Accounting

Principles

Second Canadian Edition

Weygandt Kieso Kimmel
Trenholm

Prepared by:
Carole Bowman, Sheridan College

CHAPTER

18
CASH FLOW STATEMENT

PURPOSE OF THE
CASH FLOW STATEMENT
The primary purpose of the cash flow
statement is to provide information about
the cash receipts and cash payments of an
entity during a period.
A secondary objective is to provide
information about its
Operating activities
Investing activities
Financing activities

MEANING OF CASH FLOWS

The cash flow statement is usually prepared
using cash and cash equivalents as its basis.
Cash equivalents are short-term, highly liquid
investments that are both
1. readily convertible to known amounts of
cash, and
2. so near to their maturity that their market
value is relatively insensitive to changes in
interest rates.

CLASSIFICATION OF CASH
FLOWS
Operating activities
Investing activities
Financing activities

OPERATING ACTIVITIES

Include
Cash effects of transactions that create
revenues and expenses and
Enter into determination of net income (loss)

Balance Sheet: Noncash

Current Assets and Current
Liabilities; Income Statement
Items

INVESTING ACTIVITIES

Include
Purchasing and disposing of investments
and productive long-lived assets using
cash and
Lending money and collecting the loans

Balance Sheet: Investment

and Long-Term Asset Items

FINANCING ACTIVITIES

Include
Obtaining cash from issuing debt and
repaying the amounts borrowed and
Obtaining cash from owners/shareholders
and paying them drawings/dividends

Balance Sheet: Long-Term

Liability and Equity Items

SIGNIFICANT NONCASH
ACTIVITIES
If it does not affect cash, do NOT report in
body of cash flow statement
Report in separate note to the financial
statements

ILLUSTRATION 18-2

FORMAT OF CASH FLOW STATEMENT

Operating, investing,
and financing plus
the significant
noncash investing
and financing
activities constitute
the general format of
the cash flow
statement, an
example of which is
shown on the right.

COMPANY NAME
Cash Flow Statement
Period Covered
Cash flows from operating activities
(List of individual items)
Net cash provided (used) by operating activities
XXX
Cash flows from investing activities
(List of individual items)
Net cash provided (used) by investing activities
XXX
Cash flows from financing activities
(List of individual items)
Net cash provided (used) by financing activities
XXX
Net increase (decrease) in cash
XXX
Cash at beginning of period
XXX

XX

XX

XX

PREPARING
THE CASH FLOW STATEMENT
The cash flow statement is prepared differently from
the three other basic financial statements.
1. It is not prepared from the adjusted trial balance.
2. The cash flow statement deals with cash receipts
and payments, so the accrual concept is not used
in the preparation of this statement.
The information to prepare this statement usually
comes from three sources:
1. Comparative balance sheet
2. Current income statement
3. Additional information

ILLUSTRATION 18-3

THREE MAJOR STEPS IN PREPARING

THE CASH FLOW STATEMENT
Step 1: Determine the net increase (decrease) in cash.

The difference between the

beginning and ending cash
balances can be easily calculated
from comparative balance sheets.

+ or -

Step 2: Determine net cash provided (used) by operating activities.

This step involves analysing not only the current

years income statement but also comparative
balance sheets and selected additional data.

XYZ
Goods

Step 3: Determine net cash provided (used) by investing and financing activities.

This step involves analysing

comparative balance sheet data
and selected additional information
for their effects on cash.

For
Sale

Investing

Financing

STEP 1: DETERMINE NET INCOME

(DECREASE) IN CASH

STEP 2: DETERMINE NET CASH

PROVIDED (USED) BY OPERATING
ACTIVITIES
Net income must be converted from an
accrual basis to a cash basis in the
operating activities section
Conversion may be done by two methods:
Indirect (used extensively in practice)
Direct

INDIRECT AND DIRECT METHODS

Both methods arrive at the same total
amount of cash provided (used) by
operating activities
Methods differ in disclosing the items that
make up the total amount
Choice of methods affects only the
operating activities section; the investing
and financing activities sections are the
same

OPERATING ACTIVITIES INDIRECT

METHOD

Section
Section 11

ILLUSTRATION 18-6

NET INCOME VS. NET CASH PROVIDED

BY OPERATING ACTIVITIES
The indirect method starts with net income and converts it to net cash
provided by operating activities. In other words, it adjusts net income
for items that affect reported net income but do not affect cash, as
shown below.
Accrual Basis of Accounting

Eliminate noncash revenues

Earned
Revenues

Net Income

Incurred
Expenses

Cash Basis of Accounting

Net Cash Provided

(Used) by Operating
Activities

Eliminate noncash expenses

NET INCOME TO NET CASH PROVIDED (USED) BY

OPERATING ACTIVITIES
(B/S: Noncash Current Assets and Current Liabilities)

Adjustments to Convert Net Income

to Net Cash Provided (Used) by
Operating Activities
Add*
Deduct*
Change in Current Asset Account Balance
Accounts receivable
Decrease
Increase
Inventory
Decrease
Prepaid expenses
Decrease
Other current assets
Decrease
Increase
Change in Current Liability Account Balance
Accounts payable
Increase
Accrued expenses payable
Increase
Decrease
Other current liabilities
Increase
Decrease

Increase
Increase

Decrease

NET INCOME TO NET CASH PROVIDED (USED) BY

OPERATING ACTIVITIES
(I/S: Noncash Items)

Adjustments to Convert Net

Income to Net Cash Provided
(Used) by Operating
Activities
Noncash Items on Income Statement
Amortization (of capital assets) expense
Add
Amortization of bond discount to interest expense
Add
Amortization of bond premium to interest expense
Deduct
Loss on sale of asset
Gain on sale of asset
Deduct
Income from long-term equity investment

Add

NET CASH PROVIDED (USED) BY

OPERATING ACTIVITIES
Indirect Method
Sample Format
Computer Services Corporation
Cash Flow Statement - Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable
(30,000)
Increase in inventory
(25,000)
Increase in accounts payable
15,000
Increase in accrued expenses payable
4,000
Net cash used by operating activities

35,000

(36,000)
(1,000)

OPERATING ACTIVITIES
DIRECT METHOD

Section
Section 22

CASH RECEIPTS AND CASH PAYMENTS

(Direct Method)

CASH RECEIPTS FROM

CUSTOMERS
The relationships among cash receipts from
customers, revenues from sales, and
changes in accounts receivable is:

Cash
receipts from
customers

Revenues
from sales

+ Decrease in accounts receivable

or
Increase in accounts
receivable

CASH PAYMENTS TO SUPPLIERS

The relationship among cash payments to
suppliers, cost of goods sold, changes in
inventory, and changes in accounts payable
is:
Cash
payments
to suppliers

=
Cost of
goods sold

+ Increase in inventory
or

Decrease in inventory

+ Decrease in accounts payable

or
Increase in accounts
payable

CASH PAYMENTS FOR OPERATING

EXPENSES
The relationship among cash payments for
operating expenses, changes in prepaid
expenses, and changes in accrued expenses
payable is:
Cash
payments
for services

=
Operating
dxpenses

+ Increase in prepaid
+ Decrease in accrued expenses
expenses
or
payable
Decrease in
or
prepaid expenses
Increase in accrued

CASH PAYMENTS FOR INCOME TAX

The relationships among cash payments for
income tax, income tax expense, and
changes in income tax payable is:

Cash
payments for
income tax

Income
tax
expense

+ Decrease in income tax payable

or
Increase in income tax
payable

NET CASH PROVIDED (USED) BY

OPERATING ACTIVITIES
Direct Method
Sample Format
COMPUTER SERVICES CORPORATION
Cash Flow Statement Direct Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Cash receipts from customers
Cash payments:
To suppliers
For operating expenses
For income tax
Net cash used by operating activities

$12
($75,000)
(36,000)
(10,000) (121,000)

STEP 3: DETERMINE NET CASH

PROVIDED (USED) BY INVESTING AND
FINANCING ACTIVITIES

NET CASH PROVIDED (USED) BY

INVESTING ACTIVITIES
Study the balance sheet to determine changes
in investments and long-term assets
Changes in each short-term investment
(unless incorporated as part of cash
definition) and long-term account are
analysed using selected transaction data to
determine the effect, if any, the changes had
on cash

NET CASH PROVIDED (USED) BY

FINANCING ACTIVITIES
Study the balance sheet to determine
changes in noncurrent liabilities and
owners/shareholders equity
Changes in each noncurrent account are
analysed using selected transaction data
to determine the effect, if any, the
changes had on cash

ILLUSTRATION 18-8

CASH FLOW STATEMENT

INDIRECT METHOD
COMPUTER SERVICES COMPANY
Cash Flow Statement Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable
Increase in inventory
Increase in accounts payable
Increase in accrued expenses payable
Net cash used by operating activities
Cash flows from investing activities
Purchase of equipment
Net cash used by investing activities
Cash flows from financing activities
Issue of common shares
Payment of cash dividend
Net cash provided by financing activities
Net increase in cash
Cash, January 1
Cash, December 31

$ 35,000

$ (30,000)
(25,000)
15,000
4,000

(36,000)
(1,000)

$ (10,000)
(10,000)
$ 60,000
(15,000)
45,000
34,000
$ 34,000

Operating
activities used
$1,000 cash and
investing
activities used
$10,000 cash,
while financing
activities
provided
$45,000 cash.

ILLUSTRATION 18-23

CASH FLOW STATEMENT

DIRECT METHOD
COMPUTER SERVICES CORPORATION
Cash Flow Statement
For the Year Ended December 31, 2002

Cash flows from operating activities

The cash flow
Cash receipts from customers
$120,000
statement
Cash payments:
To suppliers
shows that
$(75,000)
For operating expenses
(36,000)
operating
For income tax
activities used (10,000) (121,000)
Net cash provided by operating activities$1,000 cash
(1,000)
Cash flows from investing activities
and investing
Purchase of equipment
activities used $(10,000)
Net cash used by investing activities
(10,000)
$10,000 cash,
Cash flows from financing activities
while
Issue of common shares
$ 60,000
financing
Payment of cash dividends
(15,000)
activities
Net cash provided by financing activities
45,000
provided
Net increase in cash
34,000
$45,000 cash.
Cash, January 1
0
Cash, December 31
$ 34,000

USING CASH FLOWS TO EVALUATE

COMPANY
Liquidity
Cash current debt coverage ratio

Profitability
Cash return on sales ratio
Cash flow per share

Solvency
Cash total debt coverage

These ratios are cash-based instead

of accrual-based

CASH CURRENT DEBT COVERAGE

Cash current debt coverage indicates the amount
of cash to pay off current debt that is generated
from operating activities.
The ratio provides a better picture of liquidity
than using the current ratio because it uses cash
provided by operating activities rather than the
year-end asset balance.
Cash
Provided
by
Operating
Activities

Average
Current
Liabilities

Cash
Current
Debt
Coverage

CASH RETURN ON SALES

Cash return on sales indicates how quickly
sales are turned into cash.
The company is efficient at turning sales
into cash when its cash return on sales is
greater than its accrual-based counterpart,
the profit margin.
Cash
Provided
by
Operating
Activities

Net Sales

Cash
Return
on Sales

CASH FLOW PER SHARE

Cash flow per share indicates the cash flow
generated for each common share.

Cash Flow
from
Operating,
Investing, and
Financing
Activities

Number of
Common
Shares

Cash Flow per

Share

CASH TOTAL DEBT COVERAGE

Cash total debt coverage indicates the
amount of cash to pay off total debt that is
generated from operating activities.
The ratio is the cash based counterpart to
the debt to total assets ratio.
Cash
Provided
by
Operating
Activities

Average
Total
Liabilities

Cash Total
Debt
Coverage

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