Chapter 14

The Statement of
Cash Flows

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Learning Objectives

1. Identify the purposes of

the statement of cash
flows and distinguish
among operating,
investing, and financing
cash flows
2. Prepare the statement of
cash flows by the indirect
method

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Learning Objectives

3. Use free cash flow to

evaluate business
performance
4. Prepare the statement of
cash flows by the direct
method (Appendix 14A)
5. Prepare the statement of
cash flows by the indirect
method using a
spreadsheet (Appendix
14B)

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Learning Objective 1

Identify the purposes of the

statement of cash flows and
distinguish among operating,
investing, and financing cash
flows

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What Is the Statement of Cash Flows?

• The statement of cash flows reports on a

business’s cash receipts and cash
payments for a specific period.
• This statement does the following:
– Reports on the cash flows of a business
– Reports why cash increased or decreased
during the period
– Covers a span of time and is dated the same
as the income statement

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 Purpose of the Statement of Cash
Flows
• The statement of cash flows explains why
net income as reported on the income
statement does not equal the change in
the cash balance.
• The statement of cash flows helps:
– Predict future cash flows
– Evaluate management
– Predict ability to pay debts and dividends

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 Classification of Cash Flows

• There are three basic types of cash flows,

and the statement of cash flows has a
section for each:
– Operating activities
– Investing activities
– Financing activities

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 Operating Activities

• Operating activities is the first section on

the statement of cash flows.
• This section reports on activities that
create revenue or expense in the entity’s
business.
• This is often the most important category.

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 Investing Activities

• Investing activities is the second category

listed on the statement of cash flows.
• This section reports cash receipts and cash
payments that increase or decrease
long-term assets.
• It includes the cash inflow from selling and
the cash outflow from purchasing
long-term assets.

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 Financing Activities

• Financing activities is the last category

listed on the statement of cash flows.
• Financing activities include cash inflows
and outflows involved in long-term
liabilities and equity.
• Financing activities include issuing stock,
paying dividends, and buying and selling
treasury stock.

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Classification of Cash Flows

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 Non-cash Investing and Financing
Activities
• Companies make investments that do not
require cash.
• Such transactions are called non-cash
investing and financing activities.
• These activities appear as a separate
schedule at the bottom of the statement
of cash flows or in the notes to the
financial statements.

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Non-cash Investing and Financing
Activities

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Two Formats for Operating Activities

Indirect Direct
method method
Starts with
Restates the
accrual income
income in terms
and adjusts to
of cash
net cash

Uses account
Shows actual
relationships to
cash receipts
determine
and cash
changes in
payments
cash
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Learning Objective 2

Prepare the statement of

cash flows by the indirect
method

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How Is the Statement of Cash Flows
Prepared Using the Indirect Method?
• Items needed:
– Income statement for the current year
– Balance sheet for current year
– Balance sheet from prior year
– Additional information based on review of
transactions

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 How Is the Statement of Cash Flows
Prepared Using the Indirect Method?
• Prepare in five steps:
1. Complete the cash flows from operating
activities.
2. Complete the cash flows from investing
section.
3. Complete the cash flows from financing
section.
4. Compute the change in cash.
5. Prepare a schedule for non-cash activities.

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 How Is the
Statement of
Cash Flows
Prepared
Using the
Indirect
Method?

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 How Is the
Statement of
Cash Flows
Prepared Using
the Indirect
Method?

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 How Is the
Statement of
Cash Flows
Prepared Using
the Indirect
Method?

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 Cash Flows from Operating Activities

• When using the indirect method, the

operating activities section begins with
accrual-basis net income or loss, which
needs to be adjusted to a cash number.
• For example:
– Sales on account generate revenues that
increase net income, but the company has not
yet collected cash from those sales.
– Accrued expenses decrease net income, but
the company has not yet paid cash.

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 Depreciation, Depletion, and
Amortization Expenses
• Depreciation, depletion, and amortization
expenses are added back to net income to
reconcile net income to net cash flow from
operating activities.

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 Gains and Losses on the Disposal of
Long-Term Assets
• Disposals from long-term assets create a
gain or loss that must be removed from
net income, which is in the operating
activities section.

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Changes in Current Assets and Current
Liabilities
• Most current assets and current liabilities
result from operating activities.

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Evaluating Cash Flows from Operating
Activities
• The operating activities section starts with accrual
net income, and then adjustments are made to
reconcile net income to net cash.

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Evaluating Cash Flows from Operating
Activities

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 Cash Flows from Investing Activities

• Investing activities affect long-term

assets, such as:
– Plant assets
– Investments
– Notes receivable
• It is helpful to evaluate the T-accounts for
each long-term asset to determine if there
was an acquisition or disposal.

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 Cash Flows from Investing Activities

• Use the information available to determine

the cash received from an asset disposal:

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Cash Flows from Investing Activities

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 Cash Flows from Financing Activities

• Financing activities affect the long-term

liability and equity accounts:
– Long-Term Notes Payable
– Bonds Payable
– Common Stock
– Retained Earnings

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 Cash Flows from Financing Activities

• If the amount of cash dividend payments

is not readily available, the Retained
Earnings account can be used to
determine dividend payments.

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Cash Flows from Financing Activities

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Net Change in Cash and Cash Balances

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 Non-cash Investing and Financing
Activities
• The last step is to prepare the non-cash
investing and financing activities section.

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Learning Objective 3

Use free cash flow to

evaluate business
performance

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How Do We Use Free Cash Flow to
Evaluate Business Performance?
• Investors want to know how much cash a
company can “free up” for new
opportunities.
• Free cash flow is the amount of cash
available from operating activities after
paying for planned investments in
long-term assets and after paying
dividends.

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How Do We Use Free Cash Flow to
Evaluate Business Performance?
• ShopMart expects net cash provided by
operations of $200,000. It plans to spend
$160,000 to modernize its retail facilities
and pays $15,000 in cash dividends.

• ShopMart’s free cash flow is $25,000:

($200,000 ‒ $160,000 ‒ $15,000)

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Learning Objective 4

Prepare the statement of

cash flows by the direct
method (Appendix 14A)

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 How Is the Statement of Cash Flows
Prepared Using the Direct Method?
• The Financial Accounting Standards Board
(FASB) prefers the direct method of
reporting cash flows from operating
activities.
• This method provides clearer information
about the sources and uses of cash than
the indirect method.
• Only the operating section differs between
the two methods.

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 Cash Flows from Operating Activities

• Cash collections from customers:

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 Payments to Suppliers

• Cash paid for inventory is calculated as

follows:

• Cash paid for operating expenses is

calculated as follows:

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Payments to Suppliers

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 Net Cash Provided by Operating
Activities
• To calculate net cash provided by
operating activities using the direct
method, we add all the cash receipts and
cash payments.
• Net cash provided by operating activities
is $70,000, which is the same amount
found under the indirect method.

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 Net Cash
Provided by
Operating
Activities

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How Is the Statement of Cash Flows Prepared Using
the Indirect Method and a Spreadsheet?

• Most companies use a spreadsheet to

prepare the statement of cash flows.
• This statement starts with the beginning
balance sheet and concludes with the
ending balance sheet.
• Columns labeled “Transaction Analysis”
hold the data for the statement of cash
flows.

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How Is the Statement of Cash Flows Prepared Using
the Indirect Method and a Spreadsheet?

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How Is the Statement of Cash Flows Prepared Using
the Indirect Method and a Spreadsheet?

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