THE STATEMENT OF CASH FLOW

INTRODUCTION TO CASH FLOW STATEMENT:

The three major financial statements that are ordinarily required for external reporting are
income statement, balance sheet (statement of financial position), and a statement of cash
flows. The main purpose of the preparation of statement of cash flows is to highlight all the
major activities that directly and indirectly impact cash flows and hence affect the overall cash
balance. A very good cash management with sufficient cash balance at the right time, a
company may acquire golden opportunities. The cash flow statement answers questions that
cannot be answered by the income statement and a balance sheet. For example, where did the
owner get the cash for withdrawal of P500, 000 in a year in which, according to income
statement, it lost more than P1, 000,000? To answer such questions, familiarity with the
statement of cash flows is required.

DEFINITION OF CASH:
In preparing a statement of cash flows, the term cash is broadly defined to include both cash
and cash equivalents. Cash equivalents consist of short term, highly liquid investments such as
treasury bills, commercial paper, and money market funds that are made solely for the purpose
of generating a return on temporary idle funds. Instead of simply holding cash, most companies
invest their excess cash reserves in these types of interest bearing assets that can be easily
converted into cash. These short term liquid investments are usually included in marketable
securities on the balance sheet. Since such assets are equivalent to cash, they are included
with cash in preparing a statement of cash flows

SECTIONS OF CASH FLOW STATEMENT:

The cash flow statement is usually divided into three sections: Operating, investing and
financing activities.

OPERATING ACTIVITIES:
Operating activities involve the cash effects of transactions that enter into the determination of
net income, such as cash receipts from sales of goods and services and cash payments to
suppliers and employees for acquisition of inventory and expenses

INVESTING ACTIVITIES:
Investing activities generally involve long term assets and include (a) making and collecting
loans (b) acquiring and disposing of investments and productive long lived assets.

FINANCING ACTIVITIES:
Financing activities involve liability and stock holder’s equity items and include obtaining cash
from creditors and repaying the amounts borrowed and obtaining capital from owners and
providing them with a return on, and a return of, their investment. Below is the typical
classification of cash receipts and payments according to operating, investing and financing
activities.

EXAMPLES OF EACH SECTIONS:

Operating Activities:
Cash inflows:
From sales of goods or services.
From collection of accounts receivable
Income Statement Items
Cash outflows: (Generally
Current Assets and
To suppliers for inventories.
Current Liabilities)
To employees for services.
To government for taxes.
To lenders for interest.
To others for expenses.

Investing Activities:
Cash inflow:
From sale of property, plant and equipment.
From sale of long term investments.
Generally Non-current
Assets

Cash Outflows:
To purchase property, plant and equipment.
To purchase long term investments.
To make loans to other entities.
 Financing Activities:

Cash inflows:
From borrowing of long term loans.
From issuance of debt (bonds and notes). Generally Non-current
Liabilities and
Equity Items
Cash outflows:
To owner as withdrawals
To lenders for payment of long term debt

CASH FLOW STATEMENT EXAMPLE – DIRECT AND INDIRECT METHOD:

1. DIRECT METHOD:
(Also called the income statement method) reports cash receipts and cash disbursements from
operating activities. The difference between these two amounts in the net cash flow from
operating activates. In other words, the direct method deducts from operating cash receipts the
operating cash disbursements. The direct
Method results in the presentation of a condensed cash receipts and cash disbursements
statement.

FORMAT OF THE CASH FLOW STATEMENT (DIRECT METHOD):

Company Name
Cash Flow Statement
Period Covered

Cash Flow from Operating Activities

Px
List of individual actual cash inflows (collection from customer) x
(xx
List of individual actual cash outflows (payment to supplier) )
Net Cash Flow Pxx

Cash Flow from Investing Activities

Px
List of individual actual cash inflows (proceeds from sale of equipment) x
List of individual actual cash outflows (payment of acquisition of (xx
 property) )
Net Cash Flow Pxx

Cash Flow from Financing Activities

List of individual actual cash inflows (proceeds from longterm Px
borrowings) x
(xx
List of individual actual cash outflows (withdrawal of the owner) )
Net Cash Flow Pxx
Pxx /
Net Increase or Decrease in Cash (xx)
Cash at the beginning of period xx
Cash at the end of the period Pxx

2. INDIRECT METHOD:
(Or reconciliation method) starts with net income and converts it to net cash flow from operating
activities. In other words, the Indirect method adjusts net income for items that affected
reported net income but didn’t affected cash. To compute net cash flows from operating
activities, noncash changes in the income statement are added back to net income, and net
cash credits are deducted.

FORMAT OF THE CASH FLOW STATEMENT (INDIRECT METHOD):

Company Name
Cash Flow Statement
Period Covered

Cash Flow from Operating

Activities
Profit before interest and income tax Pxx
Adjustments for:
ADD: Non-cash expenses
deducted from profit (depreciation Pxx
expense, amortization and etc.)
DEDUCT: Non-cash
income/gains added to profit (gain on (xx) xx
sale of equipment and etc.)

Operating income before working

capital changes
 DEDUCT: increase in current
assets (receivables, prepaid (Pxx)
expenses and etc.)
ADD: Decrease in current
assets (receivables, prepaid xx
expenses and etc.)
ADD: Increase in current
liabilities (Account payables, salaries xx
payables and etc.)
DEDUCT: Decrease in current
liabilities (Account payables, salaries (xx) xx
payables and etc.)
Cash generated from operating
activities
Interest paid (xx)
Income taxes paid (xx) (xx)
Net Cash Flow Pxx

Cash Flow from Investing

Activities
List of individual actual cash
inflows (proceeds from sale of Pxx
equipment)
List of individual actual cash
outflows (payment of acquisition of (xx)
property)
Net Cash Flow Pxx

Cash Flow from Financing

Activities
List of individual actual cash
inflows (proceeds from longterm Pxx
borrowings)
List of individual actual cash
(xx)
outflows (withdrawal of the owner)
Net Cash Flow Pxx
Net Increase or Decrease in Cash Pxx / (xx)
Cash at the beginning of period xx
Cash at the end of the period Pxx
*Note that net cash provided by operating activities is the same whether the direct or indirect
method is used.

ILLUSTRATIVE EXAMPLE 1:
The following are items taken from the records of Intelligent Company for 2020:
a. Profit after income tax expense, P1, 820,000.
b. Payment for purchase of land, P400, 000.
c. Payment of long-term loans, P600, 000.
d. Depreciation expense, P750, 000.
e. Additional investments by the owner, P700, 000.
f. Patent amortization expense, P270, 000.
g. Income tax expense, P780, 000.
h. Interest expense, P100, 000.
i. Increase in accounts receivable, P340, 000.
j. Cash withdrawals of the owner, P500, 000.
k. Decrease in accounts payable, P26, 000.
l. Increase in interest payable, P18, 000.
m. Increase in income tax payable, P60, 000.
Additional information: The company’s statement of financial position reported the cash
balance of P800, 000 as of January 1, 2020 and P3,152,000 as of December 31, 2020.

Required: Prepare the Intelligent Company’s 2020 Statement of Cash Flows using the
indirect method.

SOLUTION:
INTELLIGENT COMPANY
CASH FLOW STATEMENT
FOR THE YEAR ENDED DECEMBER 31. 2020

Cash Flow from Operating Activities

P2,700,0
Profit before interest and income tax
00
Adjustments for:
ADD: Amortization expense P750,000
ADD: Depreciation expense 270,000 1,020,000
Operating income before working capital changes P3,720,0
 00
(P340,00
DEDUCT: increase in accounts receivables
0)
(P366,00
DEDUCT: Decrease in Account payables (P26000)
0)
P3,354,0
Cash generated from operating activities
00
(P82,000
Interest paid (100,000-18,000)
)
(P720,00 (P802,00
Income taxes paid (780,000-60,000)
0) 0)
P2,552,0
Net Cash Flow
00

Cash Flow from Investing Activities

(P400,00
Acquisition of Land
0)
(P400,00
Net Cash Flow
0)

Cash Flow from Financing Activities

Additional cash investments P700,000
(P500,00
Cash withdrawal
0)
Net Cash Flow 200,000
P2,352,0
Net Increase (cash)
00
Cash at the beginning of period 800,000
P3,152,0
Cash at the end of the period
00
 NOTE: Depreciation and amortization expense is added back to the profit because
there’s no actual cash outflow. Cash balance of P3, 152,000 as of December 31, 2020
should be the same as the amount of cash reported on statement of financial position.

COMPUTATIONS:
Profit before interest and income tax:
Profit before interest and income tax P2, 700,000 SQUEEZE
Interest expense (100,000)
Income tax (780,000)
Profit after interest and income tax P1, 820,000

NOTE: INCREASE means the ending balance is GREATER than the beginning balance. While
DECREASE means ending balance is LESS than the beginning balance.

If the problem only states the changes of accounts, here’s the assumption for computation
purposes:
• If there is an INCREASE of an account (That is the ending balance is GREATER than
the beginning balance), let us assume that the difference is equal to the ending balance
while the beginning balance assumed to be ZERO.
• If there is a DECREASE of an account (That is the ending balance is LESS than the
beginning balance), let us assume that the difference is equal to the beginning balance
while the ending balance assumed to be ZERO.

Interest paid:
Interest payable, beginning balance P0

Interest incurred (expense) 100,000

Interest paid (82,000) SQUEEZE

Interest payable, ending balance P18,000

Since there is an INCREASE in interest payable, the difference of P18, 000 is assumed to be
the ending balance while the beginning balance is assumed to be ZERO

Income taxes paid: (INCREASE in income tax payable)

Income tax payable, beginning balance P0
Income tax incurred (expense) 780,000
Income taxes paid (720,000) SQUEEZE
Income tax payable, ending balance P60, 000

Since there is an INCREASE in income tax payable, the difference of P60, 000 is assumed to
be the ending balance while the beginning balance is assumed to be ZERO

ILLUSTRATIVE EXAMPLE 2:
The Wisdom Company reported the following condensed profit or loss for
2020:
Sales P1,000,000
Cost of goods sold 580,000
Gross profit P420, 000
Operating Expenses
Depreciation Expense P80,000
Salaries Expense 120,000 200,000
Profit before income tax P220,000
Income tax expense 66,000
Profit P154,000

The following information is also available:

2020 2020
Accounts receivable P140,000 P90,000
Inventory 43,000 132,000
Accounts payable 154,000 108,000
Salaries payable 12,000 36,000
Income tax payable 8,000 20,000

SOLUTION
A. DIRECT METHOD
WISDOM COMPANY
CASH FLOW STATEMENT
DECEMBER 31, 2020

Cash flows from operating activities

P1,050,00
Collections from customers
0
Payments to trade creditors (P715,000)
Payments for salaries (P96000) (P811000)
Cash generated from operations P239,000
Income taxes paid 54,000
Net cash provided by operating activities P185,000
COMPUTATIONS
Collections from customers
AR, Beginning Balance P140,000
Sales on account 1,000,000
(P1,050,00 SQUEEZ
Collections from customers
0 E
AR, ending balance P90,000

Payments to trade creditors:

AP, beginning balance P154,000
Purchases on account 669,000*
SQUEEZ
Payments to trade creditors -715,000
E
AP, ending balance P108,000

*Purchases on account:
Inventories, beginning balance P43,000
SQUEEZ
Purchases on account 669,000
E
Total goods available for sale P712,000
AP, ending balance -132,000
Cost of goods sold P580,000

Payments for salaries:

Salaries payable, beginning balance P12,000
Salaries incurred (expense) 120,000
SQUEEZ
Payments for salaries (P96,000)
E
Salaries payable, ending balance P36,000

Income taxes paid:

Income tax payable, beginning balance P8,000
Income tax incurred (expense) 66,000 66,000
SQUEEZ
Income taxes paid (P54,000)
E
Income tax payable, ending balance P20,000
 (B) INDIRECT METHOD
Wisdom Company
Cash Flow Statement
As of December 31,
2020
Cash flows from Operating Activities
Profit before income tax P 220,000
Adjustments for
Depreciation expense 80,000
Operating income before working capital changes P300,000
Decrease in accounts receivable P 50,000
Increase in inventories (P89,000)
Decrease in accounts payable (P46,000)
Increase in salaries payable 24,000 (P61000)
Cash generated from operations P 239,000
Income tax paid (P54000)
Net cash provided by operating activities P 185,000

COMPUTATIONS:

NOTE: INCREASE means ending balance is GREATER than the beginning balance. While
DECREASE means ending balance is LESS than the beginning balance.

Decrease in accounts receivable (P90,000-

P50,000
P140,000)
Increase in inventory (P132,000-P43,000) 89,000
Decrease in accounts payable (P108,000-
46,000
P154,000)
Increase in salaries payable (P36,000-P12,000) 24,000
Increase in income tax payable (P20,000-P8,000)
12,000
Income taxes paid:
Income tax payable, beginning balance
P8,000
Income tax incurred (expense)
66,000
Income taxes paid
SQUEEZE
(54,000)
Income tax payable, ending balance
P20,000
*As stated earlier, net cash provided by operating activities of P185, 000 is the same whether
the direct or indirect method is used.