COMR 457

Chapter Five
Reporting and interpreting the Statement of Cash Flows
To many this is the most important financial statement!

Companies and investors need to pay special attention to, and closely
analyze, the Statement of Cash Flows. The Statement of Cash Flows
assists users in assessing the extent to which operations are generating
sufficient cash flow from the business. Has the company been
reinvesting adequate cash resources to provide for future expansion of
the business? Has the company been supporting business growth
through debt or equity? Is the company generating positive cash flow?
The answers to these questions will enable analysts and investors to
assess the extent, timing and risk associated with future cash flows.
There are three main components of a Statement of Cash Flows -
operating, investing and financing activities.

For COMR457 you will only be responsible for the indirect method.
Please work through the examples on pages 5-12 to 5-23 in the
textbook to acquaint yourself with this method. The direct method,
while not examinable, is discussed on pages 5-24 to 5-254 for those
wishing further information.

Cash flows from Operating Activities

1. The measurement of cash flow from operating activities can be

determined by either the direct method (reports the gross receipts and
gross payments) or the indirect method (starts with net income and
eliminates non-cash transaction that impact net income).
2. It is important to recognize that cash flow from operations is the
same regardless of which method is used. The indirect method is
generally the more widely used.

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 COMR 457
Cash flows from Investing Activities

1. Measures cash flow from transactions that relate to the purchase and
disposal of long-term productive assets and investments in the
securities of other companies
2. Outflows reflect cash expended to acquire the assets and inflows
result from cash received from the disposal of long-term assets
3. The difference between these cash inflows and outflows is referred to
as net cash flow from investing activities

Cash flows from Financing Activities

1. Represents the cash inflows and outflows from external sources

(owners and creditors) to finance the enterprise and its operations –
issuance of shares and bonds payable for cash.
2. Outflows reflect cash used to repay creditors or repurchase shares
from owners.
3. The difference between these cash inflows and outflows is referred to
as net cash flow from financing activities

Net Increase (Decrease) in Cash

1. Reconciliation of the net change in cash (equivalents) is presented in

the following format:

+/- Net cash from operations

+/- Net cash from investing activities
+/- Net cash from financing activities
= Net increase (decrease) in cash and cash equivalents
+/- Net cash and cash equivalents at beginning of the period
= Net cash and cash equivalents at the end of the period

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 COMR 457
Cash equivalents are amounts that are almost like cash – i.e., short-term
deposits cashable within 90 days.

You will find the use of T accounts very helpful in analyzing the changes
in the non-current Balance Sheet accounts. While current accounts
can be determined by simply determining the net change in each
account, you must analyze the noncurrent accounts completely as
they may contain both sources and uses of cash.

Relationships to the Balance Sheet and Income Statement

1. Preparation of the Statement of Cash Flow requires analysis of the
comparative Balance Sheets, an Income Statement for the period
and other information.
2. Accrual based accounting entries need to be examined for their cash
components.
3. The focus is on account balance changes on the Balance Sheet.
4. General rules for the Statement of Cash Flows:
Transactions that result in an increase in assets will result in a
decrease in cash flow
Transactions that result in a decrease in assets will result in an
increase in cash flow
Transactions that result in an increase in liabilities will result in
an increase in cash flow
Transactions that result in a decrease in liabilities will result in a
decrease in cash flow

Many will find this topic of cash flows confusing. Practicing questions is
the most efficient way of learning this material. Please attempt and
review the practice questions posted on canvas.

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 COMR 457
OVERVIEW - CASH FLOWS FROM OPERATING ACTIVITIES – INDIRECT METHOD

1. Since Net Income is computed using the accrual method, net income
will include cash and non-cash items.
2. Adjust net income for non-cash transactions (amortization,
depreciation, gains/losses on disposals of long-term investments)
3. Adjust net income for changes in current assets and current liabilities
(non-cash working capital) that relate to operations. Cash increases
when a current asset decreases or a current liability increases. Cash
decreases when a current asset increases or a current liability
decreases. Refer to Exhibit 5.7 for a summary of the impact of
changes in current assets and liabilities.
4. The format for cash flow from operations should appear as follows:
• Net Income
+/- non-cash income/expense items (from the income statement)
+/- changes in non-cash working capital accounts relating to
operating activities (from the balance sheet)
= cash flow from (to) operating activities

INTERPRETING CASH FLOW FROM OPERATIONS

1. This section focuses of cash flow from operations is to provide

feedback on the entity’s ability to generate cash flow from internal
sources through operations and management of working capital.
2. The statement should assist users in assessing the company’s ability
to meeting ongoing funding requirements, pay cash dividends and
contribute to long-term funding.
3. Special attention should be noted for entities that report growing
earnings and declining cash flow from operations. Determine the
reasons - Is it seasonality? Is it reflective of red flags related to asset
management etc.?

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 COMR 457
CALCULATING CASH FLOWS FROM INVESTING ACTIVITIES

1. This section focuses on analyzing the changes in account balances in

the short-term investments and long-term asset sections of the
Balance Sheet.
2. Transactions that increase the account balances are reflective of cash
outflows and reductions of the account balances are reflective of cash
inflows.
3. Decreases in cash flows are the result of acquisitions of short-term
investments and long-term assets for cash (acquisitions of shares in
other companies, additions to long-lived assets, acquisitions of
intangibles etc.).
4. Increases in cash flows are generally proceeds received on the
dispositions of short-term investments and long-term assets.
5. Depreciation and gains and losses although directly related to
underlying investing activities are part of cash flow from operations
due to their inclusion in the determination of net income.

INTERPRETING CASH FLOWS FROM INVESTING ACTIVITIES

1. Is the company reinvesting in new productive assets?

2. Will the company be able to undertake and fund future expansion
requirements?

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 COMR 457
CALCULATING CASH FLOWS FROM FINANCING ACTIVITIES

1. This section focuses on activities that involve the generation of

funding from creditors and investors and the eventual payments to
these stakeholders
2. It includes related current liabilities (notes payable and current
portion of long-term debt), long-term liabilities and shareholders’
equity accounts.
3. Increases to notes and long-term debt and issues of equity increases
cash flow.
4. Principal repayments, repurchases of equity and the payment of cash
dividends reduce cash flow.

NON-CASH INVESTING AND FINANCING ACTIVITY

Although transactions not involving cash are not recognized on the

Statement of Cash Flow (e.g., the issue of shares in exchange for the
acquisition of an asset) they are noted in supplemental disclosures.

In order to understand the Statement of Cash Flows you have to

understand the entries involved in all of the financial statements – that
is why we have left it for the last of the statements. In my experience,
most clients struggle to understand this statement.

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