1. STATEMENT OF CASH FLOWS
Chapter 13
STATEMENT OF CASH FLOWS
Chapter 13: Statement of cash flows. 2

2. Explain the purposes and uses of a statement of cash flows.
Learning Objective
Explain the purposes and uses of a statement of cash flows.
Learning objective number 1 is to explain the purposes and uses of a statement of cash flows.
LO1

3. Purpose of the Statement of Cash Flows
Provides information about the cash receipts and cash payments of a business entity during the accounting period.
Helps investors with questions about the company’s
Ability to generate positive cash flows.
Ability to meet its obligations and to pay dividends.
Need for external financing.
Investing and financing transactions for the period.
The Statement of Cash Flows helps users determine how a company obtains its cash and where the cash is spent. Providing this information helps explain changes in the cash balance from the beginning to the end of the period.
While it is important for users to know how much cash a company has, it is also important to know how a company funded it operations. Did it have to borrow money or sell stock to help pay the operating expenses? If so, users need to be aware of this so they can fully assess the cash flow position of the company.
Cash flow information is also useful in determining whether a business has sufficient cash to pay its debts, and/or if the business paid dividends during the period.

4. This slide shows a summary of the components of a Statement of Cash Flows. There are three main sections on the statement: operating, investing, and financing activities. The bottom of the statement reconciles the change in cash with the beginning and ending cash balances. The ending cash balance on the Statement of Cash Flows should always equal the cash balance on the Balance Sheet.

5. Learning Objective
Describe how cash transactions are classified in a statement of cash flows.
Learning objective number 2 is to describe how cash transactions are classified in a statement of cash flows.
LO2

6. Classification of Cash Flows
The Statement of Cash Flows must include the following three sections:
Cash Flows from Operating Activities
Cash Flows from Investing Activities
Cash Flows from Financing Activities
The next few slides will discuss each of the operating, investing, and financing activities sections.

7. Compute the major cash flows relating to operating activities.
Learning Objective
Compute the major cash flows relating to operating activities.
Learning objective number 3 is to compute the major cash flows relating to operating activities.
LO3

8. Cash Flows from Operating Activities
Inflows from:
Interest and dividends received.
Sales to customers. + _
Cash Flows from Operating Activities
Outflows to:
Suppliers of merchandise and services.
Employees.
Lenders for interest.
Governments for taxes.
The Operating Activities section includes cash inflows and outflows that result from the operations of the business, and some incidental business transactions. Operating cash inflows include cash received from customers in payment of goods sold as well as cash received as dividends and interest. Operating cash outflows include cash payments for salaries, supplies, inventory, taxes, and interest.

9. Compute the cash flows relating to investing and financing activities.
Learning Objective
Compute the cash flows relating to investing and financing activities.
Learning objective number 4 is to compute the cash flows relating to investing and financing activities.
LO4

10. Cash Flows from Investing Activities
Inflows from:
Selling investments and plant assets.
Collecting of principal on loans. + _
Cash Flows from Investing Activities
Outflows to:
Purchase of investments and plant assets.
Purchase debt or equity investments.
Make loans.
The Investing Activities section includes cash inflows and outflows that result from the sale and purchase of fixed assets and investments. If a company purchases a piece of equipment, it is classified as a cash outflow in the investing section. If a company has excess cash and invests it in the stock of another company, it is also classified as a cash outflow in the investing section. If this equity investment is sold in the future, it will be classified as a cash inflow in the investing section.

11. Cash Flows from Financing Activities
Inflows from:
Short-term and long-term borrowing.
Owners (for example, from issuing stock). + _
Cash Flows from Financing Activities
Outflows to:
Make payments on borrowed funds.
Owners for dividends.
Purchase treasury stock.
The Financing Activities section includes cash inflows and outflows that result from transactions with the company’s creditors and stockholders. If a company borrows money from a bank, it is classified as a cash inflow in the financing section. If this debt is repaid in the future, the amount of the principal payment is classified as a cash outflow in the financing section. Remember, the interest payment is classified as a cash outflow in the operating section. If a company issues stock of the company, it is classified as a cash inflow in the financing section.

12. Cash and Cash Equivalents
Currency
Cash includes currency and cash equivalents. Cash equivalents are short-term, highly liquid investments easily converted into cash with very little risk of loss. An example of a cash equivalent would be a short-term Treasury Bill that is government issued, very close to maturity, and has very little risk associated with it.
Short-term, highly liquid investments.
Readily convertible into cash.
So near maturity that market value is unaffected by interest rate changes.

13. Learning Objective
Distinguish between the direct and indirect methods of reporting operating cash flows.
Learning objective number 5 is to distinguish between the direct and indirect methods of reporting operating cash flows.
LO5

14. The operating cash flows section can be prepared using either the direct method or the indirect method.
Let’s look at the direct method for preparing the Statement of Cash Flows.
There are two acceptable formats for preparing the Cash Flows from Operating Activities: the Direct Method, and the Indirect Method. While each method uses a different format to arrive at Net Cash Provided (or used) by Operating Activities, the end result is the same. In other words, they use a different path to arrive at the same answer.
Let’s look at the Direct Method.

15. Direct Method Cash Received from Customers
Accrual basis revenue includes sales that did not result in cash inflows.
Can be computed as:
Cash Received from Customers
Decrease in receivables
Increase in receivables + – =
Net Sales
The Direct Method takes accrual-basis revenue and adjusts it for changes in accounts receivable to arrive at cash received from customers.
If Accounts Receivable decreases during the year, the decrease is added to accrual basis revenue. A decrease in Accounts Receivable means that customer cash payments on account exceed customer charges on account during the period. This excess is used to adjust the accrual-based revenues reported on the income statement to report the total cash received from customers during the period.
Similarly, if Accounts Receivable increases during the year, this increase is subtracted from revenue. An increase in Accounts Receivable means that customer charges on account exceeded customer cash payments on account during the period. This excess is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period.
Let’s look at an example.

16. Direct Method Cash Received from Customers
The accounts receivable balance was $80,000 on 12/31/06 and $110,000 on 12/31/07. If accrual sales revenue for 2007 was $900,000, what was cash basis revenue?
Decrease in receivables + =
Net Sales are $900,000 and the change in Accounts Receivable during the year is a $30,000 increase. What is Cash Received from Customers?
Net Sales
$900,000
Cash Received from Customers
Increase in receivables – =

17. Direct Method Cash Received from Customers
The accounts receivable balance was $80,000 on 12/31/06 and $110,000 on 12/31/07. If accrual sales revenue for 2007 was $900,000, what was cash basis revenue?
By adjusting Net Sales for the increase in Accounts Receivable, Cash Received from Customers is calculated as eight hundred seventy thousand dollars.
Net Sales
$900,000
Cash Received from Customers = $870,000
$30,000 Increase in receivables – =

18. Let’s look at some simplified formulas for computing direct method cash flows.
Now, let’s look at some other formulas for computing cash flows under the Direct Method.

19. Direct Method Interest and Dividends Received
Accrual basis revenue accounts, such as Interest Revenue and Dividends Revenue, need to be adjusted for increases or decreases in its related receivable account. These computations are very similar to the revenue example on the previous slides.

20. Direct Method Cash Paid for Merchandise
Step 1
Step 2
To determine Cash Paid for Merchandise, complete two steps: First, adjust accrual basis Cost of Goods Sold for the increase or decrease in Inventory to arrive at Purchases. Then, adjust Purchases for the increase or decrease in Accounts Payable.
Let’s look at an example.

21. Direct Method Cash Paid for Merchandise
How much did Martin Co. pay for inventory in 2007?
a. $900,000
b. $923,000
c. $947,000
d. $877,000
Purchases for 2007 were $935,000.
Purchases = $900,000 + $35,000
Cash Paid for Merchandise in 2007 was $923,000.
Cash Paid = $935,000 - $12,000
Part I
Review the information for Martin Company. How much did Martin Company pay for inventory in the year 2007?
Part II
The answer is B. Martin Company paid $923,000 for inventory in Let’s see where this number comes from.
First, take Cost of Goods Sold of $900,000 and add the $35,000 increase in Inventory. This equals $935,000 in Purchases. Now, adjust the Purchases number by subtracting the $12,000 increase in Accounts Payable, and this gives us Cash Paid for Merchandise of $923,000.

22. Direct Method Cash Payments for Expenses
After deducting depreciation and other noncash expenses, the cash paid for expenses is affected by
(1) whether the expense was prepaid, and
(2) whether the expense was accrued.
All accrual-basis expenses need to be adjusted for changes in related prepaid asset accounts and accrued liability accounts.
Cash Paid for
Expenses = +
Increase in
prepaid expenses -
Decrease
accrued liabilities

23. Now, let’s prepare a direct method Statement of Cash Flows for Martin Co.
Let’s prepare Martin Company’s Statement of Cash Flows using the Direct Method.

24. Direct Method
This is Martin’s asset section of the balance sheet. Calculate the changes in these accounts during the year.

25. Direct Method
Here is Martin’s liability and equity sections of the balance sheet. Calculate the changes in these accounts during the year.

26. Direct Method
Here is Martin’s income statement for the period.

27. Additional Information
Direct Method
Additional Information
Trading Securities were purchased during 2007 at a cost of $25,000.
Equipment with a book value of $40,000 was sold during the year for $43,000.
Equipment with a book value of $30,000 was destroyed during a freak flood in There was no insurance.
Martin owns 25% of the common stock of another company and uses the equity method to account for this investment.
Please review the additional information provided on this slide and the next.

28. Additional Information
Direct Method
Additional Information
Martin’s tax rate is 40%.
The Notes Payable to the bank carry a 12% rate. The payments are due on the first day of each month.
The Bonds Payable carry a 9% rate. Interest is payable semiannually on July 1 & Jan. 1.
Sold stock during 2007 for $50,000.
Received $10,000 dividends from its equity investment.
Now, let’s begin the Statement of Cash Flows.

29. Direct Method Cash Received from Customers Cash Paid to Employees
On the previous slides, we worked through calculations for Cash Received from Customers and Cash Paid to Employees. They are shown here. If necessary, review the previous slides that pertain to these computations.

30. Direct Method Cash Paid for Inventory Cash Paid for Interest
Next, calculate Cash Paid for Inventory and Cash Paid for Interest.

31. Direct Method Cash Paid for Taxes Other Operating Cash Flows
Then, calculate Cash Paid for Taxes. Also listed are some other operating cash flow items that pertain to Martin Company. Now, let’s put together the Operating Section on the Statement of Cash Flows.

32. Direct Method Cash Flows From Operating Activities
The operating activities section on the Statement of Cash Flows for Martin Company would look like this. Notice that all accrual-basis account balances have been converted to cash basis. Cash provided from operating activities totaled $27,370, compared to reported net income of $41,970.

33. Equipment with a book value of $40,000 was sold for $43,000.
Bonds Payable decreased from $250,000 to $150,000 during 2007.
Part I
The completed Statement of Cash Flows is shown.
Part II
The Investing section includes only the cash inflow of $43,000 from the sale of equipment.
Part III
The Financing section includes cash from the sale of stock as well as the cash outflow of $100,000 for payment on the principal of Bonds.
Part IV
The Financing section also includes the cash outflow of $10,000 for payment on the principal of a Note Payable.
Notes Payable decreased from $70,000 to $60,000 during 2007.

34. Notice that the Ending Cash Balance per the Statement of Cash Flows agrees with the 12/31/07 Cash balance on the Balance Sheet.
Notice that the ending Cash balance on the Statement of Cash Flows agrees with the ending Cash balance reported on the balance sheet.

35. Learning Objective
Explain why net income differs from net cash flows from operating activities.
Learning objective number 6 is to explain why net income differs from net cash flows from operating activities.
LO6

36. Reconciling Net Income with Net Cash Flows
There are two major categories of reconciling items. They include adjusting for:
Noncash Expenses.
Timing Differences.
Depreciation Expense
Part I
There are two major categories of reconciling items. They include adjustment for noncash expenses and timing differences.
Part II Depreciation, depletion and amortization expenses are examples of noncash expense items. They are added to net income to arrive at net cash flows from operating items.
Part III Timing differences include changes in asset and liability accounts such as accounts receivable, inventory, prepaid expenses, accounts payable, and accrued expenses payable.
Accounts receivable

37. Let’s look at the indirect method that is used by over 97% of all companies.
The vast majority of companies use the Indirect Method, so let’s look at how to prepare the Operating section of the Statement of Cash Flows using this method.

38. Learning Objective
Compute net cash flows from operating activities using the indirect method.
Learning objective number 7 is to compute net cash flows from operating activities using the indirect method.
LO7

39. Indirect Method Cash Flows from Operating Activities Net Income
Changes in current assets and current liabilities as shown on the following table.
Cash Flows from Operating Activities
Net Income
The Indirect Method starts with accrual-based net income and makes certain adjustments to arrive at Cash Flows from Operating Activities. Adjustments to accrual-based net income include adding back any noncash items that were included to arrive at net income, such as depreciation and amortization. This basically cancels out that they were originally subtracted to arrive at net income. Since these items do not represent cash outlays, they should not be included in the Statement of Cash Flows.
Gains and losses are other items on the income statement to consider. They result from the sale of an asset. Gains are added and losses are subtracted on the income statement to arrive at net income. Since gains and losses do not represent operating cash flows, gains are canceled out by subtracting and losses are canceled out by adding to net income in the operating section.
Appropriate adjustments should also be made on the income statement to reflect the change from accrual-based revenues reported to cash-based. This is done by analyzing the changes in noncash current assets and current liabilities.
+ Losses and - Gains
+ Noncash expenses such as depreciation and amortization.

40. Use this table when adjusting Net Income to Operating Cash Flows.
Indirect Method
This chart explains how to treat a change in a noncash current asset or current liability in the operating section of the statement of cash flows. Let’s begin with current assets.
If Accounts Receivable, a current asset, decreases during the year, this decrease is added to net income. A decrease in Accounts Receivable means that customer cash payments on account exceeded customer charges on account during the period. This excess of payments over charges is used to adjust the accrual-based revenues reported on the income statement to report the total cash received from customers during the period. Similarly, if Accounts Receivable increased during the year, this increase would be subtracted from net income. An increase in Accounts Receivable means that customer charges on account exceeded customer cash receipts on account during the period. This excess of charges over cash receipts is used to adjust the accrual-based revenues reported on the income statement to report the total cash received from customers during the period.
Now, let’s look at how to treat changes in current liabilities. If Salaries Payable, a current liability, decreased during the year, this decrease would be subtracted from net income. A decrease in Salaries Payable means that the company paid more in salaries than it charged during the period. This excess of cash payments over charges is used to adjust the accrual-based expense reported on the income statement to report the total cash paid for salaries during the period. Similarly, if Salaries Payable increased during the year, this increase would be added to net income. An increase in Salaries Payable means the company charged more than it paid during the period. This excess of charges over cash payments is used to adjust the accrual-based expense reported on the income statement to report the total cash paid for salaries during the period.
Use this table when adjusting Net Income to Operating Cash Flows.

41. Indirect Method
Joyce, Inc. has prepared the Balance Sheet as of March 31, 2006, and March 31, The Income Statement for the year ended 3/31/07 has also been prepared. Joyce needs help preparing the Statement of Cash Flows using the indirect method.
Let’s look at how to prepare the Statement of Cash Flows using the Indirect Method. The next few slides present the necessary financial statements for Joyce Incorporated.

42. Indirect Method
The $8,000 gain was the result of selling land costing $32,000 for $40,000 cash during the period.
Part I
This is the income statement for Joyce Incorporated.
Part II
Notice that there is an $8,000 Gain on Sale of Land. The land was originally purchased for $32,000 and was sold for $40,000 cash during 2007.

43. Indirect Method
Changes in each account can be seen in the asset section of the balance sheet, shown here.

44. Indirect Method
Joyce issued $50,000 of no par common stock to settle the $50,000 note payable.
Part I
The changes in the liabilities and equity sections of the balance sheet are shown here.
Part II
Joyce issued $50,000 of no par common stock to settle the $50,000 note payable.

45. Indirect Method
The decrease in Retained Earnings is made up of a net loss of $19,000 during the period and dividend payments of $20,000.

46. Indirect Method
With the indirect method, always start with the net income or net loss for the period.
To begin preparing the Statement of Cash Flows, start with the accrual-basis net income. Adjust net income for the changes in the noncash current assets and current liabilities. Lastly, adjust net income for noncash expenses, gains, and losses.

47. Indirect Method
The changes in the noncash current assets and current liabilities accounts are then added or subtracted as appropriate. Use this table to help determine whether to add or subtract the account changes.

48. Accounts receivable decreased.
Indirect Method
Accounts Receivable decreased, so add that change.
Accounts receivable decreased.
3/31/ /31/06
$23,000 - $40,000 = $(17,000)

49. Accounts payable increased.
Indirect Method
Accounts Payable increased by $11,000, so add that change.
Accounts payable increased.
3/31/ /31/06
$38,000 - $27,000 = $11,000

50. Indirect Method Inventory increased. 3/31/07 3/31/06
Inventory increased by $50,000, so that change will be subtracted from net income to arrive at net cash flows from operating activities.
Inventory increased.
3/31/ /31/06
$350,000 - $300,000 = $50,000

51. Salaries payable decreased.
Indirect Method
Salaries Payable decreased, so subtract that change.
Salaries payable decreased.
3/31/07 3/31/06
$ 9,000 - $14,000 = $(5,000)

52. Add back non-cash expenses.
Indirect Method
After taking care of the noncash current assets and current liabilities, take care of the noncash expenses, gains, and losses.
As shown, add Depreciation expense.
Add back non-cash expenses.

53. Indirect Method Subtract gains.
The Gain on Sale of Land is subtracted, and we arrive at net cash flows from operations of $48,000.
The Cash Flows From Operating Activities for Joyce Incorporated is a cash outflow of forty-eight thousand dollars.
Subtract gains.

54. The operating cash flows amount comes from the schedule just prepared.
Indirect Method
The operating cash flows amount comes from the schedule just prepared.
Shown is a summary total for the Operating Activities section.
Next, let’s complete the Investing Activities section.

55. Land originally costing $32,000 was sold for $40,000.
Indirect Method
Land originally costing $32,000 was sold for $40,000.
Joyce only has one investing activity. A cash inflow of $40,000 from the sale of land.
Let’s move on to the Financing Activities section.

56. Dividends of $20,000 were paid to owners during the year.
Indirect Method
Joyce only has one financing activity. Cash dividends paid of $20,000.
Let’s complete the Statement of Cash Flows.
Dividends of $20,000 were paid to owners during the year.

57. Compute the net change in cash for the period.
Indirect Method
Compute the net change in cash for the period.
There was a net decrease of $28,000 in Cash during the period.

58. Indirect Method
Complete the Statement of Cash Flows by reconciling beginning cash to ending cash.
By adding the change in Cash with the Beginning Cash balance, the Ending Cash balance is $62,000.

59. Indirect Method
Note that the ending cash amount ties back to Joyce’s Balance Sheet at 3/31/07.
Remember, the Ending Cash balance should agree with the Cash balance reported on the balance sheet.

60. Cash interest payments and cash tax payments must be disclosed.
Indirect Method
In addition, on the face of the statement or in a supplemental schedule, disclose the $50,000 noncash financing activity.
Part I
There is some supplemental information Joyce needs to report.
Part II
The exchange of stock for a Note Payable is an example of a significant noncash investing and financing activity. Since it’s a noncash transaction, it does not appear on the Statement of Cash Flows; however, it must be disclosed along with the cash paid for interest and taxes.
Cash interest payments and cash tax payments must be disclosed.

61. Learning Objective
Discuss the likely effects of various business strategies on cash flows.
Learning objective number 8 is to discuss the likely effects of various business strategies on cash flows.
LO8

62. Managing Cash Flows
Cash Budgets are used by management to plan and forecast future cash flows.
Cash budgets are used by management to plan and forecast future cash inflows as well as determine whether there may be potential cash shortages to be managed.

63. Managing Cash Flows Increase collection of accounts receivables.
Keep inventory low.
Delay payment of liabilities.
Plan timing of major expenditures.
Invest idle cash.
There are several things management can do to manage cash flows, such as increase collection on accounts receivable, keep inventory low, delay payment of liabilities, plan timing of major expenditures, and invest idle cash.

64. Learning Objective
Explain how a worksheet may be helpful in preparing a statement of cash flows.
Learning objective number 9 is to explain how a worksheet may be helpful in preparing a statement of cash flows.
LO9

65. Using a Spreadsheet
This is an example of a cash budget. It starts with the beginning cash balance. Then, anticipated cash receipts are added and anticipated cash payments are subtracted. There is a financing section at the bottom to determine whether we need to borrow cash or can repay some loans.
The ending cash balance of one month becomes the beginning cash balance of the next month.

66. Using a Spreadsheet
Notice that in June eleven thousand dollars must be borrowed in order to maintain a minimum cash balance of ten thousand dollars. In July, the plan is to repay three thousand dollars of the debt incurred in June.
Financing is needed in June because the company must maintain a minimum cash balance of $10,000.

67. End of Chapter 13
End of chapter 13. 4