Cash Flow

Statement
CHAPTER 5
 What is “cash”?
• Cash includes:
• Cash on hand
• Demand deposits

• Cash equivalents:
• Short-term, highly liquid investments
• Convertible to known amounts of cash
• Maturing within the next three months
• Examples: money market funds, treasury bills
• Bank overdrafts and lines of credit (“negative cash”)
 The importance of cash
An important aspect of performance is managing the
inflow and outflow of cash so that the enterprise has
enough cash to:
◦ pay bills and finance growth
◦ keep its borrowing under control
◦ pay investors dividends
◦ Have some “financial flexibility”
 Cash flow statement
It is a critical part of the financial statement package
◦ It provides supplementary information
◦ Bridges the other statements
◦ We do not create a cash flow statement from T-
accounts as we did the others, rather we use the
information from the other statements.
 Accrual Income vs. Cash Needs
• Many companies have earned high accrual incomes, while still
running into cash flow problems

• High accrual income does not necessarily translate into high

cash income

• As a result, it is important for present and potential investors

and creditors to have information about a firm’s cash
management and the resulting cash position.
 Example
ACME Ltd.
Statement of Earnings
2018 2019 2020
Revenue 10,000 15,000 20,000
Cost of goods sold (6,000) (9,000) (12,000)
Depreciation (2,000) (2,000) (2,000)
Other expenses (1,000) (1,500) (2,000)
Net income 1,000 2,500 4,000

What observations could we make from this statement?

 Example
ACME Ltd.
Statement of Financial Position
2017 2018 2019 2020
Cash 4,000 (6,000) (9,500) (11,500)
Accounts receivable 10,000 15,000 20,000
Inventory 6,000 9,000 12,000 15,000
Equipment, cost 90,000 90,000 90,000 90,000
Accumulated Depreciation - (2,000) (4,000) (6,000)
Total assets 100,000 101,000 103,500 107,500

Share capital 100,000 100,000 100,000 100,000

Retained earnings - 1,000 3,500 7,500
100,000 101,000 103,500 107,500

What observations could we make from this statement?

 Example
Statement of Cash Flow 2017 2018 2019 2020
Operating activities:
Cash received from collecting A/R 0 0 10,000 15,000
Cash paid for inventory (6,000) (9,000) (12,000) (15,000)
Cash paid for other expenses - (1,000) (1,500) (2,000)
(6,000) (10,000) (3,500) (2,000)
Financing activities:
Cash received from owners 100,000 0 0 0

Investing activities:
Cash paid for equipment (90,000) 0 0 0

Increase (decrease) in cash 4,000 (10,000) (3,500) (2,000)

Cash, beginning 0 4,000 (6,000) (9,500)
Cash, ending 4,000 (6,000) (9,500) (11,500)
 The Cash Flow Statement

The cash flow statement provides information about:

 Where cash came from during the year
 Where it went
 How much is left

This includes investing and financing activities; income

statement focuses only on operating activities
 Business activities – review
• Operating activities

• Investing activities

• Financing activities
Interest and Dividends

• IFRS allows companies a choice for interest and dividends

received and paid
• Interest paid can be operating or financing
• Dividends paid can be financing or operating

• Interest received can be operating or investing

• Dividends received can be operating or investing
 Exclusions

We do not report transactions that do not involve cash.

Examples:
• Issue debt to acquire assets
• Issue shares to acquire assets
• Convert debt into equity
• Exchange PPE for different PPE

Not on the statement, but disclosed in the notes

Cash Flow from Operations – 2 Methods
Indirect Method Direct Method
Start with accrual net earnings/net Start with
income operating
cash
Remove the effects on earnings of non- receipts
cash expenses (ie. depreciation) and
income (ie. gains on sale) Deduct
operating
Remove the effects on earnings cash
of changes in working capital payments

Cash generated from operations

 Indirect vs. Direct Method
• Indirect method also known as the reconciliation method
• Begins with net earnings (determined on an accrual basis)
• Shows differences between accrual earnings and cash flow

• Direct method directly reports, for example

• Cash collected from customers
• Cash paid to suppliers
• Cash paid to employees
 Deriving the Cash Flow Relationship
Assets = Liabilities + Equity
Cash + Other Assets = L + E
Cash = L + E – Other Assets
Cash = L + E - (Other Assets)

To find how cash has changed during the year, we simply have to
look at the changes in all of the other balance sheet accounts.
The cash flow statement is an analysis of those changes.
Tracking Changes
Liabilities or Equity = Cash

Liabilities or Equity = Cash

Assets = Cash

Assets = Cash

Income = Cash

Income = Cash
 Indirect method
Cash from operating activities:
1) Start with net income for the period (part of the retained
earnings change)
2) Make adjustments to eliminate non-cash components (next
slide)
3) Remove the effects of accrued income on “non-cash working
capital account changes” (A/R, A/P, inventory, prepaid
expenses, etc)
◦ Generally all items in current assets and current liabilities
except cash, dividends payable and current portion of long-
term debt
 Non-cash items

Common non-cash items included in net income:

• Depreciation expense
• gains or losses on sale of assets (investments, PPE, etc)
 Other items

Gains/losses
◦ These items are included in net income but they are not cash gains or
losses and so need to be removed as part of the “non-cash items”
◦ However, there are cash proceeds to be considered
◦ Remove the gain or loss in the operating section
◦ Add actual cash proceeds received on the sale in the investing
section
 Gain on sale
Example:

Building cost $ 10,000

Accumulated dep’n ( 7,000)
Net book value 3,000

If sold for cash proceeds of $4,000

Gain on sale of asset 1,000
 Effect on balance sheet

PPE decreases $3,000 (NBV)

Retained earnings increases $1,000 (gain)
Cash increases $4,000
+4,000 – 3,000 = + 1,000

When preparing the cash flow statement, we start with net

income (which includes the $1,000 gain). This is not cash
and so we need to deduct the gain in the operating section
We need to report the cash received and do this by adding
cash proceeds of $4,000 in the investing section
 Other items

Dividends
◦ In the financing section, show the actual cash
payment
◦ Need to recognize these are part of the changes in
retained earnings
Example
AP5-9B (Standard Card Company)