Course title

Advanced Accounting

Submitted by
Name Iqra Nawaz
Roll no 26

Class Bs commerce
Semester 4th

Submitted to
Mam Rubab Anum

Government College for Women Madina Town

 Defining the Statement of Cash Flows
A statement of cash flows is a financial statement
showing how changes in balance sheet accounts
and income affect cash & cash equivalents.
LEARNING OBJECTIVES
Indicate the purpose of the statement of cash flows
and what items affect the balance reported on the
statement
 KEY TAKEAWAYS

Key Points
In financial accounting, a cash flow statement is a
financial statement that shows how changes in
balance sheet accounts and income affect cash and
cash equivalents and breaks the analysis down to
operating, investing, and financing activities.
People and groups interested in cash flow statements
include: (1) Accounting personnel, (2) potential
lenders or creditors, (3) potential investors, (4)
potential employees or contractors, and (5)
shareholders of the business.
 Key Terms
Solvency:
The state of having enough funds or liquid assets to pay all of
one’s debts; the state of being solvent.
Liquidity:
An asset’s property of being able to be sold without affecting
its value; the degree to which it can be easily converted into
cash.
The statement captures both the current operating results
and the accompanying changes in the balance sheet. As an
analytical tool, the statement of cash flows is useful in
determining the short-term viability of a company,
particularly its ability to pay bills.
People and groups interested in cash flow statements
include: (1) Accounting personnel who need to know
whether the organization will be able to cover payroll and
other immediate expenses, (2) potential lenders or creditors
who want a clear picture of a company’s ability to repay, (3)
potential investors who need to judge whether the company
is financially sound, (4) potential employees or contractors
who need to know whether the company will be able to
afford compensation, and (5) shareholders of the business.
Components of the Statement of Cash Flows
The cash flow statement has 3 parts: operating,
investing, and financing activities. There can also be a
disclosure of non-cash activities.
LEARNING OBJECTIVES
Recognize how operating, investing and financing
activities influence the statement of cash flows
Key Points
Operating activities include the production, sales, and
delivery of the company’s product as well as
collecting payments from its customers.
Investing activities are purchases or sales of assets
(land, building, equipment, marketable securities, etc.
), loans made to suppliers or received from
customers, and payments related to mergers and
acquisitions
Key Terms
Non-cash financing activities:
Non-cash financing activities may include leasing to
purchase an asset, converting debt to equity,
exchanging non-cash assets or liabilities for other
non-cash assets or liabilities, and issuing shares in
exchange for assets.
Components of the Cash Flow Statement
In financial accounting, a cash flow statement, also
known as statement of cash flows or funds flow
statement, is a financial statement that shows how
changes in balance sheet accounts and income affect
cash and cash equivalents, and breaks the analysis
down to operating, investing, and financing activities.
The cash flow statement is partitioned into three
segments, namely:
Cash flow resulting from operating activities
Cash flow resulting from investing activities
Cash flow resulting from financing activities.
It also may include a disclosure of non-cash financing
activities
Cash Flow from Financing
Cash flows from financing activities arise from the
borrowing, repaying, or raising of money.
LEARNING OBJECTIVES
Distinguish financing activities that affect a company’s cash
flow statement from all of the business’s other
transactions
Key Points
Financing activities can be seen in changes in non-current
liabilities and in changes in equity in the change-in-equity
statement.
A positive financing cash flow could be really great for a
company (it just went issued stock at a great price) or
could be due to the company having to take out loans to
stay out of bankruptcy.
Key Terms
Financing:
A transaction that provides funds for a business.
Financing activities:
Actions where money is flowing between the
company and investors in the company, such as banks
and shareholders
Financing Activities
One of the three main components of the cash flow
statement is cash flow from financing. In this context,
financing concerns the borrowing, repaying, or raising
of money. This could be from the issuance of shares,
buying back shares, paying dividends, or borrowing
cash. Financing activities can be seen in changes in
non-current liabilities and in changes in equity in the
change-in-equity statement.
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Cash Flow from Investing:
Cash flow from investing results from activities related to
the purchase or sale of assets or investments made by
the company.
LEARNING OBJECTIVES
Distinguish investing activities that affect a company’s
cash flow statement from the business’s other
transactions
Key Points
Assets included in investment activity include land,
buildings, and equipment.
Receiving dividends from another company’s stock is an
investing activity, although paying dividends on a
company’s own stock is not.
Some examples of investment activity from the company’s
perspective would include:
Cash outflow from the purchase of an asset (land, building,
equipment, etc.).
Cash inflow from the sale of an asset.
Cash outflow from the acquisition of another company.
Cash inflow resulting from a merger.
Cash inflow resulting dividends paid on stock owned in
another company.
It is important to remember that, as with all cash flows, an
investing activity only appears on the cash flow statement
if there is an immediate exchange of cash. Therefore,
extending credit to a customer (accounts receivable) is an
investing activity, but it only appears on the cash flow
statement when the customer pays off their debt.
Cash Flow from Operations
The operating cash flows refers to all cash flows that have
to do with the actual operations of the business, such as
selling products.
 LEARNING OBJECTIVES
Distinguish events that would affect the operating
section of the cash flow statement from all of the
business’s other transaction
Key Points
Operating cash flows refers to the cash a company
generates from the revenues it brings in, excluding
costs associated with long-term investment on capital
items or investment in securities (these are investing
or financing activities).
GAAP and IFRS vary in their categorization of many
cash flows, such as paying dividends. Some activities
that are operating cash flows under one system are
financing or investing in another.
Key Terms
IFRS: International Financial Reporting Standards. The
major accounting standards system used outside of the
United States.
GAAP: Generally Accepted Accounting Principles refer
to the standard framework of guidelines, conventions,
and rules accountants are expected to follow in
recording, summarizing, and preparing financial
statements in any given jurisdiction.
The operating cash flows component of the cash flow
statement refers to all cash flows that have to do with
the actual operations of the business. It refers to the
amount of cash a company generates from the
revenues it brings in, excluding costs associated with
long-term investment on capital items or investment in
securities (these are investing or financing activities).
Essentially, it is the difference between the cash
generated from customers and the cash paid to
suppliers.
 Interpreting Overall Cash Flow
Having positive and large cash flow is a good sign for
any business, though does not by itself mean the
business will be successful.
LEARNING OBJECTIVES
Explain the significance of each component of the
Cash Flow Statement
KEY TAKEAWAYS
Key Points
The three types of cash flow are cash from from
operations, investing, and financing.
Having positive cash flows is important because it
means that the company has at least some liquidity
and may be solvent.
Key Terms
Free cash flow: net income plus depreciation and
amortization, less changes in working capital, less
capital expenditure
cash flow: The sum of cash revenues and
expenditures over a period of time.
What is a Cash Flow Statement?
In financial accounting, a cash flow statement (also
known as statement of cash flows or funds flow
statement) is a financial statement that shows how
changes in balance sheet accounts and income affect
cash and cash equivalents
Relationship to Other Financial Statements
When preparing the cash flow statement, one must
analyze the balance sheet and income statement for
the coinciding period. If the accrual basis of
accounting is being utilized, accounts must be
examined for their cash components. Analysts must
focus on changes in account balances on the balance
sheet. General rules for this process are as follows.
Transactions that result in an increase in assets will
always result in a decrease in cash flow.
Transactions that result in a decrease in assets will
always result in an increase in cash flow.
 Interpretation
An analyst looking at the cash flow statement will first
care about whether the company has a net positive
cash flow. Having a positive cash flow is important
because it means that the company has at least some
liquidity and may be solvent.
Regardless of whether the net cash flow is positive or
negative, an analyst will want to know where the cash
is coming from or going to. The three types of cash
flows (operating, investing, and financing) will all be
broken down into their various components and then
summed. The company may have a positive cash flow
from operations, but a negative cash flow from
investing and financing. This sheds important insight
into how the company is making or losing money.
 Free Cash Flows
Free cash flow is a way of looking at a business’s cash
flow to see what is available for distribution among all
the securities holders of a corporate entity. This may
be useful when analysts want to see how much cash
can be extracted from a company without causing
issues to its day to day operations.
The free cash flow can be calculated in a number of
different ways depending on audience and what
accounting information is available. A common
definition is to take the earnings before interest and
taxes, add any depreciation and amortization, then
subtract any changes in working capital and capital
expenditure.
Limitations of the Statement of Cash Flows
The statement of cash flows is a useful tool in
identifying organizational liquidity, but has limitations
when it comes to non-cash reporting.
LEARNING OBJECTIVES
Understand how the statement of cash flows should
be used, and what information it doesn’t provide as
well
KEY TAKEAWAYS
Key Points
Like all financial statements, the statement of cash
flows is useful in viewing the organization from a
given perspective. This perspective is useful in some
ways and limited in others.
The statement of cash flows primarily focuses on the
change in overall available cash and cash equivalents
from one time period to the next ( liquidity ).
Purpose of Cash Flow Statements
Cash flow statements are useful in determining
liquidity and identifying the amount of capital that is
free to capture existing market opportunities. As one
of the core financial statements publicly traded
organizations release to the public, it is also useful as
a benchmark for investors when considering the
capacity for different organizations within an industry
to adapt and capture new opportunities.
In short, we can summarize what cash flows are
used for as:
Measure liquidity and the capacity to change cash
flows in future circumstances
Provide additional information for evaluating changes
in assets, liabilities, and equity
Limitations
However, there can be a number of issues with utilizing
the statement of cash flows as an investor speculating
about different organizations. The simplest drawback to a
cash flow statement is the fact that cash flows can (but not
always) omit certain types of non-cash transactions. As the
name implies, the statement of cash flows is focused
exclusively on tangible changes in cash and cash
equivalents.
Regulation
However, to offset some of this, governments have
enacted various requirements on the statement of cash
flows to limit any information that may be misleading. The
primary pieces of legislation are the Generally Accepted
Accounting Principles (GAAP) cash flow requirements
(1973) and, later on (1992), the International Accounting
Standards 7 (IAS 7). A few key points include:
Under IAS 7, cash flow statement must include changes in
both cash and cash equivalents. US GAAP permits using
cash alone or cash and cash equivalents.
The Direct Method
The direct method lists the individual sources and uses of
cash. Typical line items include cash received from
customers, cash paid to suppliers, cash paid for wages,
etc.
Consider E3-18
Popovich Co. had the following transactions during June.
a.$20,000 of supplies were purchased with cash
b.$6,000 of supplies were consumed.
c. $60,000 of merchandise was sold. 40% of the sales
were on credit. The merchandise cost Popovich
$28,000.
d.$200,000 was borrowed from a bank
e. Interest of $2,000 was incurred and paid
f. $100,000 of equipment was purchased by issuing a
note payable.
g.$4,000 of equipment value was consumed.
We could construct the following statement of cash flow:
Cash Flow from Operations:
Cash received from customers
$36,000
Cash paid for supplies
(20,000)
Cash paid for interest
(2,000)
Cash provided by operations
14,000
Cash flow for investments
0
Cash flow from financing activities:
New bank borrowings
$200,000
Net cash flow
$214,000
For example, assume the following data from the firm’s
accrual based accounting system (all sales are credit sales);
Accounts Receivable 1/1/00 $400,000
Accounts Receivable 12/31/00 $450,000
2000 Sales
$3,000,000
How much cash did the firm receive from customers?
First, consider the entries used to record credit sales and
the
collection of cash.
Dr. Accounts Receivable
Cr. Sales
Dr. Cash
Cr. Accounts Receivable
Debits to accounts receivable result from sales
transactions,
Therefore:
Beginning Accounts Receivable
+ Credit Sales
- Cash Received
= Ending Accounts Receivable
OR
Cash Received = Beg. AR + Credit Sales – Ending AR.
Define
AR = Ending AR – Beginning AR, where
means
the change in the account balance, then:
Cash Collections = Credit Sales –
AR.
In our example,
Cash collections = $3,000,000 - $50,000 = $2,950,000.
Statement of Cash Flows Direct Method Example
Assume that accounts payable was only used to
acquire
inventory. Use the preceding information to compute
the
following:
1. Cash Received from Customers.
Sales
−
AR
5,000,000 – (-40,000) = 5,040,000
2. Cash Paid to Suppliers for Inventory
COGS + Inventory
− AP
3,500,000 + 100,000 – (-60,000) = 3,660,000
Statement of Cash Flows Indirect Method
The operating cash flow section of the Statement of
Cash
Flows using the indirect method has the following
form:
Net Income
+ Depreciation Expense
- Current Assets (minus increases, plus decreases)
+ Current Liabilities (plus increases, minus decreases)
= Cash flows from operations
Investing and Financing Cash Flows
Once we have computed the cash flows from
operations we
need to complete the sections on investing and
financing
cash flows. In general this is fairly simple. Investing
cash
flows include purchases of long-term assets and
proceeds
from the disposal of long-term assets
The end