales 1,180,000
Receivables
Total operating expenses 9,000 203,000
Income from Note: Cash
The
operationschanges1,171,000
in the current balance sheet
$187,000
Other income: accounts are determined by comparing the
beginning
Gain on sale of land and ending balances. Receivables
$12,000
Other expense:increased by $9,000 during the period.
Income tax 83,000
Net income $ 108,000
C15 - 41
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Debit Credit
Sales 1,180,000
Receivables
Total operating expenses 9,000 203,000
Cash
Income from operations 1,171,000 $187,000
Other income:
The increase $12,000
Gain on sale of land in receivables
Other expense: represents a reduction in cash inflow
Interest expense relative to the accrual
8,000 revenue
4,000
Income before income reported
tax on the income statement.
$ 191,000
Income tax 83,000
C15 - 42
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Gross profit $390,000
Cash payments for
Operating expenses: Changes
merchandise
Depreciation expense $ Debit
7,000 Credit
Other operating
Cost ofexpenses
mdse. sold 196,000
790,000
Inventories 8,000
Income from operations $187,000
Accounts payable 3,200
Other income:
Cash
Gain on sale of land $12,000
Other expense:
Income tax 83,000
C15 - 43
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 785,200
Cash payments for
merchandise
Debit Credit
Other operating
Cost ofexpenses
mdse. sold 196,000
790,000
Inventories 8,000
Other income:
Cash
Gain on sale of land $12,000 785,200
Other expense:
Income tax 83,000
C15 - 44
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 785,200
Cash payments for
merchandise
Debit Credit
Other operating
Cost ofexpenses
mdse. sold 196,000
790,000
Inventories 8,000
Other income:
Cash
Gain on sale of land $12,000 785,200
Other expense: A decrease in inventories (credit
Interest expense change) and an 8,000 4,000
decrease in accounts
Income before income tax
payable $ 191,000
(debit change) have the
Income tax opposite effects. 83,000
C15 - 45
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Operating expenses:
Depreciation
Total operating expenses Changes
203,000
Income from operations Debit $187,000
Credit
Other income:Depr. expense 7,000
Accum.
Gain on sale depreciation
of land $12,000 7,000
Other expense:
Income tax 83,000
C15 - 46
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Depreciation expense $ 7,000 0
Depreciation
Total operating expenses Changes
203,000
Income from operations Debit$187,000
Credit
Other income:Depr. expense 7,000
Accum.
Gain on sale depreciation
of land $12,000 7,000
Other expense: There is no cash flow for
Interest expense 8,000
depreciation 4,000
expense.
Income tax 83,000
C15 - 47
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Cash payments for Changes
operating expenses Changes
Other income: Debit Credit
Gain onOperating expenses $12,000
sale of land 196,000
Other expense:
Accrued expenses 2,200
Interest Cash
expense 8,000 4,000
Income tax 83,000
C15 - 48
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Other operating expenses 196,000 (193,800)
Cash payments for Changes
operating expenses Changes
Other income: Debit Credit
Gain onOperating expenses $12,000
sale of land 196,000
Other expense:
Accrued expenses 2,200
Interest Cash
expense 8,000 193,8004,000
Income tax 83,000
C15 - 49
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Gain on sale of Changes
Operating expenses:
investments Debit Credit
Cash
196,000 (193,800)
TotalInvestments
operating expenses 60,000
203,000
Income fromGain on sale of invest.
operations 12,000
$187,000
Other income:
Gain on sale of land $12,000 0
Other expense:
Income tax 83,000
C15 - 50
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
investments
Depreciation expense $ Debit
7,000 Credit 0
Cash
196,000 (193,800)
TotalInvestments
203,000
operations 12,000
$187,000
Other income:
Other expense: Why isn’t the cash inflow
of $72,0004,000
shown here?
Income tax 83,000
C15 - 51
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
investments Debit Credit
Cash
Other operating expenses 196,00072,000 (193,800)
TotalInvestments
203,000
operations 12,000
$187,000
Other income:
Other expense: The cash inflow of $72,000
Interest expense will be shown8,000in the 4,000
Income before income tax
investing section of $the
191,000
Income tax statement of cash flows. 83,000
C15 - 52
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Cash paid
Total operating for
expenses 203,000
Changes
interest expense
Income from operations Debit $187,000
Credit
Other income:
Gain onCash
sale of land $12,000 0
Other expense:
Income tax 83,000
C15 - 53
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Cash paid
Total operating for
expenses 203,000
Changes
interest expense
Income from operations 187,000
Debit Credit
Other income:
Gain onCash
sale of land $12,000 8,000 0
Other expense:
Interest expense 8,000 4,000 (8,000)
Income before income tax is no interest$payable
There 191,000
Income tax account at the end of the 83,000
year.
C15 - 54
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Cash paid for
Income from operations Changes
$187,000
Other income:income taxes Debit Credit
Gain onIncome
sale of tax
landexpense $12,000
83,000
Other expense:
Income tax payable 500
Interest Cash
expense 8,000 4,000 (8,000)
Income tax 83,000
C15 - 55
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Cash paid for
Income from operations Changes
$187,000
Other income:income taxes Debit Credit
Gain onIncome
sale of tax
landexpense $12,000
83,000
Other expense:
Income tax payable 500
Interest Cash
expense 8,000 83,500
4,000 (8,000)
Income tax 83,000 (83,500)
C15 - 56
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Income from operations $ 187,000
Other income:
Other expense:
Income tax 83,000 (83,500)
Net income $ 108,000 $ 100,500
C15 - 57
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Income from operations Two different views
$ 187,000
Other income: of income from
Gain on sale of land $12,000 operations 0
Other expense:
Income tax 83,000 (83,500)
Net income $ 108,000 $ 100,500
C15 - 58
Rundell Inc.
Income Statement
Sales $1,180,000 $1,171,000
Operating expenses:
Income from operations Two different views
$ 187,000
Other income: of income from
Gain on sale of land $12,000 operations 0
Other expense:
Income before income tax Accrual
$ 191,000 Cash
Income tax Basis
83,000 Basis
(83,500)
Net income $ $108,000
108,000 $$100,500
100,500
C15 - 59
Operating Activities – Direct Method
Cash inflows:
Cash received from customers $1,171,000
Cash outflows:
Cash payments for merchandise $785,200
Cash payments for operating expenses 193,800
Cash payments for interest 8,000
Cash payments for income tax 83,500 1,070,500
C15 - 60
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.
C15 - 61

Statement of Cash Flows Explained

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Statement of Cash Flows Explained

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Statement of Cash

The statement of cash flows reports a firm’s major

What are some

Sales of goods Merchandise

Interest Revenue Payments of

What are some

Sales of fixed assets

Sales of fixed assets Purchase of fixed

Sale of marketable Purchase of

What are some

Sales (issuance) Purchase of

Sale (issuance) of Repayment and

Borrowing from banks Payment of cash

The statement of cash flows is invaluable in

1. Reports the sources and uses of operating

1. Focuses on the differences between net

Cash flows from operating activities:

Cash flows from operating activities:

Assets = Liabilities + Stockholders’ Equity

Assets = Liabilities + Stockholders’ Equity

Assets = Liabilities + Stockholders’ Equity

Determine the debit or credit change of each item above.

These debit changes are subtracted from net income in the

These credit changes are added to net income in the operating

Start with the accrual basis net income

Because depreciation expense reduced net income but did not

These represent credit changes in the current accounts. Think

These represent debit changes in the current accounts. Think

These changes in current accounts were used to prepare

Free Cash Flow

Cash flow from operations $1,400,000

Use: To measure operating cash flow available

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