STATEMENT OF CASH FLOWS

The balance sheet, income statement, and retained earnings statement provide only limited information about
a company’s cash flows (cash receipts and cash payments). For example, comparative balance sheets show
the net increase in property, plant, and equipment (PPE) during the year. But, they do not show how the
additions were financed or paid for. The income statement shows net income based on the accrual basis of
accounting. But, it does not indicate the amount of cash generated by operating activities. The statement of
stockholders’ equity (in case of corporation) shows cash dividends declared but not the cash dividends paid
during the year. None of these statements presents a detailed summary of where cash came from and how it
was used. (Weygandt et al., 2018)

Usefulness of the Statement of Cash Flows

A statement of cash flows is an essential component within the set of basic financial statements. It provides
information about the cash receipts and cash disbursements of an entity during a period. As an analytical tool,
it is useful in determining the short-term viability of an entity, particularly its ability to pay its obligations.
The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from
operating, investing, and financing activities during a period. The information in a statement of cash flows
helps investors, creditors, and others assess the following (Weygandt et al., 2018):
1. The entity’s ability to generate future cash flows.
By examining relationships between items in the statement of cash flows, investors can better predict the
amounts, timing, and uncertainty of future cash flows than they can from accrual-basis data.
2. The entity’s ability to pay dividends and meet obligations.
If a company does not have adequate cash, it cannot pay employees, settle debts, or pay dividends.
Employees, creditors, and stockholders should be particularly interested in this statement because it
alone shows the flow of cash in a business.
3. The reasons for the difference between net income and net cash provided (used) by operating
activities.
Net income provides information on the success or failure of a business. However, some financial
statement users are critical of accrual-basis net income because it requires many estimates. As a result,
users often challenge the reliability of the number. Such is not the case with cash. Many readers of the
statement of cash flows want to know the reasons for the difference between net income and net cash
provided by operating activities. Then, they can assess for themselves the reliability of the income
number.
4. The cash investing and financing transactions during the period.
By examining a company’s investing and financing transactions, a financial statement reader can better
understand why assets and liabilities changed during the period.
Reporting the sources, uses, and net increase or decrease in cash helps investors, creditors, and others know
what is happening to a company’s most liquid resource. Because most individuals maintain a checkbook and
prepare a tax return on a cash basis, they can comprehend the information reported in the statement of cash
flows. The statement of cash flows provides answers to the following simple but important questions:
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period? (Kieso et al., 2019)
Measurement of Cash Flows
For purposes of this statement, cash is defined as including both cash and cash equivalents. Cash
equivalents are investments that can be quickly converted to cash. They have a maturity of 90 days or less
when they are purchased, and they include the following:
 Money market accounts
 Commercial paper (short-term corporate notes)
 Treasury bills
Because cash and cash equivalents are combined, the statement of cash flows does not report transactions
between cash and cash equivalents, such as cash paid to purchase cash equivalents and cash received from
selling cash equivalents. Conversion of cash into cash equivalents or conversion of cash equivalents into cash
are not cash flow activities. Thus, the purchase of an instrument classified as cash equivalent is not a cash
flow activity. Likewise, the termination of money market placements (which is a cash equivalent) into cash is
not a cash flow activity, and is, therefore, not presented in the statement of cash flows. (Shaw)

Presentation of Statement of Cash Flows

Companies classify cash receipts and cash payments during a period into three (3) different activities in the
statement of cash flows—operating, investing, and financing activities.
1. Operating activities involve the cash effects of transactions that enter into the determination of net
income.
Cash flows from operating activities are primarily derived from the main revenue-producing activities
of the business. As discussed in the previous topics, revenue is reported on the income statement on
the year when the goods are delivered or when services are rendered. On the other hand, collections
from customers will be reported on the statement of cash flows on the year when cash is received.
Also, expenses are reported on the income statement when it is incurred. However, cash
disbursements for these expenses are reported on the statement of cash flows on the year payments
are made. The following are examples of operating activities:
a. Cash received from customers (cash receipts from the sale of goods or rendering of services)
b. Cash received from fees, commissions, and other income
c. Cash payments to suppliers
d. Cash payments to employees
e. Cash payments for other operating expenses
f. Interest payments
2. Investing activities include making and collecting loans and acquiring and disposing of investments
(both debt and equity) and property, plant, and equipment.
Cash flows from investing activities is the second section on the statement of cash flows. Cash flows
from investing activities hints on the company’s ability to generate future cash flows. Negative cash
flows from investing activities imply that the company used cash to acquire long-term assets intended
to generate cash and revenue in the future. On the other hand, positive cash flow may indicate that
the company is divesting or downsizing. Examples include:
a. Cash payments to acquire PPE, intangibles and other long-term assets
b. Cash receipts from the sale of PPE, intangibles and other long-term assets
c. Cash advances and loans made to other parties (long-term notes receivable)
d. Cash collections on long-term notes receivable
3. Financing activities involve liability and owners’ equity items. They include (a) obtaining resources
from owners and providing them with a return on their investment, and (b) borrowing money from
creditors and repaying the amounts borrowed.
Cash flows information arising from financing activities is useful in predicting claims on future cash
flows by providers of capital to the enterprise. It involves cash flow transactions with long-term
creditors and shareholders. Examples include:
a. Cash proceeds from issuing shares
b. Cash received from issuing notes or getting a long-term loan from a bank (long-term notes
payable)
c. Cash dividends distributed to shareholders
d. Cash withdrawals of owners
e. Cash paid for principal of long-term debt
To compute the payment for cash dividends, you may use the following formula:
Net income P xxx
Add: Retained Earnings, beg. xxx
Less: Retained Earnings, end. xxx
Payments for dividends P xxx
 The general condensed format of a statement of cash flows follows:

ABC Com Statement

of C
For the Year Ended D

Cash flows from operating activities Cash P xxx xxx

flows from investing activities Cash flows from xxx
financing activities Net increase (decrease) in xxx
cash xxx
Cash and cash equivalents balance, beginning
Cash and cash equivalents balance, ending P xxx

Figure 1. Condensed statement of cash flows

Figure 2. Cash inflows and outflows

Source: Intermediate Accounting 17th Edition, 2019, p.5-18

The cash flows from operating activities section always appear first, followed by the investing activities section
and then the financing activities section. The sum of the operating, investing, and financing sections equals
the net increase or decrease in cash for the period. This amount is added to the beginning cash balance to
arrive at the ending cash balance—the same amount reported on the balance sheet.
Note the following general guidelines:
1. Operating activities involve income statement items.
2. Investing activities involve cash flows resulting from changes in investments and long-term asset items.
3. Financing activities involve cash flows resulting from changes in long-term liability and stockholders’
equity items.
Operating activities involve the day-to-day sale of goods and services; investing activities involve long-term
assets and investments, and financing activities deal with stockholders’ equity accounts and debt (borrowing).
Companies classify some cash flows related to investing or financing activities as operating activities. For
example, receipts of investment revenue (interest and dividends) are classified as operating activities. So are
payments of interest to lenders. Why are these considered operating activities? Because companies report
these items in the income statement, where results of operations are shown.
Preparation of Statement of Cash Flows
Preparing the statement of cash flows from these sources involves four (4) steps:
1. Determine the net cash provided by (or used in) operating activities.
2. Determine the net cash provided by (or used in) investing and financing activities.
3. Determine the change (increase or decrease) in cash during the period.
4. Reconcile the change in cash with the beginning and the ending cash balances.
ILLUSTRATION:
The following shows Exodus’ income statement and comparative balance sheets.
Exodus Company
Income Statement
For the Year Ended December 31, 201B
Sales P 590,000
Less: Cost of Goods Sold 300,000
Gross Profit 290,000
Less: Wages and Other Operating Expenses P 216,000
Interest Expense 7,000
Depreciation Expense 24,000 247,000
Operating Income 43,000
Other Gains (Losses)
Add: Gain on Retirement of Bonds 16,000
Less: Loss on Sale of Plant Assets 6,000 10,000
Income before taxes 53,000
Less: Income tax expense 15,000
Net Income P 38,000

Exodus Company
Income Statement
December 31, 201B and 201A
Increase
201B 201A
(decrease)
Assets
Current Assets
Cash P 17,000 P 12,000 P 5,000
Accounts Receivable 60,000 40,000 20,000
Inventory 84,000 70,000 14,000
Prepaid Expenses 6,000 4,000 2,000
Total Current Assets 167,000 126,000

Non-current Assets
Property, Plant and Equipment 250,000 210,000 40,000
Accumulated Depreciation (60,000) (48,000) 12,000
Total Assets P 357,000 P 288,000

Liabilities
Current Liabilities
Accounts Payable P 35,000 P 40,000 P (5,000)
Interest Payable 3,000 4,000 (1,000)
Income Taxes Payable 22,000 12,000 10,000
Total Current Liabilities 60,000 56,000
Long-term Notes Payable 90,000 64,000 26,000
Total Liabilities 150,000 120,000 30,000

Equity
Ordinary Share Capital, P5 par P 95,000 P 80,000 P 15,000
Retained Earnings 112,000 88,000 24,000
Total Equity 207,000 168,000
Total Liabilities and Equity P 357,000 P 288,000
Additional information for 201B:
1. The accounts payable balances result from inventory purchases.
2. Purchased P60,000 in plant assets by issuing P60,000 of notes payable.
3. Sold plant assets with a book value of P8,000 (original cost of P20,000 and accumulated depreciation
of P12,000) for P2,000 cash, yielding a P6,000 loss.
4. Received P15,000 cash from issuing 3,000 ordinary shares
5. Paid P18,000 cash to retire notes with a P34,000 book value, yielding P16,000 gain.
6. Declared and paid cash dividends of 14,000.
To prepare the statement of cash flows, we will use the illustration given.
An enterprise should report cash flows from operating activities using either the:
a. Direct method, whereby major classes of gross cash receipts and gross cash payments are
disclosed; or
b. Indirect method, whereby the profit or loss is adjusted for the effects of transactions of a non-cash
nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of
income or expense associated with investing or financing cash flows.
The direct method separately lists operating cash receipts (such as cash received from customers) and
operating cash payments (such as cash paid to suppliers). The cash payments are then deducted from cash
receipts. The indirect method reports net income and then adjusts it for items that do not affect cash. It does
not report individual items of cash inflows and cash outflows from operating activities. The net cash amount
provided by operating activities is identical under both the direct and indirect methods. The difference is with
the computation and presentation. The Financial Accounting Standards Board (FASB) has expressed a
preference for the direct method but allows the use of either method. The presentation of cash flow from
investing and financing activities are just the same for both methods.

DIRECT METHOD
International Accounting Standards (IAS) 7 encourages enterprises to report cash flows from operating
activities using direct method because it provides information that may be useful in estimating future cash
flows that are not available under the indirect method. Furthermore, the direct method shows each major class
of cash receipts and cash disbursements or payments. The amounts reported as cash receipts and cash
payments under the direct method are taken by converting the accrual basis revenues and expenses from the
income statement to a cash basis by considering the changes in the related accounts in the statement of
financial position. The following are the major classes of cash receipts and cash payments:

Cash Received from Customers. If all sales are for cash, cash received from customers equals the sales
reported on the income statement. When some or all sales are on credit, the amount of sales must be
adjusted for the change in Accounts Receivable. Using the information in the financial statements given, the
cash received from customers is computed as follows:
Accounts Receivable
Beg balance 40,000
Sales 590,000 Cash receipts 570,000
End balance 60,000
Cash receipts can also be computed using as sales of P590,000 less increase in accounts receivable of
P20,000.

Cash Paid to Suppliers. This is computed by analyzing cost of goods sold and inventory. If all inventory
purchases are for cash and the balance of Inventory is unchanged, the amount of cash paid for inventory
equals cost of goods sold, which is uncommon. Also, some or all purchases are often made on credit, which
changes the Accounts Payable balance. When the balances of Inventory and Accounts Payable change, the
cost of goods sold must be adjusted to compute the cash paid to suppliers.
The first step is to use the change in Inventory and the cost of goods sold amount to compute the purchases
for the period. An increase in inventory means that the company bought more than it sold, and this is added to
the inventory balance. If there is a decrease in inventory, then this is deducted from the cost of goods sold.
The amount of purchases is computed as follows:
 Inventory
Beg balance 70,000
Purchases 314,000 COGS 300,000
End balance 84,000
The amount of purchases for the period can also be computed as cost of goods sold of P300,000 plus the
increase in inventory of P14,000.
The second step is to use the change in accounts payable and the cost of purchases to compute the cash
paid to suppliers. Using a T- account:
Accounts Payable
Beg balance 40,000
Cash payments 319,000 Purchases 314,000
End balance 35,000
Alternatively, cash paid to suppliers is equal to purchases of P314,000 plus the P5,000 decrease in accounts
payable.

Cash Paid for Wages and Other Operating Expenses. In the income statement of Exodus, all operating
expenses are combined. To compute the cash paid for wages and other operating expenses, we adjust for
any changes in the related balance sheet accounts. Look for any prepaid expenses and accrued expenses
related to wages and other operating expenses. The balance sheet shows prepaid expenses, but there are no
accrued liabilities. The adjustment is computed by assuming that all cash paid for wages and other operating
expenses is initially debited to Prepaid Expenses. You may also refer to the Adjusting Process topic in 01
Review of the Accounting Process for a more detailed discussion about prepaid expenses and accrued
expenses. Using a T-account:
Prepaid Expenses
Beg balance 4,000
Wages and Other
Cash payments 218,000 216,000
Operating Exp.
End balance 6,000
Alternatively, this can be computed as wages and other operating expenses plus the increase in prepaid
expenses of P2,000.

Cash Paid for Accrued Expenses. The balance sheet of Exodus does not report any accrued expenses, but
it is still included in the formula to explain the adjustment to cash when they exist. A decrease in accrued
expenses means that the company paid cash for more goods or services than received this period, so cash
paid is higher than the recorded expense. On the other hand, an increase implies that the company paid less
cash than what was received, so cash paid is less than the recorded expense.

Cash Paid for Interest and Income Taxes. Computing operating cash flows for interest and taxes requires
adjustments for amounts reported on the income statement for changes in related balance sheet accounts.
The Exodus income statement shows interest expense of P7,000 and income taxes expense of P15,000. To
compute the cash paid, adjust the interest expense for the change in interest payable and adjust the income
taxes expense for the change in income taxes payable. These computations involve reconstructing both
liability accounts and show cash paid for interest of P8,000 and cash paid for income taxes of P5,000.
Interest Payable
Beg balance 4,000
Cash paid for interest 8,000 Interest expense 7,000
End balance 3,000
Income Tax Payable
Beg balance 12,000
Cash paid for taxes 5,000 Income tax expense 15,000
End balance 22,000
Analyzing Additional Expenses, Gains, and Losses
Exodus Company has three (3) more items reported on its income statement: depreciation, loss on sale of
assets, and gain on retirement of debt.
1. Depreciation Expense. Depreciation expense is P24,000. It is considered a noncash expense
because depreciation has no cash flows. Depreciation expense is not reported on a statement of cash
flows using the direct method; nor is depletion or amortization expense.
2. Loss on Sale of Assets. Sale of assets frequently result in gains and losses reported as part of net
income, but the amount of recorded gain or loss does not impact cash. Thus, the gain or loss on a
sale of assets is not reported on a statement of cash flows using the direct method.
3. Gain on Retirement of Debt. Retirement of debt usually yields a gain or loss reported as part of net
income, but that gain or loss does not impact cash. Thus, the gain or loss from retirement of debt is
never reported on a statement of cash flows using the direct method.
A summary of adjustments for direct method are as follows:
Item Accrual Basis Adjustments Required Cash Basis
Cash Receipts
+ Accounts Receivable, beg.
- Accounts Receivable, end.
or
Net sales/Sales = Cash receipts
From sales + Decrease in accounts
revenue from customers
receivable or
- Increase in accounts Receivable

+ (Rent, interest, dividend) Receivable, beg.

- (Rent, interest, dividend) Receivable, end.
From rent, Rent revenue or = Cash receipts
interest, Interest revenue from rent, interest
+ Increase in receivable
or Dividend revenue or dividends
dividends or
- Decrease in receivable
Cash Payments
+ Inventory, end
+ Accounts Payable, beg.
- Inventory, beg.
- Accounts Payable, beg.
or = Cash paid to
To suppliers Cost of Goods Sold
+ Increase in Inventory suppliers
- Decrease in Inventory

+ Decrease in accounts payable

- Increase in accounts payable
+ Prepaid Expense, end
Operating
For operating + Accrued Expense, beg. = Cash paid for
Expenses (e.g.,
expenses - Prepaid Expense, beg. operating expenses
insurance, rent) - Accrued Expense, end.
+ Salaries Payable, beg.
- Salaries Payable, end.
Wages (Salaries) or = Cash paid to
To employees
Expense + Decrease in salaries employees
payable or
- Increase in salaries payable
 + Interest Payable, beg.
- Interest Payable, end.
or = Cash paid for
For interest Interest Expense
+ Decrease in interest payable interest
or
- Increase in interest payable
+ Income Tax Payable, beg.
- Income Tax Payable, end.
Income Tax or = Cash paid for
For taxes
Expense + Decrease in income tax payable income tax
or
- Increase in income tax payable

The statement of cash flows using the direct method is shown below:

Exodus Company
Statement of Cash Flows
For the Year Ended December 31, 201B

Cash flows from operating activities

Cash received from customers P 570,000
Cash paid to suppliers (319,000)
Cash paid for wages and other operating expenses (218,000)
Cash paid for interest (8,000)
Cash paid for taxes (5,000)
Net cash provided by operating activities P 20,000

Cash flows from investing activities

Cash received from sale of plant assets 2,000
Net cash provided by investing activities 2,000

Cash flows from financing activities

Cash received from issuing shares 15,000
Cash paid to retire notes (18,000)
Cash paid for dividends (14,000)
Net cash used in financing activities (17,000)
Net increase in cash 5,000
Cash balance, December 31, 201A 12,000
Cash balance, December 31, 201B P 17,000

INDIRECT METHOD
Net income is computed using accrual accounting. Revenues and expenses rarely match the receipt and
payment of cash. The indirect method adjusts net income to get the net cash provided or used by operating
activities. This method provides a useful link between the statement of cash flows and the profit or loss in the
income statement and the account balances listed in the statement of financial position. Most accountants
prefer this method for the ease and convenience in its preparation.
Same with the direct method, the net cash provided/used by operating activities is determined by converting
net income from an accrual basis to a cash basis. This step involves not only analyzing the current year’s
income statement but also the comparative balance sheets and selected additional data that are needed to
determine how cash was provided or used during the period.
In applying the indirect method, it begins with the net income to get the net cash provided (used) by operating
activities. The Exodus Company reported a net income of P38,000.
There are two (2) types of adjustments when using the indirect method:
1. Adjustments to income statement items that do not impact cash; and
2. Adjustments for changes in current assets and current liabilities.

There are two (2) types of adjustments when using the indirect method:
1. Adjustments to income statement items that do not impact cash; and
2. Adjustments for changes in current assets and current liabilities.

1. Adjustments to income statement items that do not impact cash

Some expenses and losses subtracted from net income were not cash outflows. Examples are depreciation,
amortization, depletion, bad debts expense, loss from sale of asset, and loss from retirement of notes payable.
Expenses and losses with no cash outflows are added back to the net income . These expenses and
losses did not reduce cash, and adding them back cancels their deductions from net income. Any cash
received or paid from a transaction that yields a loss, such as from an asset sale or payment of a note, is
reported under investing or financing activities.
a. Depreciation. The depreciation expense is the only operating item in net income that had no effect on
cash flows. The P24,000 depreciation expense is added back to net income because depreciation did
not reduce cash.
b. Loss on Sale of Plant Assets. The company reported a P6,000 loss on sale of plant assets that
reduced net income but did not affect cash flows. This P6,000 loss is added back to net income
because it is not a cash outflow.
Revenues and gains with no cash inflows are subtracted from the net income.
a. Gain on Retirement of Debt. A P16,000 gain on retirement of debt increased net income but did not
affect cash flows. This gain is deducted from net income because it was not a cash inflow.

2. Adjustments for Changes in Current Assets and Current Liabilities

a. Adjustments for changes in current assets
 Decreases in current assets are added to net income.
 Increases in current assets are deducted from net income.
b. Adjustments for changes in current liabilities
 Increases in current liabilities are added to net income.
 Decreases in current liabilities are deducted from net income.

Common Adjustments to Net Income

Item Explanation Adjustment
Depreciation, depletion
Expense items that decrease the net
or amortization of Add to net income
intangibles income but have no cash effect
The gain increases (loss decreases) the
Gain or loss on sale of Deduct gain from (add
net income but the cash effect is shown in
assets loss to) net income
the investing activities section
Represent revenue recognized for the
period with no corresponding cash receipts
Increase in accounts
Deduct from net income
receivable
The increase means that the company
collects less cash than is reported in sales.
Decrease in accounts Represents cash receipts from revenue of
Add to net income
receivable previous periods
Portion of purchases for the period does
Increase in inventory not form part of the cost of goods sold; Deduct from net income
hence, profit is increased.
 Cost of goods sold includes goods
Decrease in inventory Add to net income
purchased and paid in prior years
Increase in prepaid Payments during this period exceed related
Deduct from net income
expenses expenses shown in the income statement
Expenses recognized during this period
Decrease in prepaid
exceed related payments for goods and Add to net income
expenses services
Increase in trade
Expenses exceed related payments to
payables and accrued Add to net income
suppliers and others
expenses
Decrease in trade
Cash payments to suppliers and others
payables and Deduct from net income
exceed related expenses
accrued expenses

The statement of cash flows using the indirect method is shown below:

Exodus Company
Statement of Cash Flows
For the Year Ended December 31, 201B
Cash flows from operating activities
Net income P 38,000
Adjustments for
Depreciation expense 24,000
Loss on sale of PPE 6,000
Gain on retirement of notes (16,000)
Increase in accounts receivable (20,000)
Increase in inventory (14,000)
Increase in prepaid expenses (2,000)
Decrease in accounts payable (5,000)
Decrease in interest payable (1,000)
Increase in income taxes payable 10,000
Net cash provided by operating activities P 20,000
Cash flows from investing activities
Cash received from sale of plant assets 2,000
Net cash provided by investing activities 2,000
Cash flows from financing activities
Cash received from issuing shares 15,000
Cash paid to retire notes (18,000)
Cash paid for dividends (14,000)
Net cash used in financing activities (17,000)
Net increase in cash 5,000
Cash balance, December 31, 201A 12,000
Cash balance, December 31, 201B P 17,000

References
Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting 17th Edition. Wiley.
Robles, N. S., & Empleo, P. M. (2017). The Intermediate Accounting Series: Volume 3. Millennium Books, Inc.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles. John Wiley & Sons, Inc.
Wild, J., & Shaw, K. (2018). Fundamental Accounting Principles. McGraw-Hill Education.