The Statement of Cash Flows 15. Overview of the Statement of Cash Flows OBJECTIVE 1: Describe the...

The Statement of Cash Flows 15

Overview of the Statement of Cash Flows

OBJECTIVE 1: Describe the principal purposes and uses of the statement of cash flows, and identify its components.

Figure 1: Classification of Cash Inflows and Cash Outflows

Exhibit 1: Consolidated Statement of Cash Flows


• The statement of cash flows is a major financial statement.


• Purposes of the statement of cash flows– The statement of cash flows provides

information that is not provided by the other three statements.


• Purposes of the statement of cash flows (cont.)– The statement of cash flows shows the effects on

cash and cash equivalents of operating, investing, and financing activities.

• Cash equivalents are short-term, highly liquid investments.

• Marketable securities are not cash equivalents.

– The statement of cash flows provides information about a company’s cash receipts and cash payments.


• Uses of the statement of cash flows– The statement of cash flows also provides

information about a company’s investing and financing activities.


• Uses of the statement of cash flows (cont.)– Investors, creditors, and management use the

statement of cash flows for many reasons:• To assess a company’s ability to generate positive

future cash flows

• To assess a company’s ability to pay debts

• To assess a company’s ability to pay dividends

• To assess a company’s need for additional financing

• To plan for investing idle cash


• Classification of cash flows– Operating activities include cash received from

customers; interest and dividends received; sales of trading securities; and cash paid for wages, goods, services, interest, taxes, and purchases of trading securities.


• Classification of cash flows (cont.)– Investing activities involve long-term asset and

marketable-security transactions and loans made and collected.

– Financing activities involve stock, bond, and note transactions, as well as dividends paid.

• A schedule of noncash investing and financing transactions should accompany the statement of cash flows.


• In the statement of cash flows, individual cash inflows and outflows are shown separately in their respective categories.


• Unethical means of falsely enhancing cash flows range from failing to fully disclose financial transactions to misclassifying payments and expenses.

Analyzing Cash Flows

OBJECTIVE 2: Analyze the statement of cash flows.


• Many companies put their cash to good use, but sometimes shareholders suffer when management is too conservative and keeps cash in low-yielding assets.


• Cash-generating efficiency is the ability of a company to generate cash from operations.– Cash flow yield is the quotient of net cash

flows from operating activities divided by net income.

– Cash flows to sales is the quotient of net cash flows from operating activities divided by net sales.


• Cash-generating efficiency is the ability of a company to generate cash from operations. (cont.)– Cash flows to assets is the quotient of net cash

flows from operating activities divided by average total assets.


• To interpret a statement of cash flows, it is important to know the right questions to ask.– Why did cash flow from operating activities

differ from net income?– What investing activities are important other

than capital expenditures?– How did the company manage it’s financing

activities during the fiscal year?


• Free cash flow is net cash flows from operating activities less dividends and investments in plant assets plus proceeds from the sale of plant assets.

Operating Activities

OBJECTIVE 3: Use the indirect method to determine cash flows from operating activities.

Exhibit 2: Income Statement

Exhibit 3: Comparative Balance Sheets Showing Changes in Accounts

Figure 2: Indirect Method of Determining Net Cash Flows from Operating Activities

Exhibit 4: Schedule of Cash Flows from Operating Activities: Indirect Method


• Under the indirect method, cash flows from operating activities equal net income adjusted by items that increase or decrease cash flow from operations.– Items to be added back to net income:

• Depreciation expense, amortization expense, and depletion expense

• Losses


• Under the indirect method, cash flows from operating activities equal net income adjusted by items that increase or decrease cash flow from operations. (cont.)– Items to be added back to net income:

• Decreases in accounts receivable, inventory, and prepaid expenses

• Increases in accounts payable, accrued liabilities, and income taxes payable


• Under the indirect method, cash flows from operating activities equal net income adjusted by items that increase or decrease cash flow from operations. (cont.)– Items to be deducted from net income:

• Gains• Increases in accounts receivable, inventory, and

prepaid expenses• Decreases in accounts payable, accrued liabilities,

and income taxes payable


• The direct and indirect methods produce the same results, and both are GAAP.

Investing Activities

OBJECTIVE 4: Determine cash flows from investing activities.


• Investing activities include the following:– Purchase and sale of long-term assets– Purchase and sale of short-term investments


• Gains and losses under the indirect approach.– deducted from and added back to net income to

arrive at net cash flows from operating activities– full cash proceeds are entered into the cash flows

from investing activities section of the statement of cash flows

• Upon a sale, the full cash proceeds are entered into the statement of cash flows.


• Upon a purchase, the full cash outflows are entered into the statement of cash flows.

Financing Activities

OBJECTIVE 5: Determine cash flows from financing activities.

Exhibit 5: Statement of Cash Flows: Indirect Method


• Financing activities include the following:– Short- and long-term borrowing (notes and

bonds) and repayment– Issuance and repurchase of capital stock

• Changes in retained earnings are explained through analyses of net income and dividends declared.


• The direct and indirect methods differ only in the cash flows from operating activities section of the statement of cash flows.

• Exhibit 5 shows a completed indirect method statement of cash flows.– The essence of the indirect approach is the

conversion of net income to net cash flows from operating activities.

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