ACTIVITY 43 UNDERSTANDING THE STATEMENT OF CASH FLOWS

Purpose: • Understand positive amounts indicate cash inflows and negative amounts
indicate cash outflows.
• Identify operating, investing, and financing activities.

The ongoing operation of any business depends on its ability to generate cash from operations. It is cash
that an organization needs to pay employees, suppliers, creditors, and investors … not profits. Therefore,
the real issue is cash. The statement of cash flows organizes cash inflows and cash outflows as operating
activities, investing activities, and financing activities because …

MANAGEMENT uses accounting information to make decisions regarding

Financing —> Investing —> Operating —>

FINANCING ACTIVITIES: Creditors lend and owners contribute $$$ to finance a company.

INVESTING ACTIVITIES: The $$$ obtained through financing is used to purchase revenue-
generating assets such as property, plant, and equipment (PPE) and
investment securities.

OPERATING ACTIVITIES: PPE and other revenue-producing assets are used to manufacture
goods, offer services, and generate dividends and interest, that in turn
result in $$$ profits.

FINANCING ACTIVITIES: $$$ profits are reinvested to internally finance the company.

INVESTING ACTIVITIES: $$$ obtained through financing are used to purchase revenue-
producing assets … and the cycle continues.

TRANSACTIONS REPORTED ON THE STATEMENT OF CASH FLOWS

OPERATING ACTIVITIES (Direct Method)
CASH INFLOWS CASH OUTFLOWS
Cash from customers Cash paid to suppliers
Cash from interest and dividends Cash paid to employees
Other operating cash receipts Interest paid
Other operating cash payments
INVESTING ACTIVITIES
CASH INFLOWS CASH OUTFLOWS
Sell property, plant, equipment Purchase property, plant, equipment
Sell investment securities Purchase securities
Receive loan repayments Make loans
FINANCING ACTIVITIES
CASH INFLOWS CASH OUTFLOWS
Borrow cash from creditors Repay amounts borrowed (debt principal)
Issue debt securities (bonds) Repurchase equity shares (treasury stock)
Issue equity securities (capital stock) Pay cash dividends

Q1 On the statement of cash flows, a positive amount indicates a cash ( inflow / outflow), whereas a
negative amount indicates a cash (inflow / outflow).
Q2 Identify the following transactions as Operating, Investing, or Financing activities.
(O / I / F) a. Receive cash from customers
(O / I / F) b. Purchase property, plant, and equipment
(O / I / F) c. Pay employee wages
(O / I / F) d. Issue common stock
(O / I / F) e. Pay suppliers
(O / I / F) f. Pay back long-term debt

Q3 Refer to the cash flow information displayed below to answer the following questions.

Southwest Airlines STATEMENT OF CASH FLOWS ($ in millions)

2011 2010 2009
Net cash from operating activities $ 1,385 $ 1,561 $ 985
Net cash from investing activities (1,051) (1,265) (1,569)
Net cash from financing activities (766) (149) 330

a. For Southwest Airlines, the primary source of cash is ( operating / investing / financing)
activities, which is considered (favorable / unfavorable / depends).

For an established company, the expected primary source of cash is ( operating / investing /
financing) activities. Southwest Airlines is a(n) (young / established) company.

b. The purchase and sale of long-term assets are reported as (operating / investing /
financing) activities, which for this company is a cash (inflow / outflow). This company is
(purchasing / selling) long-term assets, which is considered ( favorable / unfavorable /
depends).

c. Borrowing funds, issuing stock, and paying dividends are reported as

(operating / investing / financing) activities.

During 2009, borrowing and repaying debt are the primary financing activities. During 2009,
financing activities report a net cash (inflow / outflow), indicating this company
(borrowed / paid off) more long-term debt.

During 2011, issuing and repurchasing common stock are the primary financing activities.
During 2011, financing activities report a net cash (inflow / outflow), indicating this
company (issued / repurchased) more common stock.

d. For operating activities, a net cash (inflow / outflow / depends) is preferred. Why? Because
It helps to show that company is getting money, has positive cash flow to be able operate
operating expenses.

For investing activities, a net cash (inflow / outflow / depends) is preferred. Why?Because
it indicates that company is investing. For example: purchasing a robot for housekeeping
service so that purchasing is investment and cash going out from our balance (outflow).
Purchasing PPE and other income-producing assets indicates the organization is
growing and expanding.
For financing activities, a net cash (inflow / outflow / depends) is preferred. Why? Because its
mean actions that finance company. For example: paying lease, repaying equity. It’s
about investing in company so that is why we indicate outflow in the statement.
ACTIVITY 44 OPERATING ACTIVITIES
Purpose: • Understand operating activities on the statement of cash flows.

OPERATING ACTIVITIES (Direct Method)

CASH INFLOWS CASH OUTFLOWS
Cash from customers Cash paid to suppliers
Cash from interest and dividends Cash paid to employees
Other operating cash receipts Interest paid
Other operating cash payments

Q1 Operating activities include cash transactions that primarily affect ( current asset / long-term
asset/ current liability / long-term liability / stockholders’ equity) accounts. (Circle all that apply)

Q2 Identify transactions recorded in the operating section of the statement of cash flows.
(Operating / Not) a. Receive cash from customers paying on account.
(Operating / Not) b. Pay rent for the next accounting period.
(Operating / Not) c. Receive the utility bill for this accounting period that will be paid next
accounting period. (Not paid this accounting period)
(Operating / Not) d. Extend $100,000 of credit to Supplier Barry for a purchase. (Non-cash)
(Operating / Not) e. Receive interest payment of $8,000 from Supplier Barry.
(Operating / Not) f. Supplier Barry pays off the $100,000. (Financing)

The operating activity section on the face of the statement of cash flows can be reported using the direct
or the indirect method. The direct method reports sources and uses of cash during the accounting period.
The indirect method reconciles accrual-based “Net Income” to cash-based “Net Cash from Operating
Activities.”

Southwest Airlines (LUV)

STATEMENT OF CASH FLOWS—Operating Activities
($ in millions) 2011 2010 2009
Net income (loss) $ 178 $ 459 $ 99
Depreciation expense 715 628 616
(Increase) decrease in accounts receivable (26) (26) 40
(Increase) decrease in other current assets 65 49 85
Increase (decrease)in payables 253 193 59
Other operating changes, net 200 258 86
Net cash from operating activities (NCOA) $ 1,385 $ 1,561 $ 985

Refer to the information immediately above to answer the following questions.

Q3 Cash flows from operating activities is reported using the (direct / indirect) method.

Q4 The strongest year for LUV was (2011/ 2010 / 2009). Why? Because in 2010, LUV generated
highest net cash from operating activities (NCOA) among that consecutive 3 years.
Q5 The weakest year for LUV was (2011/ 2010 / 2009). Why? Because this year, LUV generated lowest
net cash.