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TABLE OF CONTENTS

History and Variations01What Is A Cash Flow Statement? ..02Components of Cash Flows Statements..03

Operating Activities03Investing Activities.03

Financing Activities04Format of Cash Flow Statement..05Example...06Methods of Computation of Operating Activities06Direct Method...06

Indirect Method08Key Terms10How to Analyze a Cash Flow Statement..11Conclusion13


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CASH FLOW STATEMENT

History and variations:

Cash basis financial statements were common before accrual basis financialstatements. The cash flow statement was previously known as the statement ofchanges in financial position or flow of funds statement. The cash flow statementreflects a firm's liquidity or solvency.

In the United States in 1971, the Financial Accounting Standards Board (FASB)defined rules that made it mandatory under Generally Accepted AccountingPrinciples (US GAAP) to report sources and uses of funds, but the definition of"funds" was not clear. "Net working capital" might be cash or might be the difference

between current liabilities and current assets. From the late 1970 to the mid-1980s,the FASB discussed the usefulness of predicting future cash flows. In 1987, FASBStatement No. 95 (FAS 95) mandated that firms provide cash flow statements.

In 1992, the International Accounting Standards Board issued InternationalAccounting Standard 7 (IAS 7), Cash Flow Statements, which became effective in1994, mandating that firms provide cash flow statements. US GAAP and IAS 7 rulesfor cash flow statements are similar. Differences include

IAS 7 requires that the cash flow statement include changes in both cash and cash

equivalents. US GAAP permits using cash alone or cash and cash equivalents.

IAS 7 permits bank borrowings (overdraft) in certain countries to be included in

cash equivalents rather than being considered a part of financing activities.

IAS 7 allows interest paid to be included in operating activities or financing

activities. US GAAP requires that interest paid be included in operating activities.

US GAAP (FAS 95) requires that when the direct method is used to present the

operating activities of the cash flow statement, a supplemental schedule must alsopresent a cash flow statement using the indirect method. The IASC stronglyrecommends the direct method but allows either method. The IASC considers theindirect method less clear to users of financial statements. Cash flow statementsare most commonly prepared using the indirect method, which is not especiallyuseful in projecting future cash flows.

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What is a Cash Flow Statement?

The cash flow statement is basically the most important financial statement a businessprepares. It traces the flow of funds or in other words working capital into and out of

your business during an accounting period. The cash flow statement became arequirement for publicly traded companies in 1987. There are various rules governinghow information is reported on cash flow statements, as determined by generallyaccepted accounting principles (GAAP). While your business may not be a publiccompany, a cash flow statement is still important to measure and track the flow ofcash into and out of your business

For a small business, a cash flow statement should probably be prepared as frequentlyas possible. This means either monthly or quarterly. An annual statement is a must forany kind of business. A cash flow statement can be used to assess the timing, amountand predictability of future cash flows and it can be used as the basis for budgeting. .A cash flow statement is also a key to understanding the investment and financing

philosophy of a borrower.

Cash flow is essentially the movement of money into and out of your business; it's thecycle of cash inflows and cash outflows that determine your business' solvency.

The purpose of the statement of cash flows is to provide an entry for the cash balanceshown on your balance sheet. But, in essence, the statement of cash flows provides a

business with so much more. An examination of the statement of cash flows willshow you exactly where your cash surplus or deficit is coming from.

Cash flow analysis is the study of the cycle of your business' cash inflows andoutflows, with the purpose of maintaining an adequate cash flow for your business,and to provide the basis for cash flow management. Cash flow analysis involvesexamining the components of your business that affect cash flow, such as accountsreceivable, inventory, accounts payable, and credit terms. By performing a cash flowanalysis on these separate components, you'll be able to more easily identify cashflow problems and find ways to improve your cash flow.

The statement of cash flows is meant to serve as a bridge between the minute detail ofthe profit and loss sheet, and the sketchy details of the balance sheet. When properly

used, the statement of cash flows will fill in many gaps left in the reporting ofinformation from one level of detail to the next.

The balance sheet is a snapshot of a firm's financial resources and obligations at asingle point in time, and the income statement summarizes a firm's financialtransactions over an interval of time. These two financial statements reflect theaccrual basis accounting used by firms to match revenues with the expensesassociated with generating those revenues. The cash flow statement includes onlyinflows and outflows of cash and cash equivalents; it excludes transactions that do notdirectly affect cash receipts and payments. These non-cash transactions includedepreciation and write-offs on bad debts. The cash flow statement is a cash basis

report on three types of financial activities: operating activities, investing activities,and financing activities. Non-cash activities are usually reported in footnotes.

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The cash flow statement is intended to

1. provide information on a firm's liquidity and solvency and its ability to changecash flows in future circumstances

2. provide additional information for evaluating changes in assets, liabilities and

equity3. improve the comparability of different firms' operating performance by

eliminating the effects of different accounting methods4. indicate the amount, timing and probability of future cash flows

The cash flow statement has been adopted as a standard financial statement because iteliminates allocations which might be derived from different accounting methods,such as various timeframes for depreciating fixed assets.

Components of Cash flows Statements:

In the accounting, banking and business communities there has been much debate asto the best method to report cash flow information. Accounting experts recommendusing three categories to organize cash flow data which are as follows:-

1. Operating Activities2. Investing Activities3. Financing Activities

Operating Activities:

The area of cash flows from operating activities will show you if your sales, your cashreceipts, and inventory and your accounts receivables are experiencing any dramaticchanges. Cash flow from operating activities is probably the most complex section

because there are two methods of computing it. The direct method will be introducedfirst. However, the direct method is not the most widely used method to calculate thecash flow from operating activities. Many companies use the Indirect Method. Thechoice of method does not change the amount of cash flow reported from operatingactivities. These methods will be discussed later. It includes

receipts from the sale of goods or services

receipts for the sale of loans, debt or equity instruments in a trading portfolio

interest received on loans

dividends received on equity securities payments to suppliers for goods and services

payments to employees or on behalf of employees

tax payments interest payments (alternatively, this can be reported under

financing activities

Investing Activities:

Cash flow from investing activities is the second part of both types of cash flowstatements. Investing activities are the changes to your cash position owing to the

buying or selling of non current assets. This includes selling and replacing equipmentthat wears out or acquiring a new building or land so that your company can grow.Investing activities can also include the purchase or sale of stock, bonds, and

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securities. Lending money and receiving loan payments are also considered investingactivities

The area of cash flows from investing activities will provide you with a quickreference for any changes in permanent assets. Any sales or purchases of equipment,

even bonds, will show up here. The monitoring of investment activities, when usedwith your operating activities, will tell you when moments of opportunity and needare presenting themselves. It includes

collections on loan principal and sales of other firms' debt instruments

investment returns from other firms' equity instruments, including sale of

those instruments receipts from sale of plant and equipment

expenditure for purchase of plant and equipment

loans made and acquisition of other firms' debt instruments

expenditure for purchase of other firms' equity instruments (unless held for

trading or considered cash equivalents)

Financing Activities:

The financing activities section of the cash flow statement will show repayments ofdebt, borrowing of funds, as well as injections of capital and the payment ofdividends. As a company expands, this area of the cash flow statement will becomeincreasingly important. It will tell outsiders how the company has grown and thefinancial strategies of management. The area of cash flows from financing activitiesrefers to any activity of investing, borrowing. It includes

proceeds from issuing shares

proceeds from issuing short-term or long-term debt

payments of dividends

payments for repurchase of company shares

repayment of debt principal, including capital leases

for non-profit organizations, receipts of donor-restricted cash that is limited to

long-term purposes

Conclusion is that together, the three sections of the cash flow statement show the net

change in cash during the period being examined. A comparison between past periodswill give owners and managers a good idea of the trend of their business. Positivetrends in cash flow may encourage owners to consider long-term financing as an aidto growth and increase their comfort level concerning the company's ability togenerate cash for repayment. Strong cash flow will also make it easier to acquirefinancing and to negotiate with lenders from a position of strength. Preparation of acash flow statement is the first step toward financial management for long-termsuccess. Prepared on a regular basis, it is a powerful tool for growth and long-termsuccess.

Format of Cash Flow Statement

Company name

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Statement of Cash flows

Period Covered

Cash flow from operating activities

(List of individual items) XX

Net cash provided by operating activities XXX

Cash flow from investing activities

(List of individual inflows and outflows) XX

Net Cash provided by investing activities. XXX

Cash flow from financing activities

(List of individual inflows and outflows) XX

Net Cash provided by financing activities. XXX

Net increase (decrease) in cash XXX

Cash at the beginning of the period XXX

Cash at the end of period XXX

EXAMPLE:

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Cash Flow Statement

ABC Company

For the year ended 200X

Cash Flow From Operations

Net Income* $200Additions(Sources of cash(

Depreciation $100

Increase in accounts payable $30

Increases in accrued income taxes $10

Subtractions (Uses of cash(

Increase in Accounts Receivable ) $150(

Increase in Inventory ) $25(

Net cash flow from operations $165

Cash Flows from Investing Activities

Equipment ) $400(

Cash Flows Associated with Financing

Activities Notes payable $30

Net change in Cash ) $205(

Methods of Computation of Operating activities:

1. Direct method2. Indirect method

Direct method:

The statement of cash flows from operating activities can be presented in a directformat, or an indirect format. The information reported for the investing and financingactivities, doesnt change. The format variable here affects only the operatingactivities cash statements.

Operating activities computation is a bit different in direct method. The direct methodfor creating a cash flow statement reports major classes of gross cash receipts and

payments. Under IAS 7, dividends received may be reported under operatingactivities or under investing activities. If taxes paid are directly linked to operatingactivities, they are reported under operating activities; if the taxes are directly linkedto investing activities or financing activities, they are reported under investing orfinancing activities.

Sample cash flow statement using the direct method

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Cash flows from operating activities

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Cash receipts from customers $27,500

Cash paid to suppliers and employees )20,000(

Cash generated from operations (sum( 7,500

Interest paid )2,000(

Income taxes paid )2,000(

Net cash flows from operating activities $3,500

Cash flows from investing activities

Proceeds from the sale of equipment 7,500

Dividends received 3,000

Net cash flows from investing activities 10,500

Cash flows from financing activities

Dividends paid )12,000(

Net cash flows used in financing activities )12,000(

.

Net increase in cash and cash equivalents 2,000

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Cash and cash equivalents, beginning of year 1,000

Cash and cash equivalents, end of year $3,000

Indirect method:

The indirect method is used more frequently simply because it is the less expensiveto use, and if you choose the direct method, you still must produce the reconciliation,which in essence is the indirect method.

The access to the information used to create a Statement of Cash Flows using theindirect method is more readily available due to one simply fact: changes in the cashaccount results in a change in one or more non-cash accounts; the changes to theseaccounts is presented on the Income Statement and the Owner Equity Statement.Then it is simply a matter of pulling information from those statements in order to

prepare the Statement of Cash Flows.

There are some rules which we need to cater for. These are as follows:-

Decrease in non-cash current assets are added to net income

Increase in non-cash current asset are subtracted from net income

Increase in current liabilities are added to net income Decrease in current liabilities are subtracted from net income

Expenses with no cash outflows are added back to net income

Revenues with no cash inflows are subtracted from net income (depreciation

expense is the only operating item that has no effect on cash flows in theperiod)

Non-operating losses are added back to net income

Non-operating gains are subtracted from net income

Cash Flow Statement

ABC Company

For the year ended 200X

Cash Flow From Operations

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Net Income* $200

Additions(Sources of cash(

Depreciation $100

Increase in accounts payable $30

Increases in accrued income taxes $10

Subtractions (Uses of cash(

Increase in Accounts Receivable ) $150(

Increase in Inventory ) $25(

Net cash flow from operations $165

Cash Flows from Investing Activities

Equipment ) $400(

Cash Flows Associated with Financing

Activities Notes payable $30

Net change in Cash ) $205(

Cash flows of operating activity in direct method:

Sources Of Cash (additions:(

Cash received from customers

Dividends received

Cash provided by operating activities

Uses Of Cash (subtractions:(

Cash paid for inventory Cash paid for insurance

Cash paid for selling expenses

Interest paid

Taxes paid

Net Cash from Operating Activities

Cash flows of investing activity:

(+) Proceeds From Sale of Assets

(-) Purchases of Property and Equipment

(=) Total Net Cash Provided (used) By Investing Activities

Cash flows from financing activity:

(+) Net Borrowing under Line Of Credit Agreement

(+) Proceeds from New Borrowings

(-) Repayment of Loans

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(-) Principal Payments under Capital Lease Obligations

(-) Dividends/distributions/withdrawals Paid

(+) Proceeds From Issuance of Stock

(+) Partner/owner Capital Contributions

(=) Total Net Cash Provided (used) By Financing Activities

KEY TERMS:

Depreciation And Amortization

Any depreciation and amortization amounts shown on the P & L statement are added

to net income. This is because a depreciation or amortization allowance has no cashcomponent. It is simply an allocation of the cost of an asset (a real asset in the case ofdepreciation or an intangible asset in the case of amortization) to an expense account.The only time cash will enter into the transaction is when the asset is sold.

When using the indirect method to compute the cash flows from operating activities,any depreciation or amortization expense must be added back to income because itwas deducted as an expense when net income was computed. (Amortization, as usedhere, is the write-off as an expense of the costs incurred to acquire an intangible asset,such as a patent or copyright.)

Accounts Receivable

If accounts receivable decreased during the time period, this means that customershave paid off some accounts, (that is, the company received cash payments) and so,net income should be increased by the amount accounts receivable decreased duringthe period. Conversely, if accounts receivables increased during the period, netincome will be reduced. This adjustment shows that net income overstates cash

because it includes both cash sales and sales on account.

Income Tax

Adjustments for increases in income tax expense are subtracted from net incomebecause, most often, income taxes will not be paid until a few months after thebeginning of the next year. While income taxes have been deducted from net incomeon the P & L statement, they actually are a future expense and do not reflect areduction in cash. So, they are added back to net income.

On the worksheet you will use to construct cash flow from operating activities usingthe indirect method, cash activities are organized as to whether they representadditions or subtraction's to cash. At this stage, it is more important that youunderstand the basic philosophy behind the changes rather than memorize how itworks. If in doubt, follow these rules. If there is an increase in income taxes payable,

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the amount of the change is added to net income. If there is a decrease in income taxespayable, the amount of the change is subtracted from net income

Inventory

If there is an increase in inventory, the amount of the change is deducted from netincome. If there is a decrease in inventory, the amount of the change is added to netincome.

Accounts Payable

If there is an increase in accounts payable, the amount of the change is added to netincome. If there is a decrease in accounts payable, the amount of the change issubtracted from net income.

Accrued Wages Payable

If there is a decrease in accrued wages payable, the amount of the change is deductedfrom net income. If there is an increase in accrued wages payable, the amount of thechange is added to net income.

Prepaid Insurance

If there is a decrease in prepaid insurance, the amount of the change is added to netincome. If there is an increase in prepaid insurance, the amount of the change is

subtracted from net income.

How to Analyze a Cash Flow Statement:

Use the Sources and Uses of Funds Worksheet to complete the indirect method cashflow worksheet for your business. Group transactions according to operating,investing, and financing activities.

Once you have constructed a cash flow statement, you will be much closer tounderstanding the financial position of your company. While a balance sheet andincome statement are tools for management, without a cash flow statement they arelimited barometers and may even be misleading.

Operating Activities:

The cash flow statement will tell you where money came from and how it was used.When analyzing cash flow, the first place to look is the cash flow from operating

activities. It tells you whether the firm generated cash or whether it needs a cashinfusion.

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A few periods of negative cash from operating activities is not by itself a reason foralarm if it is based on plans for company growth or due to a planned increase inreceivables or inventories. However, if a negative cash flow from operating activitiesis a surprise to managers and owners, it may be undesirable. Over time, ifuncorrected, it can foretell business failure. Managers and owners should pay

particular attention to increases in accounts receivable. The cash flow statement givesthe true picture of the account. A large increase in accounts receivables may warrantnew billing or collection procedures.

Investing Activities

The cash flow statement puts investing activities into perspective. At one glance, youcan see whether or not a surplus in operations is being used to "grow" the company. Alack of investing activities that is few purchases of new equipment or other assets mayindicate stagnant growth or a diversion of funds away from the company.

Financing Activities

The financing activities section of the cash flow statement will show repayments ofdebt, borrowing of funds, as well as injections of capital and the payment ofdividends. As a company expands, this area of the cash flow statement will becomeincreasingly important. It will tell outsiders how the company has grown and thefinancial strategies of management.

Together, the three sections of the cash flow statement show the net change in cashduring the period being examined. A comparison between past periods will giveowners and managers a good idea of the trend of their business. Positive trends incash flow may encourage owners to consider long-term financing as an aid to growthand increase their comfort level concerning the company's ability to generate cash forrepayment. Strong cash flow will also make it easier to acquire financing and tonegotiate with lenders from a position of strength. Preparation of a cash flowstatement is the first step toward financial management for long-term success.Prepared on a regular basis, it is a powerful tool for growth and long-term success.

Operating Activities

When you prepared the operating activities portion of the cash flow statement by

the direct method, did you also prepare it by the indirect method to reconcile netincome to cash flow from operating activities?

Has net income been adjusted for changes in accounts receivable, inventory,

accounts payable, wages payable, and income taxes?

Investing Activities

Is every cash transaction to purchase equipment or other assets represented?

If any loans were made by the company, are they reflected here?

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Financing Activities

Are all loan payments reported?

Have all cash dividends been reported?

Are there any unreported cash inflows from owners or investors?

Cash Flow Analysis

What is the trend in cash flow from operating activities for your company?

Is there a reason for any large increase in accounts receivable?

How do you expect the financing activities of your company to change in the next

year and the next two years?

Conculsion:

A company can use a cash flow statement to predict future cash flow, which helpswith matters in budgeting. For investors, the cash flow reflects a company's financialhealth: basically, the more cash available for business operations, the better. However,this is not a hard and fast rule. Sometimes a negative cash flow results from a

company's growth strategy in the form of expanding its operations.

By adjusting earnings, revenues, assets and liabilities, the investor can get a very clearpicture of what some people consider the most important aspect of a company: howmuch cash it generates and, particularly, how much of that cash stems from core

operations.

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