LO4.1.

4 STATEMENT OF CASH FLOWS

Learning Objectives

After reading this information sheet, you must be able to:

1. Discuss the components and structures of a Cash Flow Statement.
2. Prepare direct and indirect method of Cash Flow Statement.

A cash flow statement is a financial report that provides a summary of the cash inflows
and outflows for a company over a specific period. It highlights how a company generates
cash and where that cash is spent, offering valuable insights into the company's liquidity,
solvency, and overall financial health.

The cash flow statement is divided into three main sections:

1. Operating Activities
2. Investing Activities
3. Financing Activities

STRUCTURE OF THE CASH FLOW STATEMENT (CFS)

REDJ COMPANY
HEADING CASH FLOW STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2022

Cash flows from Operating Activities

OPERATING Receipts from Customers 1,000,000
ACTIVITIES Payments to Suppliers and Employees (700,000)
Net cash generated by Operating Activities 300,000
Cash flows from Investing Activities
INVESTING
ACTIVITIES Purchases of Property and Equipment (150,000)
Net cash used in Investing Activities (150,000)
Cash flows from Financing Activities
Long term loan from a bank 300,000
FINANCING
ACTIVITIES Additional investment from owner 100,000
Withdrawals by owner (80,000)
Net cash generated by Financing Activities 320,000
Net increase in cash and cash equivalents 470,000
Cash, January 1, 2022 100,000

Cash, December 31, 2022 570,000

Importance: The CFS shows the net change in the cash balance of a company for a period.
This helps owners to see, if their income is actually transformed to cash collections or if they
have enough cash coming in to pay any maturing liabilities.
Below are the three sections of the statement of cash flow, followed by a list of statement
of financial position accounts which affects it.

1. Operating activities
Operating activities are the base-line cash of activities of the entity related to its
normal operating cycle. Furthermore, such activities are related to the primary revenue-
producing activity or profit determination of the entity. IAS (IASB, 2001) lists the following
transactions as examples of operating activities.

ACTIVITIES EFFECTS
+ (increases cash) inflow
• (decreases cash)
outflow
Cash receipts from sale of goods and +
rendering of services
Cash receipts from royalties, fees, +
commission, and other revenues
Cash payments to suppliers of goods and -
services
Cash payments to employees -
Cash payments to income taxes -
Interest paid -
Interest received +
Dividends received +

Cash provided from or used by Operating Activities

a. Non-cash expenses are added back while non-cash revenues are deducted. Gain/loss
on sale of non-current assets are deducted/added back because the cash transaction is
recorded under investing activities.

b. Changes in current assets and current liabilities are either added or deducted
depending on whether they increased or decreased during the year.

Increase in current assets – deducted to net income

• Accounts Receivable – increases revenue which increases net income but is not a
cash transaction
• Prepaid Expense – decreases cash but does not change the net income
Decrease in current assets – added to net income
• Accounts Receivable – increases cash but does not change the net income
• Prepaid Expense – increases expenses which decreases net income but is not a
cash transaction

Increase in current liabilities – added to net income

• Accounts Payable – increases expenses which decreases net income but is not a
cash transaction
• Unearned Income – increases cash but does not change the net income

Decrease in current liabilities – deducted to net income

• Accounts Payable – decreases cash but does not change the net income
• Unearned Income – increases revenue which increases net income but is not a
cash transaction
Investing Activities

Investing activities generally result from acquisition and disposal of non-current

assets. IAS 7 (IASB 2001) lists the following activities as investing activities:

ACTIVITIES EFFECTS
+ (increases cash) inflow
• (decreases cash)
outflow
Cash payments to acquire property, plant and -
equipment
Cash payment to acquire intangible assets -
Cash receipts from sales of property, plant and +
equipment
Cash receipts from sales of intangible assets +
Cash receipts from sale of long-term assets +

Cash provided from or used by Investing Activities

• Long term Investment
• Land
• Buildings
• Furniture and Fixtures
• Vehicles

Financing Activities

Financing activities arise from changes in non-current liabilities and owner’s equity
of a business organization. IAS (IASB 2001) lists the following items as financing activities.

ACTIVITIES EFFECTS
+ (increases cash) inflow
• (decreases cash)
outflow
Cash investment from owners +
Cash proceeds from bank loans +
Cash distribution from owners -
Repayment of bank loans -

Cash provided from or used by Financing Activities

• Bond payables
• Deferred Income Tax
• Cash Investment by the owner
• Cash withdrawal by the owner
The cash flow from Investing and Financing Activities are the same whether Indirect
method or Direct method.

Preparation of a Cash Flow Statement

Step 1: Gather Financial Information

Collect the necessary financial data from the company’s financial records, including
the income statement, balance sheet, and previous cash flow statements.

Step 2: Analyze the Cash Transaction

Every cash transaction should be carefully analyzed to determine its nature, the
effect and the classification or section where it belongs.

Step 3: Calculate Cash Flows from Operating Activities

Operating activities are the base-line cash of activities of the entity related to its
normal operating cycle. Furthermore, such activities are related to the primary revenue-
producing activity or profit determination of the entity.

Approaches of the Statement of Cash Flows

According to IAS 7 (IASB 2001), entities are given an option to present the statement
of cash flow whether to use the direct or indirect method.

a. Direct Method
The direct method presents each major classification of gross receipts and gross
payments for operating activities. This is in line with the items presented in the table
below. IAS (IASB, 2001) encourages the use of the direct method.

REDJ Trading
Statement of Cash Flows
For the Period Ended December 31, 2022
Cash Flow from Operating Activities:
Cash receipts from rendering of services 200,000
Cash payment to suppliers of goods and services (50,000)
Net cash flow from Operating Activities 150,000

Sample of Statement of Cash Flows using Direct Method.

b. Indirect method
The indirect method however, presents the operating activities starting with the pre-
tax income. It then reconciles the pre-tax for non-cash income and expenditures. After
which, the movement in current assets and liabilities are adjusted to the resulting figure.
Below is an example of a statement of cash flows presented using the indirect method:

REDJ Trading
Statement of Cash Flows
For the Period Ended December 31, 2022
Cash Flow from Operating Activities:
Income before income tax 125,000
Adjustment for:
Depreciation 10,000
Amortization 20,000
Operating income before working capital changes 155,000
Increase in accounts receivable (10,000)
Decrease in inventories 15,000
Increase in accounts payable 5,000
Decrease in notes payable (15,000)
Net cash flow from Operating Activities 150,000
Sample of Statement of Cash Flows using Indirect Method.

For the purpose of this text, the direct method will be used; it is more preferred by IAS 7
(IASB 2001). Furthermore, beginners in preparing the statement of cash flow will appreciate
the said format.

Step 4: Calculate Cash Flows from Investing Activities

Include cash flows related to the purchase and sale of long-term assets and
investments.

Step 5: Calculate Cash Flows from Financing Activities

Include cash flows related to borrowing, repaying debt, issuing stock, and paying
dividends.

Step 6: Calculate Net Increase (Decrease) in Cash

Sum the net cash provided or used in operating, investing, and financing
activities.

Step 7: Determine Cash at Beginning and End of Period

Add the net increase (or subtract the net decrease) in cash to the cash balance at
the beginning of the period to find the cash balance at the end of the period.

The cash flow statement is a crucial financial document that offers insights into a company's
cash management and liquidity. By understanding and accurately preparing a cash flow
statement, businesses can better manage their cash resources, plan for future financial
needs, and communicate their financial health to stakeholders.