1. Prepared by: Keri Norrie, Camosun College
ACCOUNTING PRINCIPLES
Third Canadian Edition
Prepared by: Keri Norrie, Camosun College

2. THE CASH FLOW STATEMENT
CHAPTER 17
THE CASH FLOW STATEMENT

3. USEFULNESS OF THE CASH FLOW STATEMENT
The cash flow statement helps users assess:
The company’s ability to pay dividends and meet obligations.
The company’s ability to generate future cash flow.
The reason for the difference between net income and cash provided (used) by operating activities.
The investing and financing transactions during the period.

4. DEFINITION OF CASH “Cash” can include cash equivalents
Cash equivalents are short-term, highly liquid investments that are both:
readily convertible to known amounts of cash
so near to their maturity that their market value is relatively insensitive to changes in interest rates
Because the definition of “cash” varies,
companies must clearly define cash equivalents.

5. CLASSIFICATION OF CASH FLOWS
Operating activities include the cash effects of transactions that create revenue and expenses
Income statement items must be adjusted for noncash transactions and for certain noncash working capital accounts

6. CLASSIFICATION OF CASH FLOWS
Investing activities:
Include acquiring and disposing of investments and long-lived assets and lending money and collecting loans
Affect temporary investments that are not cash equivalents and long-term asset accounts

7. CLASSIFICATION OF CASH FLOWS
Financing activities:
Include obtaining cash from issuing debt or from shareholders, repaying the amount borrowed, and paying dividends
Affect short-term notes payable and long-term liability and equity accounts

8. SIGNIFICANT NONCASH ACTIVITIES
If it does not affect cash, do NOT report it in the body of the cash flow statement
Report it in a separate note to the financial statements
Common
Shares
Not reported on cash flow statement.

9. FORMAT OF CASH FLOW STATEMENT
(ILLUSTRATION 17-3)
COMPANY NAME
Cash Flow Statement
Period Covered
Operating activities
(List of individual inflows and outflows) XX
Net cash provided (used) by operating activities XXX
Investing activities
(List of individual inflows and outflows) XX
Net cash provided (used) by investing activities XXX
Financing activities
Net cash provided (used) by financing activities XXX
Net increase (decrease) in cash XXX
Cash at beginning of period XXX
Cash at end of period XXX
Note x:
Noncash investing and financing activities
(List of significant noncash transactions) XXX

10. PREPARATION OF THE CASH FLOW STATEMENT
The cash flow statement is prepared differently from the other financial statements
It is not prepared from the adjusted trial balance, rather, the information to prepare this statement usually comes from three sources
Comparative balance sheet
Current income statement
Additional information
The accrual concept is not used, since the cash flow statement deals with cash receipts and payments.

11. STEP 1: PREPRATION OF THE OPERATING ACTIVITIES SECTION
Net income must be converted from an accrual basis to a cash basis in the operating activities section
Conversion may be done by one of two methods:
Indirect
Direct

12. INDIRECT AND DIRECT METHODS
Both methods arrive at the same total amount of cash provided (used) by operating activities
Methods differ in disclosing the items that make up the total amount
Choice of methods affects only the operating activities section; the investing and financing activities sections are the same

13. STEPS IN PREPARING THE CASH FLOW STATEMENT
(ILLUSTRATION 17-4)
Step 1: Determine the net cash provided (used) by operating activities by converting net income from an accrual basis to a cash basis.
Analyse the current year’s income statement, comparative balance sheet, and selected additional data.
Step 2: Determine the net cash provided (used) by investing activities by analysing changes in temporary investment and long-term asset accounts.
Analyse the comparative balance sheet and selected additional data for their effects on cash.

14. STEPS IN PREPARING THE CASH FLOW STATEMENT
(ILLUSTRATION 17-4)
Step 3: Determine the net cash provided (used) by financing activities by analysing changes in short-term notes payable and long-term liability and equity accounts.
Analyse the comparative balance sheet and selected additional data for their effects on cash.
Step 4: Determine the net increase (decrease) in cash. Compare the net change in cash with the change in cash reported on the balance sheet to make sure the amounts agree.
Calculate the difference between the beginning and ending cash balance from the comparative balance sheet.

15. INDIRECT METHOD
Section 1

16. STEP 1: OPERATING ACTIVITIES
(ILLUSTRATION 17-6)
ADJUSTMENTS TO CONVERT NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net Cash Provided (Used) by Operating Activities
Net Income
+/–
Adjustments = +
Add back noncash expenses such as amortization expense
+/–
Add back losses and deduct gains that result from investing and financing activities
+/–
Analyse changes to noncash current asset and current liability accounts and adjust accordingly

17. STEP 1: OPERATING ACTIVITIES
(ILLUSTRATION 17-7)
NET CASH PROVIDED BY OPERATING
ACTIVITIES — INDIRECT METHOD

18. SUMMARY OF ADJUSTMENTS TO CONVERT NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
(ILLUSTRATION 17-8)
Adjustment Required to Convert Net Income to Net Cash Provided (Used) by Operating Activities
Noncash charges
Amortization expense
Add
Gains and losses
Gain on sale of asset
Loss on sale of asset
Deduct
Changes in noncash current asset and current liability accounts
Increase in current asset account
Decrease in current asset account
Increase in current liability account
Decrease in current liability account

19. STEP 2: INVESTING ACTIVITIES
Study the balance sheet to determine changes in temporary investments and long-term assets
Changes in each account are analysed using selected transaction data to determine the effect, if any, the changes had on Cash

20. STEP 3: FINANCING ACTIVITIES
Study the balance sheet to determine changes in short-term notes payable and long-term liability and equity accounts
Changes in each account are analysed using selected transaction data to determine the effect, if any, the changes had on Cash

21. CASH FLOW STATEMENT INDIRECT METHOD
(ILLUSTRATION 17-9)
Operating activities provided $172,000 cash, investing activities used $141,000 cash, and financing activities used $9,000 cash.

22. DIRECT METHOD
Section 2

23. STEP 1: OPERATING ACTIVITIES DETERMINE NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS
The direct method calculates net cash provided (used) by operating activities by adjusting each item on the income statement from the accrual basis to the cash basis
Only major classes of operating cash receipts and cash payments are reported

24. MAJOR CLASSES OF CASH RECEIPTS AND CASH PAYMENTS (ILLUSTRATION 17-11)

25. STEP 1: OPERATING ACTIVITIES CASH RECEIPTS FROM CUSTOMERS
The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable is:
Cash receipts from customers =
Revenues from sales {
+ Decrease in accounts receivable or – Increase in accounts receivable

26. STEP 1: OPERATING ACTIVITIES CASH PAYMENTS TO SUPPLIERS
The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:
Cash payments to suppliers =
Cost of goods sold {
+ Increase in inventory or – Decrease in inventory
+ Decrease in accounts payable or – Increase in accounts payable

27. STEP 1: OPERATING ACTIVITIES CASH PAYMENTS FOR OPERATING EXPENSES
The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:
Cash payments for services
+ Increase in prepaid expenses or – Decrease in prepaid expenses
+ Decrease in accrued expenses payable or – Increase in accrued expenses payable =
Operating expenses { {

28. STEP 1: OPERATING ACTIVITIES CASH PAYMENTS FOR INCOME TAX
The relationships among cash payments for income tax, income tax expense, and changes in income tax payable is:
Cash payments for income tax { =
Income tax expense
+ Decrease in income tax payable or – Increase in income tax payable

29. STEP 1: OPERATING ACTIVITIES
NET CASH PROVIDED BY OPERATING ACTIVITIES DIRECT METHOD (ILLUSTRATION 17-17)

30. STEP 2: INVESTING ACTIVITIES
Study the balance sheet to determine changes in temporary investments and long-term assets
Changes in each account are analysed using selected transaction data to determine the effect, if any, that the changes had on Cash

31. STEP 3: FINANCING ACTIVITIES
Study the balance sheet to determine changes in short-term notes payable and long-term liability and equity accounts
Changes in each account are analysed using selected transaction data to determine the effect, if any, that the changes had on Cash

32. CASH FLOW STATEMENT—DIRECT METHOD
(ILLUSTRATION 17-18)
Operating activities provided $172,000 cash, investing activities used $141,000 cash, and financing activities used $9,000 cash.

33. USING THE INFORMATION IN THE FINANCIAL STATEMENTS
Earnings before interest, tax, depreciation, and amortization (EBITDA)
Free cash flow

34. EBITDA
EBITDA (earnings before interest, tax, depreciation, and amortization) is a measure of a company’s ability to generate cash from operating activities
Canadian companies generally use the term “amortization” rather than “depreciation”
Income Tax Expense
Net Income
Interest Expense + +
Amortization Expense + =
EBITDA

35. Cash Provided (Used) by Operating Activities Net Capital Expenditures
FREE CASH FLOW
Free cash flow calculates the cash remaining from operating activities after adjustments for capital expenditures and dividends
Investors and creditors use it to assess a company’s discretionary cash flow
Cash Provided (Used) by Operating Activities
Net Capital Expenditures – –
Dividends Paid =
Free Cash Flow

36. COPYRIGHT
Copyright © 2004 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.