Accounting for Managers

Module 13: Statement of Cash Flow

Key Concepts in Cash Flows
Non-Cash Activities

• In order to prepare cash flow statement, we need to understand which items on income
statement and balance sheet may not involve transfer of cash
• Non-cash activities include depreciation, amortization, & obsolescence
• Non-cash items need to be properly recorded on income statement but disregarded on cash
flow statement
• Cash and cash equivalents are items on balance sheet that are liquid assets
• Cash equivalents include money market accounts, & treasury bills, and are easy to move to
checking account if cash is needed
Operating Activities

• Two methods to compute cash flow statement: direct and indirect

• Several sections on cash flow statement
• First section, operating activities: transactions that happen in normal course of business, affecting
revenue and expense accounts on income statement
• “Inflow” is the money in, and “outflow” is money going out
• Portion of cash flow statement can help better understand the need to have effective accounts
receivable system
• Cash budget: important to financial health of companies
Investing Activities

• The second section of the cash flow statement involves investing activities. We will again be
chatting about inflows and outflows as it relates to investments.\
• If you invest in property, plant, equipment, stocks, bonds or another company, these are all
investment activities on your cash flow statement.
Financing Activities

• Third part of cash flow statement involves financing activities

• Some inflows from financing activities (borrowing money or selling common stock) and
outflows (paying principal part of debt, buying back stock, paying dividend)
Direct Method versus Indirect Method
The Indirect Method

• Companies mostly use direct method, however indirect method is important

• Starts with net income and adds or subtracts items based on changes in their balances
• Related accounts on balance sheet for when changes happen and how they affect statement
of cash flows
The Direct Method

• Starts with income statement and rebuilds it on the cash basis

• most companies operate on accrual basis where income is recognized when earned & expenses when
they occur
• Method typically used
• Wouldn’t be concerned with changes in accounts’ receivable balance
Preparing a Statement of Cash Flow
Net and Gross Cash Flows

• Gross cash flows don’t exist in operating portion of cash flow statement, instead for
investing and financing
• Includes purchase price in cash of new piece of property or equipment and cash gain of sale
of piece of property or equipment
Net and Gross Cash Flows: Table
Assets and Liabilities If the account balance If the account balance
increases decreases
Non-current assets – –
(Investing activities)
Property, Plant, and Subtract Add
Equipment (P, P & E)
Long-term investments Subtract Add
Loans to others Subtract Add
Liabilities and Equity – –
(Financing Activities)
Bonds payable Add Subtract
Common stock (our own Add Subtract
company)
Retained earnings * *
Steps for Preparing a Statement of Cash Flow

• Indirect method is working from bottom of income statement and adjusting it to the cash
basis
• take net income first and work from there
• First step is to add back depreciation (non-cash expense)
• Second step is to analyze net changes in balance sheet accounts
Cash Flow Analysis

• Once customer acquisition process and collection procedures are corrected, cash flow will
improve, bills will be paid on time, and cash balance will be positive
• Easy to see how important analyzing cash flow is and how it can improve business processes
• Can also look at forecasted cash flow to help us see where our company is at from a cash
standpoint
• Forecasted cash flow statement can be created based on historical data or from budgeted
amounts
Quick Review

Importance of cash flow analysis and forecasting cannot be stressed enough

Direct (takes income statement to cash based format) and indirect (starts with net income and
adds and subtracts items from income statements) methods

Depreciation is added back as it is a non-cash expense, then account is analyzed to come to net
change in cash

Great resources with templates and assistance in preparing cash flow statements