Statement of Cash Flows

Prof. PUTTU GURU PRASAD FACULTY INC GUNTUR pgp4149@gmail.com

Statement of Cash Flows
• Assesses the firm’s ability to generate cash and cash equivalents • Assesses the firm’s cash requirements or uses • Statement of Cash Flows shows
– Where did the cash come from? – What was the cash used for? – What was the change in the cash balance?

Statement of Cash Flows
• Cash activities are divided into three main categories:

Operating Activities
– Normal day-to-day activities

Investing Activities
– Changes in long-term assets and investments

Financing Activities
– Changes in equity and non-operating

Cash Inflows and Outflows
Operating Activities
•When operating cash receipts > cash expenditures

Investing Activities
•Sale of property, plant, and equipment •Sale of debt or equity securities of other entities •Collection of loans to other entities

Financing Activities
•Issuance of equity securities •Issuance of debt (bonds and notes)

Cash Pool Cash Inflows

Cash Inflows and Outflows
Cash Outflows Cash Pool

Operating Activities
•When operating cash expenditures < cash receipts

Investing Activities
•Purchase of property, plant, and equipment •Purchase of debt or equity securities of other entities •Loans to other entities

Financing Activities
•Payment of dividends •Redemption of debt •Reacquisition of capital stock

Statement of Cash Flows
• There are TWO methods of preparing the statement of cash flows:
– indirect method (alternative #1) – direct method (alternative #2)

• The indirect method analyses balance sheet account changes • The direct method analyses the changes in cash by determining cash flows directly for each source or use of cash • Any non-cash transactions are omitted from the statement (under each method)

Preparing a Cash Flow Statement

Alternative #1 (Indirect Method) Information required:
1. Comparative Balance Sheets 2. Current Income Statement 3. Other information and transaction data

Indirect Method
Operating Activities
• Start with Net Income (Loss) • Changes in Current Assets (other than cash) and Liabilities
– Increase in a current asset = use of funds (Decrease = source of funds) – Increase in a current liabilities = source of funds (Decrease = use of funds)

• Non-cash expenses (e.g. amortization, bad debts expense) • Non-operating gains and losses
– Gains are treated as a use of funds from operating activities – Losses are treated as a source of funds from operating

Indirect Method
Investing Activities • Changes in Long-term assets
– Increase = use of funds – Decrease = source of funds

• If assets have been disposed, report only the cash proceeds of disposition Financing Activities • Changes in Long-term liabilities and equity
– Increase = source of funds – Decrease = use of funds

Usefulness of the Statement of Cash Flows
• Cash is the long-term indicator of a firm’s success or failure • Useful to creditors in answering three main questions
1. Success in generating net cash from operating activities 2. Operating cash flow trends or patterns 3. Major reasons for positive or negative net cash from operating activities (Diagnostics)

The Cash Flow Statement

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