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StIce | StIce |Skousen
Statement of Cash Flows
and Articulation
Chapter 5
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
1. Describe the circumstances in which
the cash flow statement is a
particularly important companion of
the income statement.
2. Outline the structure of and
information reported in the three
main categories of the cash flow
statement: operating, investing, and
financing.
Learning Objectives (cont.)
3. Compute cash flow from operations
using either the direct or the indirect
method.
4. Prepare a complete statement of
cash flows and provide the required
supplemental disclosures.
5. Assess a firm’s financial strength by
analyzing the relationships among
cash flows from operating, investing,
and financing activities and by
computing financial ratios.
Learning Objectives (cont.)
6. Demonstrate how the three primary
financial statements tie together, or
articulate, in a unified framework.
7. Use knowledge of how the three
primary financial statements tie
together to prepare a forecasted
statement of cash flows.
Why Do We Need the Cash Flow
Statement?
• It explains the change during the
period on cash and cash
equivalents.
• Sometimes earnings fail.
• Everything is on one page.
• It is used as a forecasting tool.
Cash Equivalents
• To qualify as a cash equivalent:
1. The item must be readily convertible
to cash.
2. It must be so near to its maturity
that there is insignificant risk of
change in value due to changes in
interest rate.
Cash Flow Activities
• Operating Activities -Transactions and
events that enter into the determination
of net income.
• Investing Activities -Transactions and
events that involve the purchase and sale
of securities, property, plant, equipment,
and other assets not generally held for
resale, and the making and collecting of
loans.
• Financing Activities -Transactions and
events whereby resources are obtained
from or repaid to owners and creditors.
Cash Flow Pattern
• The normal pattern of positive
inflows or negative outflows of cash
reported are as follows:
– Cash from operating activities, +
– Cash from investing activities, −
– Cash from financing activities, + or −
Noncash Transactions
• There are investing and financing
activities that do not affect cash.
• Significant transactions should be
disclosed separately.
• These transactions do not affect the
statement of cash flows.
Operating Activities Section
• Simple concept: difference between
cash received and cash disbursed.
• Two methods to report operating
activities:
– Direct Method- shows cash receipts and
payments for a period of time. This
method is more straight forward.
– Indirect Method- involves reconciling net
income to a cash basis. It shows how
noncash flows affect net income.
Direct Method
• This method reports directly the major
classes of operating cash receipts and
payments of an entity during a period.
• Accrual basis revenues and expenses
must be converted to equivalent cash
receipts and payments.
• The amount of cash actually collected
or paid is determined.
Indirect Method
The indirect method makes the
following adjustments:
• Adjustments for receivables and
other current operating assets.
• Adjustments for payables and other
current liabilities.
• Adjustments for depreciation and
other noncash items.
• Adjustments for gains and losses.
Operating Activities
Cash Inflow
Cash
Outflow
• Cash receipt of
sales
• Inventory payments
• Collection of • Interest payments
receivables
• Wages
• Interest revenue
• Utilities
• Dividend revenue
• Rent
Investing Activities
Cash Inflow
Cash Outflow
• Sale of plant
• Purchase of plant
assets
• Sale of securities,assets
• Purchase of securities,
other than
trading securitiesother than trading
securities
• Collection of
• Making of loans with
principal on loans
other entities
Financing Activities
Cash Inflow
• Issuance of
own stock
• Borrowings
Cash Outflow
• Dividend
payments
• Repaying
principal on
borrowing
• Treasury Stock
purchase
General Format of a Cash Flow
Statement
Cash Provided by (Used for):
Operating Activities
$XXX
Investing Activities
XXX
Financing Activities
XXX
Net Increase (Decrease) in Cash $XXX
Cash—Beginning of Year
XXX
Cash—End of Year
$XXX
Six Step Process to Prepare a
Cash Flow Statement
1. Compute how much the cash balance
changed during the year.
2. Convert the income statement from an
accrual-basis to a cash-basis summary of
operations.
a. Eliminate expenses that do not involve the
outflow of cash, such as depreciation.
b. Eliminate gains and losses associated with
investing or financing activities.
c. Adjust for changes in the balances of current
assets and current liabilities.
Six Step Process to Prepare a
Cash Flow Statement
3. Analyze the long-term assets to identify the
cash flow effects of investing activities.
4. Analyze the long-term debt and
stockholders’ equity account to determine
the cash flow effects of any financing
transactions.
5. Make sure that the total new cash flow from
operating, investing, and financing activities
is equal to the net increase or decrease in
cash as computed in Step 1, then prepare a
formal statement.
6. Prepare supplement disclosure of
significant noncash transactions.
International Cash Flow
Statements
In 1987, the United
States led the world
concerning the
statement of cash
flows by issuing SFAS
No. 95.
International Cash Flow
Statements
• Operating activities
• Returns on investments
and servicing of finance
• Taxation
• Capital expenditures
and financial investment
In 1991, the United
• Acquisition and disposal
Kingdom issued FRS 1. • Equity dividend paid
It specified eight
• Management of liquid
categories for
resources
classifying cash flows. • Financing
Assessing Financial Strength
Cash flow-to-net income
Cash from operations
Net income
• Measure of earnings quality
• Tends to be greater than 1
• Should remain fairly stable for the
years for a specific company
Assessing Financial Strength
Cash flow adequacy
Cash from operations
Net income
• Measures relationship between investment
spending and cash generated by operations
• Indicate a company’s attitude towards
reinvestment in long-lived production assets
• When ratio is small it indicates that cash
flows from operations fall short of funding
growth
Assessing Financial Strength
Cash times interest
earned
Cash from operations + Interest paid +
Taxes paid
Interest expense
• Measures ability to service debt
• Generally, a higher ratio indicates
more solvency
Forecasted Statement of Cash
Flows
Six Steps
1. Compute the change in cash.
2. Convert the income statement
from an accrual to cash basis.
3. Analyze the long-term asset
accounts.
4. Analyze the long-term debt and
stockholders’ equity.
5. Prepare the forecasted
statement of cash flows.
6. Disclose noncash activities.