Cash Flow Statement

Cash flow statement

Cash flows are inflows and outflows of cash and cash equivalents. The statement of cash flow is a better tool of analysis as cash is more important than working capital and the cash flow statement provides the information about generating cash. It is through the statement of cash flows that the health and efficiency of a business entity is determined while it enables to assess the liquidity and solvency position of a business.

Why Cash Flow Statement?

Paradoxically a situation arises when profits are reported but negative cash flows are experienced by the business entities. Cash flow statement is necessary to assess the ability of a business entity to generate cash so that it can be used as and when it is needed. Moreover, it is required to assess the liquidity and solvency position of a business. The cash flow statement is an important tool as it explains the changes in cash and gives the information related to the business operating, investing and financing activities in a way to bring advantage to short term analysis and cash planning of the business.

Why Cash Flow Statement?

Executives want to know if the cash generated by the company will be sufficient to fund their expansion strategy Stockholders want to know if the firm is generating enough cash to pay dividends Suppliers want to know if their customers will be able to pay if offered credit Investors want to evaluate future growth potential Employees are interested in the overall viability of their employer as indicated by its ability to fund its operations

Cash flow statement is divided into three sections: Cash flow from operating activities: shows the results of cash inflows and outflows related to the fundamental operations of the basic line or lines of business in which the company engages. (Example: cash receipts from the sale of goods or services and cash outflows for purchasing inventory and paying rent and taxes.) Cash flow from investing activities: associated with purchases and sales of non-current assets (Example: building and equipment purchases or sales of investments or subsidiaries.) Cash flow from financing activities: associated with financing the firm (Example: selling and paying off bonds and issuing stock and paying dividends)

Preparing a cash flow statement

Cash flow statement can be prepared by two methods, direct and indirect method. Both methods provide the same results. As the direct method differs from the indirect method by the way of presentation of operating activities only. Choosing a method requires assessment of availability of data.

Preparing a cash flow statement

Direct method: shows how much cash came in for sales and how much cash went out for inventory and other operating expenditures. Indirect method: starts with net income as a figure that summarizes most of the cash transactions for operating activities in a firm. However, net income also includes transactions that are not cash and non operating, so we must eliminate the noncash and non operating transactions from the net income figure to arrive at an accurate presentation of cash flow from operating activities.

Preparing a cash flow statement

In order to prepare the statement of cash flows, balance sheet at the beginning and at the end of the period are needed as the changes related to assets, liabilities and capital can be determined. The income statement of the current year is used to provide the information about the operations by making the adjustments to the non-cash items. Besides, additional data is collected to know how cash has been used.

Basic Form of Cash Flow Statement

Cash Flow From Operating Activities
Direct method or indirect method (direct requires also a reconciliation of net income to cash flow from operating activities)

Cash Flow from investing activities Cash Flow from financing activities
Total (positive or negative) cash flow is added to beginning cash balance and should result in ending cash balance

Flow from Operating Activities

Receipts from the sale of goods or services Receipts for the sale of loans, debt or equity instruments in a trading portfolio (as a business activity) Interest received on loans given Payments to suppliers for goods and services. Payments to employees or on behalf of employees Interest payments (alternatively, this can be reported under financing activities in IAS 7, and US GAAP) buying Merchandise (Purchases)

Flow from Investing Activities

Includes: Short-term and long-term investments
Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities, etc.) Loans made to suppliers or received from customers Payments related to mergers and acquisitions. Dividends received on equity securities as investments other than the main course of business.

Flow from Financing Activities

Includes:
Short-term and long-term loans Capital Stock and Paid in Capital in excess of par Retained earnings (net income aspect is operating) Dividends Paid

General Theory
Take revenue or expense account (includes cash and accrual) adjust out accrual amounts Result is net cash in or out.
Too expensive to classify all cash transactions into operating, financing, investing activities. Cheaper to use

accrual systems and adjust out accrual information

Operating Activities Indirect Method

Net Income + Depreciation exp (noncash exp) + Losses from sale of assets
(full amount of sale already included in investing section)

- Gains from sale of assets

(full amount of sale already included in investing section)

- increases in current assets + decreases in current assets + increases in current liabilities - decreases in current liabilities = Net cash from operating activities

Operating Activities Direct Method

+ Cash Received from Customers - Cash paid for inventory - Cash paid for operating expenses - Cash paid for income taxes - Cash paid for interest + Cash received from dividends and interest = Net cash from operating activities

Cash Received from Customers

Sales - Increase in A/R (receive less cash) OR + Decreases in A/R (receive more cash) - writeoffs (beg allowance + bad debt exp. - ending allowance) + Increase in unearned revenue (receive more cash) OR - Decrease in unearned revenue (receive less cash) = Cash Received from Customers

Cash Received from Customers (other variations)

Sales + Beg Net A/R - End Net A/R - Bad debt exp adj - Beg unearned rev + End undearned rev = Cash from Customers Sales + Beg A/R - End A/R - writeoffs
= beg allowance + bad debt exp. - ending allowance

- Beg unearned rev + End unearned rev = Cash from Customers

Cash Paid For Inventory

Cost of Goods Sold + End Inventory - Beginning Inventory = Purchases + Beg A/P - End A/P = Cash paid for inventory

Cash Paid for Operating Expenses

Operating Expenses (do not include interest

exp., depreciation exp., nor gains & losses from sale of investments) - Beg prepaids + End prepaids + Beg accrued exp - End accrued exp = Cash paid for operating expenses

Cash Paid for Income Taxes

Income Tax Exp + Beg tax payable - End tax payable = Cash paid for income Taxes

Cash Paid for Interest

Interest Exp + Beg interest payable - End interest payable = Cash paid for interest

Cash Received from dividends and interest

Dividend and Interest Income + Begining interest receivable - End interest receivable = Cash Received from dividends and interest

Cash Flow from Investing Activities

Cash received (sale) or paid (purchase) for:
short term investments long-term investments property plant and equipment

Whole cash amount received or paid. Look at change in investment and fixed asset accounts but may need more specific information

Financing Activities
Cash received from:
sale of stock issuance of debt Issue of shares

Cash paid for

Payment of debt Payment of dividends

Look at change in stock, debt and retained earnings (for R/E

only dividends portion applies to financing activities while net income portion should tie into indirect method in operating activities)

Ways to Check Your Work

Indirect and Direct methods must equal each other Net cash flow added to beginning cash balance must equal ending cash balance (Marketable
securities are most often included as part of these cash balances.)

Account for every change in B/S accounts and every item on income statement (some noncash items are adjusted out or not included in cash flow calculations)