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The Statement of Cash Flows

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The statement of cash flowsreports the entity’s cash flows

(cash receipts and cash payments)during the period.

Purpose of The Statement ofCash Flows: Basic Concepts

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Identify the purposes ofthe statement of cash flows.

Objective 1

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Purposes of the Statementof Cash Flows

Statementof Retained

Earnings

12/31/x1 For the Year Ended 12/31/x2 12/31/x2(a point in time) (a period of time) (a point in time)

Statementof CashFlows

IncomeStatement

BalanceSheet

BalanceSheet

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Purposes of the Statementof Cash Flows

The statement of cash flows is designed to fulfill the following:

– predict future cash flows– evaluate management decisions– determine the ability to pay dividends plus

interest and principal– show the relationship of net income to changes

in the firm’s cash

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Cash Balance Includes...

– cash on hand.– cash in the bank.– cash equivalents.

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Cash Equivalents Are....

– short-term, highly liquid investments convertible into cash with little delay.

– money market accounts.– Government Treasury bills.

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Report cash flows from operating,investing, and financing activities.

Objective 2

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Basic Organization of theStatement of Cash Flows

A business may be evaluated in terms of three types of business activities:

1 Operating activities2 Investing activities3 Financing activities

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Operating Activities

Operating activities are related to thetransactions that make up net income.

Interest and dividends received arerelated to investing activities.

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Investing activities increase and decreasethe assets that are available to the business.

Investing Activities

Investing activities are related to theLong-Term Asset accounts.

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These are transactions involving obtainingresources from the owners or returning

resources to them.

Financing Activities

It also involves obtaining resources from creditors and repaying the

amount borrowed.

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Format of the Statementof Cash Flows

ICAI in Accounting Standard 3 has approved two methods for reporting cash flows from operating activities.

1 Direct method2 Indirect method

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Format of the Statementof Cash Flows

The direct method lists cash receipts from specific operating activities and cash payments for each major operating activity.

The indirect method is a short-cut method for accrual systems.

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Prepare a statement of cashflows by the direct method.

Objective 3

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Cash flows from operating activities:Receipts:Collections from customers Rs. 271Interest received on notes receivable 10Dividends received on investments in stock 9Total receipts Rs. 290

Statement of Cash Flows (Direct Method)Year Ended December 31, 2002 (Thousands)

The Direct Method

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Payments:To suppliers Rs. 133To employees 58For interest 16For income tax 15Total payments 222Net cash inflows from operating activities Rs. 68

The Direct Method

Statement of Cash Flows (Direct Method)Year Ended December 31, 2002 (Thousands)

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Cash flows from investing activities:Acquisition of plant assets Rs. (306)Loan to another company (11)Proceeds from sale of plant assets 62Net cash outflow frominvesting activities Rs. (255)

The Direct Method

Statement of Cash Flows (Direct Method)Year Ended December 31, 2002 (Thousands)

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Cash flows from financing activities:Proceeds from issuance of common stock Rs. 101Proceeds from issuance of long-term notes payable 94Payment of long-term notes payable (11)Payment of dividends (17)Net cash inflow from financing activities Rs. 167

The Direct Method

Statement of Cash Flows (Direct Method)Year Ended December 31, 2002 (Thousands)

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Net cash inflows from operating activities Rs. 68Net Cash outflow from investing activities (255)Net Cash inflow from financing activities 167Net (decrease in cash) Rs. (20)Cash balance, December 31, 2001 42Cash balance, December 31, 2002 Rs. 22

The Direct Method

Statement of Cash Flows (Direct Method)Year Ended December 31, 2002 (Thousands)

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Compute the cash effectsof a wide variety of

business transactions.

Objective 4

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Revenues or expenses from the income statement+–

Adjusted for the change in therelated balance sheet account(s)

Amount for the statement of cash flows=

Computing Individual Amounts for the Statement of Cash Flows

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Revenues and gains:Sales revenue Rs. 284Interest revenue 12Dividend revenue 9Gain on sale of plant assets 8Total revenues and gains Rs. 313

Computing Individual Amounts for the Statement of Cash Flows

Income StatementYear Ended December 31, 2002 (Thousands)

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Expenses:Cost of goods sold Rs. 150Salary expense 56Depreciation expense 18Other operating expense 17Interest expense 16Income tax expense 15Total expenses Rs. 272

Computing Individual Amounts for the Statement of Cash Flows

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Total revenues and gains Rs. 313Total expenses 272Net income Rs. 41

Computing Individual Amounts for the Statement of Cash Flows

Income StatementYear Ended December 31, 2002 (Thousands)

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Assets 20x2 20x1 Inc./(Dec.)Current:Cash Rs. 22 42 (20)Accounts receivable 93 80 13Interest receivable 3 1 2Inventory 135 138 (3)Prepaid expenses 8 7 1Long-term receivable 11 – 11Plant assets, net 453 219 234Total assets Rs. 725 487 238

Comparative Balance Sheets

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Liabilities 20x2 20x1 Inc./(Dec.)Current:Accounts payable Rs. 91 57 34Salary payable 4 6 (2)Accrued liabilities 1 3 (2)Long-term notes payable 160 77 83Stockholders’ equity:Common stock 359 258 101Retained earnings 110 86 24Total liabilities andshareholders’ equity Rs. 725 487 238

Comparative Balance Sheets

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Computing Cash Collectionsfrom Customers

Collections can be computed by converting sales revenue to the cash basis.

Beginning Accounts Receivable balance + Sales on account – Collections = Ending Accounts Receivable balance

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Computing Cash Collectionsfrom Customers

Rs.80,000 + Rs.284,000 – 93,000 = Rs.271,000 Because Accounts Receivable increased by

Rs.13,000, the business received Rs.13,000 less cash than its sales revenue for the period.

All collections of receivables are computed following the pattern illustrated for collections from customers.

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Computing Paymentsto Suppliers

This computation includes two parts, payments for inventory and payments for expenses other than interest and income tax.

Payments for inventory are computed by converting cost of goods sold to the cash basis.

This is accomplished by analyzing the Inventory and Accounts Payable accounts.

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Payments for Inventory

Inventory

Beg. inventory 138,000Purchases x

Cost of goods sold 150,000

End. inventory 135,000

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Payments for Inventory

How much were the purchases? Rs.138,000 + x – Rs.150,000 = Rs.135,000 x = Rs.135,000 – Rs.138,000 + Rs.150,000 Rs.147,000

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Payments for Inventory

Accounts Payable

Payments forinventory x

Beg. balance 57,000

End. balance 91,000

Purchases 147,000

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Payments for Inventory

How much did the business pay for this inventory?

Rs.57,000 + Rs.147,000 – x = Rs.91,000 x = Rs.57,000 + Rs.147,000 – Rs.91,000 x = Rs.113,000

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Payments for Operating Expenses

Increases in prepaid expenses require cash payments, and decreases indicate that payments were less than expenses.

Decreases in accrued liabilities can occur only from cash payments, and increases mean that cash was not paid.

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Payments to Employees

Salary Payable was Rs.6,000 at the beginning of the year and Rs.4,000 at year end.

During the year Salary and Wages Expense was Rs.56,000.

How much did the business pay? Rs.58,000

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Acquisition and Salesof Plant Assets

The business had plant assets net of depreciation of Rs.219,000 at the beginning of the year and Rs.453,000 at year end.

Further, the acquisition of plant assets amounted to Rs.306,000 during the year.

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Acquisition and Salesof Plant Assets

The income statement shows depreciation expense of Rs.18,000 and a Rs.8,000 gain on sale of plant assets.

What is the book value of the assets sold? Beginning net balance + Acquisitions –

Depreciation – Book value of assets sold = Ending balance

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Acquisition and Salesof Plant Assets

Rs.219,000 + Rs.306,000 – Rs.18,000 – x = Rs.453,000

x = Rs.219,000 + Rs.306,000 – Rs.18,000 – Rs.453,000

x = Rs.54,000 (book value) How much are the proceeds from the sale

of plant assets?

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Acquisition and Salesof Plant Assets

Book value + Gain or – Loss = Proceeds Rs.54,000 + Rs.8,000 = Rs.62,000 How do we determine acquisitions? Beginning net balance + Acquisitions

– Depreciation – Book value of assets sold = Ending balance

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Computing the Cash Amountsof Financing Activities

Financing activities affect liability and stockholders’ equity accounts.

– Notes Payable– Bonds Payable– Long-Term Debt– Common Stock– Paid-in Capital– Retained Earnings

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Issuance and Payments ofLong-Term Notes Payable

Beginning balance was Rs.77,000. New debt amounting to Rs.94,000 was

incurred during the year. The ending balance for the Long-Term

Notes Payable account was Rs.160,000. How much was the payment? Rs.11,000

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Computing Dividend Payments

Dividend payments are computed by analyzing the Dividends Payable account.

Beginning balance + Dividends declared – Dividend payments = Ending balance

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Noncash Investing andFinancing Activities...

– are not reported in the statement of cash flows.

The Accounting Standard 3 requires that significant non-cash investing and financing activities be shown in a separate schedule at the bottom of the statement.

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Reconciling Net Incometo Net Cash Flow

The Accounting Standard requires companies that format operating activities by the direct method to report a reconciliation from net income to net cash inflow (or outflow).

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Prepare a statement of cash flowsby the indirect method.

Objective 5

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Current Assets

Add to Net Income if this account has decreased

The Indirect Method

Deduct from Net Income if this account has increased

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Current Liabilities

Add to Net Income if this account has increased

The Indirect Method

Deduct from Net Income if this account has decreased

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Statement of Cash Flows (Indirect Method)Year Ended December 31, 2002 (Thousands)

Cash flows from operating activities:Net Income 41Add (deduct) items that affect net incomeand cash flows differently:Depreciation 18Gain on sale of plant 8Increase in accounts receivable (13)Increase in interest receivable (2)Decrease in inventory 3

The Indirect Method

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Add (deduct) items that affect net incomeand cash flows differently:Increase in prepaid expenses (1)Increase in accounts payable 34Decrease is salary payable (2)Decrease in accrued liabilities (2)Net cash inflow from operating activities 68

The Indirect Method

Statement of Cash Flows (Indirect Method)Year Ended December 31, 2002 (Thousands)