Cash Flow Statement

Importance of Cash Flow

A company needs
both net income and
strong cash flow to
succeed

Cash Flow Statement

Shows cash receipts and payments during a

period
Purposes:
Predicts future cash flows
Evaluates management decisions
Determines ability to pay dividends and interest
Shows relationship of net income to cash flows

Structure of Cash Flows Illustrated

Format of the Cash Flow Statement

Cash Flow Categories

Operating activities
Related to the transactions that result in net income
Most important as they reflect core of the business

Investing activities
Related to long-term assets
How a company uses its resources in the long-term

Financing activities
Related to long-term debt and equity
How a company obtains resources

Preparing the Cash Flow Statement

Determining net cash flow from

operating activities
Direct method
Indirect method

Direct method
Cash received from customers

Preparing the Cash Flow Statement,

continued

Indirect method
Non-cash items
Net operating items
Changes in working capital items

From Accrual to Cash

Item

O I or F

+ or -

a.

Net Income

b.

Cash dividend

c.

Sale of LT investment

d.

Loss on sale of equip.

e.

Amortization

f.

Issuance of LTNP

g.

Depreciation expense

h.

Issuance of stock

E12-15

Item

O I or F

+ or -

O
NIF

Payment of long-term
debt
m. Purchase building

n.

Accrual of salary expense

o.

Purchase of long-term
investment

j.
k.

Increase in accts pay

Purchase of equipment with
note payable

l.

Item

O I or F

+ or -

p.

Decrease in inventory

q.

Increase in prepaid
expenses

r.

Sale of land

s.

Decrease in accrued
liabilities

Income Statement

The
Indirect
Method
Revenues
$ 100,000
Cost of Goods Sold
Gross Profit
Operating expenses:
Salaries expense
Depreciation expense
Other expenses
Total operating expenses
Other income:
Gain on sale of plant assets
Net Income

40,000
60,000
20,000
10,000
5,000
35,000
3,000
$ 38,000

Add back to net

income
Subtract from
net income
Use as first line
in operating
section

Comparative Balance Sheets

December 31, 2009 and 2008
12-31-09
Cash
$ 20,000
Accounts Receivable
25,000
Inventory
42,000
Long-term assets
150,000
Total assets
$ 237,000
Accounts payable
15,000
Salaries payable
10,000
Long-term liabilities
98,000
Stockholders' equity
114,000
Total liabilities & equity
$ 237,000

12-31-08 Change
$ 18,000
30,000
(5,000)
30,000
12,000
162,000
$ 240,000
18,000
(3,000)
6,000
4,000
105,000
111,000
$ 240,000

Added to
net income
Subtracted
from net
income
Subtracted
from net
income
Added to
net income

Preparing the Cash Flow Statement,

continued

Investing activities
Purchase and sale of fixed assets
Purchase and sale of investments
Interest and dividend received
IFRS/Ind AS/AS

Non-cash investing

10

Investing Activities

Affect long-term assets:

Plant assets
Investments
Notes receivable

Purchases = outflows
Sales = inflows

Loans made = outflows

Collections = inflows

Computing Purchases and Sales of Plant Assets

Plant assets, net, beginning balance

From Balance
Sheet

+ Acquisitions
- Depreciation

From Income
Statement

- Book value of assets sold

= Plant assets, net, ending balance

From Balance
Sheet

Proceeds from Sales of Plant Assets

Compare book value of assets sold to gain or
loss
Gain or loss located on income statement
Book value + Gain on sale

Book value Loss on sale

Cash
Proceeds

Computing Purchases and Sales of Investments

Investments, beginning balance
+

Purchases

Cost of investments sold

Investments, ending balance

To compute cash proceeds of investments sold:

Cost + Gain on sale
Cost Loss on sale

Cash
Proceeds

Computing Loans Made and Collections on Notes

Notes receivable, beginning balance
+

Loans made

Collections

Notes receivable, ending balance

Financing Activities

Affect long-term liabilities & equity:

Long-term Debt
Notes payable
Bonds payable

Payments = outflows
Borrowings = inflows

Common stock and Paid-in Capital

Retained earnings
Cash dividends = outflows

Issuance of new shares =

inflows

Computing Issuance and Payments of Long-Term Debt

Long-term debt, beginning balance
+

Issuance of new debt

Payments of debt

Long-term debt, ending balance

Computing Issuance of Stock and Purchases of Stock

Common stock, beginning balance
+ Issuance of new stock

Inflow of cash

= Common stock, ending balance

Treasury stock, beginning balance

+ Purchase of treasury stock
= Treasury stock, ending balance

Outflow of cash

Computing Dividend Payments

Retained earnings, beginning balance
+ Net Income
-

From income statement

Dividends declared

= Retained earnings, ending balance

Noncash Investing and Financing

Activities
Transactions that involve long-term assets,
long-term debt and/or equity
But do not increase or decrease cash

Examples:
Purchasing plant assets by signing a note payable
Issuing stock for land
Stock dividends

Preparing the Cash Flow Statement,

continued

Financing activities
Issuance and buy-back of share capital
Dividends
IFRS/Ind AS/AS

Raising and repayment of borrowings

Interest paid
Non-cash financing

Reporting Cash Flows

Operating activities
Direct method
Indirect method
Investing activities
Financing activities

Interpreting the Cash Flow Statement

Increase (decrease) in cash despite net

loss (net profit)
Paying for acquisitions and capital
expenditure
Utilizing the proceeds of a share issue

Free Cash Flow

What is free cash flow?

Positive and negative cash flow
Interpreting free cash flow
Use of free cash flow in enterprise

Free Cash Flow

Free cash flow is the difference between net cash

flows from operating and investing activities.
Positive free cash flow means that net cash
generated from operating activities is more than
what the company can invest in new assets.
(stable firms)
Negative free cash flow implies that the firm is
investing more cash in new assets than the cash it
generates from operations (growing firms)