Chapter

10

Statement of Cash Flows

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•
Basic Elements of the Statement of
Cash Flows
• Uses a concept of cash that includes not only
cash but also short-term, highly liquid
investments
– Referred to as the cash and cash equivalent focus
• Explains the changes in focus accounts
•

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•
Basic Elements of the Statement of
Cash Flows—Continued
• Uses of the statement of cash flows
– Internal (management) users
• Determine dividend policy
• Evaluate cash generated by operations
• Review investing and financing policy
– External users
• • Determine a firm’s ability to increase dividends
• Determine a firm’s ability to pay debt from operations
• Determine the percentage of cash from operations in relation
to the cash from financing

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•
Structure of the Statement of Cash
Flows
Cash Flows from Operating Activities
Add
: Cash Flows from Investing Activities
Add
: Cash Flows from Financing Activities
Beginning
Change in Cash Balance
Add: Change in cash
Ending Cash Balance
•
Supplemental disclosure: Noncash investing
and financing activities

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• Operating Activities
Include the cash effects of events that enter into
the determination of net income
• Cash inflows from • Cash outflows for
– Sale of goods or payments
services – For acquisitions of
• – Returns on loans inventory
(interest) – To employees
– Return on equity – For taxes
securities (dividends) – For interest expenses
– For other expenses

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• Investing Activities
Lending and collecting money and acquiring and
selling investments and long-term assets
• Cash inflows from • Cash outflows for
– Receipts from loans – Loans to other entities
collected – Investment in debt or
• – Sales of debt or equity equity securities of
securities of other other entities
corporations – Purchase of property,
– Sale of property, plant, plant, and equipment
and equipment

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• Financing Activities
Include cash flows relating to liability and owners’
equity
• Cash inflows from • Cash outflows for
– Sale of equity – Payment of dividends
securities – Reacquisition of
• – Sale of bonds, capital stock
mortgages, notes, and – Payment of amounts
other short- and long- borrowed
term borrowings

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product or service or otherwise on a password-protected website for classroom use.
•
Presentation of Cash Flows From
Operations
• Direct method
– Converts the income statement from accrual basis to a
cash basis
– Encouraged by SFAS No. 95
– Supplemental information required
• Reconciliation of net income to cash provided by operations
• • Indirect method
– Adjusts net income for items that affected net income
but did not affect cash
– Supplemental information required
• Cash paid for income taxes and for interest

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product or service or otherwise on a password-protected website for classroom use.
•
Exhibit 10-1—Statement of Cash
Flows: Direct Method

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product or service or otherwise on a password-protected website for classroom use.
•
Exhibit 10-1—Statement of Cash
Flows: Direct Method

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product or service or otherwise on a password-protected website for classroom use.
•
Exhibit 10-1—Statement of Cash
Flows: Indirect Method

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product or service or otherwise on a password-protected website for classroom use.
•
Exhibit 10-1—Statement of Cash
Flows: Indirect Method

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product or service or otherwise on a password-protected website for classroom use.
•
Financial Ratios and the
Statement of Cash Flows
• Traditional ratios related income statement
item(s) to a balance sheet item(s)
• Statement of cash flows became a required
statement in 1987
• Cash flow financial ratios were slowly developed
• – Operating cash flow to current maturities of debt
– Operating cash flow to total debt
– Operating cash flow per share
– Operating cash flow to cash dividends

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•
Operating Cash Flow to Current
Maturities of Debt
• Indicates a firm’s ability to meet its current
maturities of debt
• Higher ratio indicates better liquidity

Operating Cash Flow

Current Maturities of Long-Term Debt and Current Note Payable
•

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• Operating Cash Flow to Total Debt

• Indicates a firm’s ability to cover total debt with

the yearly operating cash flow
• The higher the ratio, the better the firm’s ability to
carry its total debt
• Conservative approach is to include all possible
• balance sheet debt

Operating Cash Flow

Total Debt

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• Operating Cash Flow per Share
• Indicates the funds flow per common share
outstanding
• Higher than earnings per share as depreciation is
not deducted

⎛ Operating Cash ⎞ Operating Cash Flow − Preferred Dividends

• ⎜ ⎟ =
⎝ Flow per Share ⎠ Diluted Weighted Average Common
Shares Outstanding

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•
Operating Cash Flow per Share—
Continued
• A better indication of a firm’s ability to make
capital expenditure decisions and pay dividends
than is earnings per share
• Does not reflect firm’s profitability
– Firms are prohibited from reporting this on financial
statements
•

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•
Operating Cash Flow to Cash
Dividends
• Indicates a firm’s ability to cover cash dividends
with the yearly operating cash flow
• Higher the ratio, the better the firm’s ability to
cover cash dividends

• Operating Cash Flows

Cash Dividends

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• Alternative Cash Flow
• No standard definition of cash flow
• Alternative definition
– Net income plus depreciation expense
• Less useful than the net cash flow from operating activities

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•
Procedures to Develop the Statement
of Cash Flows
• Analyze all balance sheet accounts other than
cash and cash equivalents.
Increase Decrease
Current assets Operating outflow Operating inflow
Noncurrent assets Investing outflow Investing inflow
• Current liabilities Operating inflow Operating outflow
Long-term liabilities Financing inflow Financing outflow
Stockholders’ equity Financing inflow Financing outflow

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•
Procedures to Develop the
Statement of Cash Flows
• Three techniques used to prepare the statement
of cash flows
– The visual method
• Determine change in cash and cash equivalents
• Compute the net change in all other balance sheet accounts
• Classify as operating, investing, and financing
• – The T-account method
– The worksheet method

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•
Procedures to Develop Operating Cash
Flows: Direct Approach
• Operating section describes income statement
accounts in terms of receipts or payments
• Cash receipts
– From customers
– From other operating sources
• • Cash payments
– For merchandise
– To employees
– For other operating expenses

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•
Procedures to Develop Operating Cash
Flows: Indirect Approach
• Begin with net income
• Add or deduct adjustments to change accrual
basis net income to cash basis net income
– Changes in current noncash assets
– Changes in noncash assets go in the inverse direction
of changes in cash
•
– Changes in current liabilities
– Changes in noncash liabilities go in the same direction
of changes in cash

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•
Procedures to Develop Operating Cash
Flows: Indirect Approach
• Adjust net income (loss) for noncash expenses
(like depreciation expense) and noncash
revenues
• Eliminate non cash gains and losses that relate
to investing and financing activities
•

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
product or service or otherwise on a password-protected website for classroom use.