FINANCIAL ANALYSIS AND REPORTING

STATEMENT OF CASH FLOW &

U N I T 4
STATEMENT OF RETAINED EARNINGS

T h i s  unit focuse s o n t h e p r e pa r a t i o n a n d a n a l y s i s o f T O P I C S

th e Statement o f C a s h F l o w s a n d S t a t e m e n t o f
R e t a ined Earni n g s .
Cash Flow
4.1 Statement
It i n troduces th e p u r p o s e o f a C a s h F l o w S t a t e m e n t ,
th e two method s u s e d i n i t s p r e p a r a t i o n , w i t h
e m p hasis on th e i n d i r e c t m e t h o d , a n d i t s t h r e e ( 3 )
b a s i c categories s u c h a s c a s h f l o w s f r o m o p e r a t i n g , 4.2 Analyzing Cash Flow
in v e sting, and f i n a n c i n g a c t i vi t i e s .  

T h i s unit also c o v e r s t h e p r e se n t a t i o n a n d a n a l y s i s o f
th e Statement o f R e t a i n e d E a r n i n g s .   Statement of
4.3 Retained Earnings

E S S E N T I A L Q U E S T I O N S

• W h a t a r e t h e s p e c i f i c t r a n s a c t i o n s t h a t a f f e c t t h e c a t e g o r i e s o f C a sh F lo w suc h
as Operating, Investing, and Financing?

• H o w a r e t h e f o r e c a s t i n g t e c h n i q u e s u s e d i n i d e n t i f y i n g t h e f u t ur e c a sh i n f lo ws
and outflows, and ownership changes in the firm?

INTENDED LEARNING OUTCOME

E x p l ain the rele v a n c e o f c a s h f l o w s i n a n a l y z i n g b u s i n e s s activities.

D e s cribe the p r e p a r a t i o n a n d a n a l y s i s o f t h e s t a t e m e n t of cash flows and
s t a t ement of r e t a i n e d e a r n i n g s .
Id e n tify the ope r a t i n g , i n v e s ti n g , a n d f i n a n c i n g a c t i v i t i e s and
tr a n sactions tha t a f f e c t a f i r m’ s c a s h i n f l o w s a n d o u t f l o w s
P r o g nosticate a n d c o n s t r u c t c o m p a r a t i v e p r o j e c t e d / p r o forma cash flow
s t a t ement and s t a t e m e n t o f c h a n g e s i n e q u i t y

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4 . 1
CASH FLOW STATEMENT

THE STATEMENT OF CASH FLOWS

T h e statement o f c a s h f l o w s r e p o r t s c a s h r e c e i p t s a n d
c a s h payments b y o p e r a t i n g , f i n a n c i n g , a n d i n v e s t i n g
a c t i vities—the p r i m a r y b u s i ne s s a c t i v i t i e s o f a c o m p a n y .

DIRECT METHOD INDIRECT METHOD

The direct method, which presents a summary In indirect method, the items included in

of cash receipts and cash disbursements, each section are as follows:

using the difference to reconcile with the 1. Operating activities, including selling,

change in cash on the balance sheet. It purchasing, and producing goods;

tracks actual cash movements, so many non- providing services; and paying suppliers,

cash transactions are not recognized. employees, and lenders.

2. Investing activities, including collection of

Cash collected from customers
loans receivable; acquiring and selling
Interest and dividends received
securities; and acquiring and selling plant
Other operating receipts
assets.
Cash paid to employees and suppliers
3. Financing activities, including proceeds
Interest payments
from the issuance of the company’s bonds
Income tax payments
or stocks; outlays to retire bonds; and the

payment of dividends.

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T H E PURPOSE O F C A S H F L O W S T A T E M E N T
r e c o nciles the c h a n g e i n c a s h o n t h e b a l a n c e s h e e t a n d n et income reported
in t he income s t a t e m e n t .
it i s logically or g a n i z e d i n t h r e e s e c t i o n s ( o p e r a t i n g a c t i v ities, investing
a c t i vities, and f i n a n c i n g a c t i vi t i e s ) , w h i c h c o r r e s p o n d t o t he primary pursuits
n e c e ssary to g e n e r a t e p r o f i t s . P r o v i d e s i n f o r m a t i o n a b o ut cash flows to and
fr o m entities, s u c h a s c u s t o me r s , s u p p l i e r s , c r e d i t o r s , a n d investors, with
w h o m the firm c o n d u c t s b u s i n e s s .
a s s i sts analysts w i t h n u m e r ou s o t h e r t a s k s , s u c h a s u n c o vering accounting
d i s c retion, calc u l a t i n g f r e e c as h f l o w s a n d i d e n t i f y i n g o t her information
u n a vailable else w h e r e i n t h e f i n a n c i a l r e p o r t s .

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R e l e vance of C a s h

Photo by Kissclipart
A n o ld saying in f i n a n c e i s “ Ca s h i s k i n g . ”
C a s h flow, the l i f e b l o o d o f t he f i r m , i s t h e p r i m a r y i n g r e dient in
a n y financial va l u a t i o n m o d el . W h e t h e r a n a n a l y s t w a n t s
to p ut a value o n a n i n v e s t me n t t h a t a f i r m i s c o n s i d e r i n g or the
o b j e ctive is to v a l u e t h e f i r m i t s e l f , e s t i m a t i n g c a s h f l o w is
c e n t ral to the v a l u a t i o n p r o ce s s .

C a s h is t he most liq u i d o f a s s e t s an d o f f e r s a c o m p a n y b o t h
liqu idity and fl e x i b i l i t y . I t i s bo t h t h e b e g i n n i n g a n d t h e end of a
c o m pany’s oper a t i n g c y c l e . A c o m p a n y ’ s o p e r a t i n g a c t i v i t i es
in v o lve cash con v e r s i o n i n t o v a r i o u s a s s e t s ( s u c h a s i n v e n tories)
th a t are used to y i e l d r e c e i v ab l e s f r o m c r e d i t s a l e s . T h e
o p e rating cycle i s c o m p l e t e wh e n t h e c o l l e c t i o n p r o c e s s returns
c a s h to the comp a n y , e n a b l i ng a n e w o p e r a t i n g c y c l e t o b egin.

How much cash is generated from or used in operations?

What expenditures are made with cash from operations?
How are dividends paid when confronting an operating loss?
What is the source of cash for debt payments?
How is the increase in investments financed?
What is the source of cash for new plant assets?
Wh a t are som e e a r l y
Why is cash lower when income increased?
s i g n s of cash fl o w
What is the use of cash received from new financing?
p r o blems?
C a s h flow prob l e m s d o
n o t have to catc h y o u Wh a t are som e g o o d c a s h
o f f guard - ther e a r e flow habits?
e a r l y warning si g n s y o u B e c o ming bette r a t
p r e s erving cas h f l o w i s
c a n watch out f o r .
e n t i rely possibl e w i t h
S o m e of them i n c l u d e :
s t r o ng cash flow h a b i t s .
R e l y ing on big
F i r s t and foremo s t , m a k e
c u s t omers payi n g l a r g e
s u r e you’re runn i n g a
b i l l s to “get yo u
p r o f itable busin e s s -
th r o ugh” tough t i m e s .
m e a ning you mu s t s e l l
Y o u have too m a n y
m o r e than you s p e n d .
r e c e ivables an d y o u ’ r e W a tc h your deb t a n d c u t
n o t being paid s t e a d i l y . c o s t s wherever y o u c a n .
Y o u are not ge t t i n g Y o u should als o n e g o t i a t e
d i s c ounts when p a y i n g th e best terms p o s s i b l e
y o u r bills. w i t h your vend o r s ,
Y o u have a lot o f s h o r t - liqu idate obso l e t e a s s e t s ,
te r m debt. a n d build up y o u r r e s e r v e s
Y o u have too m u c h e n s u ring you d o n ’ t g e t i n t o
in v e ntory and s a l e s a r e a c a sh flow crun c h .
d o w n.

W h y is cash flow i m p o r t a n t f or m y b u s i n e s s ? T h e a n s w e r s to all of the other

q u e stions on t h i s l i s t h e l p a n s w e r t h i s o n e : c a s h f l o w p r ovides the money
n e c e ssary to p a y y o u r b i l l s , b u y s u p p l i e s , p a y y o u r e m p l o yees, and keep your
b u s iness opera t i n g .

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COVID, Inc.

Statement of Cash Flows

For the year ended December 31, 199X

Cash Flows from Operating Activities

Cash received from customers

Cash received as interest income *

Cash received as dividend income

Cash paid for cost of goods sold *

Cash paid for selling expenses

Cash paid for general & administrative expenses

Cash paid for interest (including interest on capital leases)

Cash paid for income taxes

Cash that would have been paid for taxes except for “excess tax deduction” related to stock based compensation

Net cash provided by (or used by) operating activities

Cash Flows from Investing Activities

Cash received from sale of property, plant, & equipment

Cash received from sale of investments

Cash received from repayment of note receivables

Cash paid to acquire property, plant, and equipment

Cash paid to acquire investments

Cash paid out as a loan

Net cash provided by (or used by) investing activities

Cash Flows from Financing Activities

Cash received as proceeds from issuance of debt

Cash received as proceeds from issuance of stock

Cash received as proceeds from reissuance of treasury stock

Cash paid to repay debt (principal payment)

Cash paid on principal related to capital leases

Cash paid to reacquire stock (purchase treasury stock)

Cash paid as dividends

Cash retained due to “excess tax deduction” related to stock options

Net cash provided by (or used by) financing activities

Net increase (decrease) in cash

Beginning cash and cash equivalents balance

=Ending cash and cash equivalents balance

Schedule of Noncash Investing and Financing Activities

Assets for Liabilities &/or Equity

Liabilities &/or Equity for Assets

Liabilities for Equity and Equity for Liabilities

Capital lease (acquisition of asset and obligation for lessee)

A reconciliation of net income to cash provided by operations

*Brackets indicate items that are normally combined

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4 . 2
ANALYZING CASH FLOW

3 C A TEGORIES O F C A S H F L O WS

1 . O p erating ac t i v i t i e s a r e the earning - r e l a t e d a c t i vi t i e s

o f a company. B e y o n d r e v e n u e a n d e x p e n s e a c t i v i t i e s r e p resented in an income
s t a t ement, the y i n c l u d e t h e n e t i n f l o w s a n d o u t f l o w s o f c ash resulting from
r e l a ted operat i n g a c t i v i t i e s l i k e e x t e n d i n g c r e d i t t o c u s t o mers, investing in
in v e ntories, and o b t a i n i n g c re d i t f r o m s u p p l i e r s . O p e r a t i n g activities relate to
in c o me stateme n t i t e m s ( w i t h m i n o r e x c e p t i o n s ) a n d t o b alance sheet items
r e l a ting to oper a t i o n s — u s u al l y w o r k i n g c a p i t a l a c c o u n t s like receivables,
in v e ntories, pre p a y m e n t s , p ay a b l e s , a n d a c c r u e d e x p e n s es.

2 . In v e sting acti v i t i e s a r e means of a c q u i r i n g a n d d i s p o s i n g o f n o n c a s h a s s e t s .

T h e se activities i n v o l v e a s s e ts e x p e c t e d t o g e n e r a t e i n c o m e for a company, such
a s p urchases a n d s a l e s o f P P E a n d i n v e s t m e n t i n s e c u r i t i e s. They also include
le n d ing funds a n d c o l l e c t i n g t h e p r i n c i p a l o n t h e s e l o a n s .

3 . F i n a ncing acti v i t i e s a r e means of c o n t r i b u t i n g , w i t h d r a w i n g , a n d s e r v i c i n g

fu n d s to suppo r t b u s i n e s s a c t i v i t i e s . T h e y i n c l u d e b o r r o w ing and repaying funds
w i t h bonds and o t h e r l o a n s . T h e y a l s o i n c l u d e c o n t r i b u t i o ns and withdrawals by
o w n ers and the i r r e t u r n ( d i v i d e n d s ) o n i n v e s t m e n t .

OPERATING ACTIVITIES INVESTING ACTIVITIES FINANCING ACTIVITIES

Cash Inflows Cash Outlflows Cash Inflows Cash Outflows Cash Inflows Cash Outflows

(a) Sales of goods (a) Purchases of (a) Issuing (selling) (a) Dividends of (a) Sale of property, (a) Acquisition of

and services for cash materials and more common or common or preferred plant, and equipment property, plant, and

and the collection of supplies preferred stock stock paid to owners (b) Sale of a portion equipment

accounts (b) Employee (b) Issuing bonds, (b) Principal of the business, such (b) Making loans to

receivable compensation notes, and mortgages payments on bonds, as a division another organization

(b) Interest and (c) Taxes notes, and mortgages (c) Sale of securities (c) Purchase of

dividends received on (d) Interest on (c) Buying of stock (investments) securities

investments borrowed money for treasury purposes (investments)

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INFLOWS (SOURCES) OUTFLOWS (USES)

Decrease in any asset Increase in any asset

Increase in any liability Decrease in any liability

Net profits after taxes Net loss

Depreciation and other Dividends paid

noncash charges
Repurchase or retirement of
Sale of stock stock

How do I do a cash flow forecast?

U n d erstanding y o u r f u t u r e c a s h f l o w i s c r i t i c a l t o a l l o w i n g a business to function
a n d flourish - p r e d i c t i n g i t s fu t u r e f i n a n c i a l n e e d s . T h e r e are five steps to
fo r e casting cash f l o w :

Understand where, when, and how the cash flows in and out of the business ensures thatthe
5- Analyze Information
company will have the capital it needs to function and grow.

Predict the amount that will be spent over the coming period, including capital
4 - Anticipate Expenses
investments, cost of doing the business, payroll, etc.

Determine what additional income you will have. This can include
3 - Anticipate Inflow of Cash
investment money, tax refunds, grants etc.

You can use the previous year’s sales, and look at 2 -Forecast Sales
trends to forecast your expected sales.

Includes price increase prediction, sales

estimates,sales cycles or seasonal changes. general 1 - Calculate Assumptions
cost increases, and payroll increases

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4 . 3
STATEMENT OF RETAINED EARNINGS

T h e statement o f r e t a i n e d e a r n i n g s i s a n a b b r e v i a t e d f o r m of the statement of

s t o c kholders’ eq u i t y . U n l i k e th e s t a t e m e n t o f s t o c k h o l d e rs’ equity, which shows
a l l equity accou n t t r a n s a c t i o ns t h a t o c c u r r e d d u r i n g a g i v en year, the statement
o f r etained earn i n g s r e c o n c i le s t h e n e t i n c o m e e a r n e d d u ring a given year, and
a n d cash divid e n d s p a i d , w i t h t h e c h a n g e i n r e t a i n e d e a r n ings between the start
a n d the end of t h a t y e a r .

Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings

T h e statement c o n s i s t s o f t h e
b e g inning bala n c e o f
r e t a ined earning s , t h e n e t
in c o me (loss), a n y d i v i d e n d s
p a i d out, and th e e n d i n g
b a l a nce of retai n e d e a r n i n g s.

R e t a ined earni n g s a r e t h e
a c c u mulated pr o f i t s t h a t
h a v e not been d i s t r i b u t e d
to t he shareho l d e r s t h r o u g h
p a y m ent of div i d e n d s . A
p o r t ion of the r e t a i n e d
e a r n ings can b e e a r m a r k e d
fo r purposes o t h e r t h a n
d i v i dend distrib u t i o n .

R e s t ricted earni n g s r e d u c e t he a m o u n t o f r e t a i n e d e a r n i n gs that are free and

a v a i lable for di v i d e n d s . W h e n t h e n e e d f o r t h e a p p r o p r i a tion passes, the amount
s e t aside is ret u r n e d t o t h e re g u l a r a c c o u n t , a g a i n a v a i l a ble for dividends.
A p p ropriations s h o u l d b e d i s c l o s e d c l e a r l y i n t h e e q u i t y section of the statement
a n d are often fo o t n o t e d t o pr o v i d e f u l l d i s c l o s u r e . A m o ng the type s o f r e s t r i c t e d
e a r n ings are a p p r o p r i a t i o n s f o r p l a n t e x p a n s i o n a n d c o n tingencies
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