Statement of Cash Flows

The Statement of Cash Flows

One of the three main financial statements
under US GAAP.
The SCF must be presented by all businesses
whenever the company presents a balance
sheet and income statement.
 
The primary purpose is to provide information
regarding the receipts and uses of cash.
Classification of Activities
1)    Operating activities,
2)    Investing activities, and
3)    Financing activities.
 
1) Operating Activities
Any item that is not classified as either an investing or
financing activity is an operating activity.
• Interest paid on bonds and other debt (loans,
leases, mortgages, etc.).
• Interest received and dividends received from
debt and equity investments.
• Cash flows from the purchase, sale and maturity of
trading securities.
• Cash paid to the government for taxes and cash
received back from the government as a tax refund.
2) Investing Activities
Activities the company undertakes to generate a
future profit, or return.
• Purchasing and selling fixed assets.
• Making and collecting loans to other parties.
• Acquiring and disposing of stock of other
companies.
• Acquiring and disposing of debt instruments.
• Acquiring and disposing of available-for-sale
or held-to-maturity securities.
3) Financing Activities
Activities that a company undertakes to raise
capital to finance the business.
• Issuance of stock.
• Treasury stock transactions.
• Paying dividends.
• Issuing debt (bonds).
• Repayment of debt obligations.
• Obtaining and repaying a loan.
Present Each Side of
Transactions
Each activity in investing and financing
activities has two sides.
The rule is to present cash inflows and
cash outflows separately from each
other for a particular activity.
Noncash Investing and Financing
Either investing or financing in nature, but did
not involve cash in the transaction.
• Converting debt to equity.
• Buying or selling fixed assets for something
other than cash.
• Obtaining a building or other item by gift .
• Buying fixed asset by obtaining a loan.
These are presented separately in a schedule
at the end of the SCF.
Cash Equivalents on the SCF
Cash equivalents are considered to be cash
and are therefore treated as cash in the
SCF.
IFRS Notes for Cash Flows
The main difference between US GAAP and IFRS in
respect to the Statement of Cash Flows has to do
with the classification of activities.
1. Interest and dividends received can be classified
as either an operating or investing activity.
2. Interest and dividends paid can be classified as
either an operating or financing activity.
3. Noncash investing and financing activities are
disclosed in the Notes to the financial statements,
and not on the Statement of Cash Flows.
Preparing the Statement of
Cash Flows
Preparing the SCF
We know the final answer before we begin
to prepare it.
There are two acceptable methods in US
GAAP for the preparation and presentation
of the statement of cash flows – the direct
method and the indirect method.
Cash flows from operating activities
…… $X
Net cash flows from operating activities $X
Cash flows from investing activities
…… $X
Net cash flows from investing activities $X
Cash flows from financing activities
…… $X
Net cash flows from financing activities $X
Net increase in cash and cash equivalents $X

Cash and cash equivalents at beginning of year $X

Cash and cash equivalents at end of year $X

Schedule of noncash investing and financing activities.

Overview of the Two Methods
The direct method makes adjustments to each
individual line to take out the effect of noncash
and non-operating activity transactions.

The indirect method makes all of the

adjustments to net income from the income
statement.
 Revenue
- COGS
- Salary expense The starting point for the
- Rent expense Operating Activities section is
- Depreciation expense the income statement.
+ Gain on sale of FA
= Net income
 Revenue +/- adjustment Cash from customers
- COGS +/- adjustment Cash paid to suppliers
- Salary expense +/- adjustment Cash paid to employees
- Rent expense +/- adjustment Cash paid for rent
- Depreciation expense +/- adjustment -------------------
+ Gain on sale of FA +/- adjustment -------------------
= Net income = Cash from Operating Activities

The Direct Method adjusts

each individual line of the
income statement.
 Revenue
- COGS
- Salary expense
- Rent expense
- Depreciation expense
+ Gain on sale of FA
= Net income
+/- adjustment
+/- adjustment The Indirect Method makes
+/- adjustment adjustments to net income.
+/- adjustment
+/- adjustment
+/- adjustment
= Cash from Operating Activities
 Revenue +/- adjustment Cash from customers
- COGS +/- adjustment Cash paid to suppliers
- Salary expense +/- adjustment Cash paid to employees
- Rent expense +/- adjustment Cash paid for rent
- Depreciation expense +/- adjustment -------------------
+ Gain on sale of FA +/- adjustment -------------------
= Net income = Cash from Operating Activities
+/- adjustment
+/- adjustment
+/- adjustment Cash From Operating Activities is
+/- adjustment the same under both methods.
+/- adjustment
+/- adjustment
= Cash from Operating Activities
 Revenue +/- adjustment Cash from customers
- COGS +/- adjustment Cash paid to suppliers
- Salary expense +/- adjustment Cash paid to employees
- Rent expense +/- adjustment Cash paid for rent
- Depreciation expense +/- adjustment -------------------
+ Gain on sale of FA +/- adjustment -------------------
= Net income = Cash from Operating Activities
+/- adjustment
+/- adjustment
+/- adjustment The adjustments are the same
+/- adjustment under both methods.
+/- adjustment
+/- adjustment
= Cash from Operating Activities
Cash flows from operating activities
…… $X
Net cash flows from operating activities $X
Cash flows from investing activities
…… $X
Net cash flows from investing activities $X
Cash flows from financing activities
…… $X
Net cash flows from financing activities $X
Net increase in cash and cash equivalents $X

Cash and cash equivalents at beginning of year $X

Cash and cash equivalents at end of year $X

Schedule of noncash investing and financing activities.

The Indirect Method
The Indirect Method
Net Income is the top line of the operating
activities section and all adjustments are
made to it.
Indirect Method Adjustments
There are five steps for the indirect method:
1. Eliminate noncash items from the income
statement.
2. Eliminate non-operating activity transactions
that are included in the income statement.
3. Adjust for changes in operating account
balances.
4. Adjust for trading securities activities.
5. Make required disclosures.
1. Eliminate Noncash Items
The income statement includes some
expense items that are not cash payments.
These need to be eliminated.
The most common examples of this are:
• Depreciation expense
• Amortization expense
2. Eliminate Non-Operating Activities
The income statement reports results of all
transactions the company entered into
during the period, including events that
were not operating activities.
These non-operating transactions created
gains and losses on the income statement.
• Gains are subtracted from net income
• Losses are added back to net income
3. Individual Account
Adjustments
After taking out the noncash items and investing
and financing activity items, The company needs to
make adjustments for operating activities that did
not involve cash.
Individual asset and liability accounts that are
related to operating activities need to be looked at.

The adjustments for a few of the individual

accounts are discussed in detail, and then a general
rule that can be used in this process is presented.
Adjusting for Accounts
Receivable
Net income needs to be adjusted for the
change in the accounts receivable balance
over the period.

• Increase in AR balance is subtracted

from net income.
• Decrease in AR balance is added to net
income.
Adjusting for Accounts Payable
Similarly, net income must be adjusted for
a change in accounts payable.
• An increase in AP must be added to net
income.
• A decrease in AP must be subtracted
from net income.
Adjusting for Inventory
• An increase in inventory must be
subtracted from net income.
• A decrease in inventory must be added
to net income.
 
Rule for Adjustments
Asset Accounts (adjustment is opposite of change)
Asset account increases Subtracted from net
income
Asset account decreases Added to net income

Liability Accounts (adjustment is same as change)

Liability account increases Added to net income
Liability account Subtracted from net
decreases income
4. Cash Flows and Trading Securities
Cash flows from the purchase, sale and
maturity of trading securities are to be
classified based on the nature and
purpose for which the securities were
acquired. Usually, this means they will be
classified as operating activities, not
investing activities.
5. Indirect Method Disclosures
If a company uses the Indirect Method to
prepare the SCF, it must also separately
report the amount of cash paid for
1. Taxes, and
2. Interest.
Investing and Financing
Activities
Investing Activities
Must look at all cash flows relating to the
items included in investing activities.
Example: Knox Co. sold a fixed asset that had an original cost of $20,000 and
accumulated depreciation of $12,000 at the time of the sale. Knox realized a
gain of $5,000 on the sale. Calculate the cash received.
At the time of the sale the asset had a book value of $8,000
($20,000 cost - $12,000 accumulated depreciation).

Since the asset was sold at a $5,000 gain, we know that Knox
must have received $5,000 more than the book value, or
$13,000.

This $13,000 is presented as an investing activity. The $5,000

gain will be an adjustment in the operating section.
Financing Activities
As with investing activities, we are
interested only in the amount of cash in
the transaction.