Statement of Cash Flows

• Links Balance Sheet and Income Statement

elements to change in cash position.
• Integral part of “holy trinity” of financial
statements … shows the ability of the firm to
generate cash (given normal assumptions like
continuity, stability etc.)
• “Undoes” some accrual accounting adjustments
underlying the income statement.
• Presents cash flows logically organized by source
or type of activity generating the cash flows.
403MSBASOCF.ppt 1
 Statement of Cash Flows
• Two ways to prepare:
– Direct method: Start with cash collected from
customers and cash paid for operating
activities. Also shows reconciliation of net
income to change in cash position as well.
– Indirect method: Start with net income, add
back non-cash expenses, adjust changes in
assets and liabilities and end with net increase
or decrease in cash.
403MSBASOCF.ppt 2
 Statement of Cash Flows
Exhibit 5-4 of Brownlee et. al. lays out the
differences in the two methods clearly. Main
things to note are:
• Depreciation and other “non-cash charges” and
adjustments for changes in assets and liabilities
appear only in the indirect method SCF.
• Both statements are similar beyond the
derivation of CFOPS.

403MSBASOCF.ppt 3
 Statement of Cash Flows
• In the US SCF has 3 sections:
– Cash flow from operations
• Cash generated by selling goods & services
– Cash flow from investing activities
• Cash used/generated by changes in long-term assets
– Cash flow from financing activities
• Cash used/generated by changes in equity & debt.

403MSBASOCF.ppt 4
 Statement of Cash Flows
• Direct method requires more
information/computation.
• E.g to compute cash collected from customers
Cash collected =
Credit Sales +/- Decrease/Increase in Accounts
Receivable
If cash and credit sales are/can not be separately
identified in the problem, then replace “Credit
Sales” in the equation with “Sales”.

403MSBASOCF.ppt 5
 Statement of Cash Flows
• To compute cash paid to suppliers,
Cash paid =
Purchases +/- Decrease/Increase in Accounts
Payable
If Purchases are/can not be separately identified
in the problem, then need to compute purchases
as: Ending Inventory + Cost of Goods Sold –
Beginning Inventory.

403MSBASOCF.ppt 6
 Statement of Cash Flows
• To compute cash paid to suppliers,
Cash paid =
Purchases +/- Decrease/Increase in Accounts
Payable
If Purchases are/can not be separately identified
in the problem, then need to compute purchases
as: Ending Inventory + Cost of Goods Sold –
Beginning Inventory.

403MSBASOCF.ppt 7
 Statement of Cash Flows
• Non-cash items (depreciation, amortization) are
expenses that do not have to be “paid” to outside
entities. Hence they are not a use of cash in the direct
method. In the indirect method, depreciation has
already been subtracted to compute net income, so we
must add it back to compute cash from operations.
Hence non-cash items are informally called “sources”
of cash. This does not mean more deprecitation
expense increases the cash balance.

403MSBASOCF.ppt 8
 Statement of Cash Flows
• In general, increases in assets is a use of cash –
increases in current assets represent a use of
cash in operations. Decreases in current assets
are sources of cash from operations.
• In general increases in liabilities is a source of
cash – increases in current liabilities represent a
source of cash from operations. Decreases in
current liabilities are uses of cash from
operations.
403MSBASOCF.ppt 9