Cash Flow Statement - AccountingCoach.com 2020-01-28 · The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet,

(Explanation)

Cash Flow Statement

Our materials are copyright © AccountingCoach, LLC and are for personal use by the original purchaser only. We do not allow our materials to be reproduced or distributed elsewhere.

For personal use by the original purchaser only. Copyright © AccountingCoach®.com. 2

Introduction to the Cash Flow Statement

The official name for the cash flow statement is the statement of cash flows. We will use both names as well as SCF throughout AccountingCoach.com.

The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement, statement of comprehensive income, and statement of stockholders’ equity.)

The cash flow statement reports the cash generated and used during the time interval specified in its heading. Generally, the period of time is the same as the income statement. For example, the heading may state “For the Three Months Ended December 31, 2019” or “The Fiscal Year Ended September 30, 2019”.

The cash flow statement reports a company’s major cash flows in the following categories:

1.Operating activities

2. Investing activities

3. Financing activities

4. Supplemental information

- Converts the items reported on the income statement from the accrual basis of accounting to cash.

- Reports the purchase and sale of long-term investments and property, plant and equipment.

- Reports the issuance and repurchase of the company's bonds and stock, the payment of dividends, and borrowings and repayment of short-term and long-term bank loans and other debt.

- Reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid.

What Can the Statement of Cash Flows Tell Us?

Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected or turned into cash. Similarly, the expenses reported on the income statement might not have been paid. A person could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors recognize the SCF as an important financial statement.

Here are a few ways the statement of cash flows is used:

1. The net cash from operating activities is compared to the company’s net income. (“Net cash” is the cash inflows minus the cash outflows.) If the net cash from operating activities is consistently greater than the net income, the company’s net income or earnings are said to be of a “high quality”. If the net cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.

2. Some investors believe that “cash is king”. The cash flow statement identifies the cash that is


flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to expand its operations, replace inefficient equipment, increase its dividend, buy back some of its stock, reduce its debt, or acquire another company. All of these are perceived to be good for stockholder value.

3. Some financial models are based upon cash flow.

Understanding The Changes In Cash

We often enhance our comprehension of a topic when we have to think through solutions to problems, so to help you understand the cash flow statement, we’ve put together some questions for you to answer. (Answers appear at the end of this explanation.) As you formulate your response you will be learning to think about cash flows the way an accountant does.

1. When Mary Smith invests her personal money into her new company, what will happen to her company’s Cash account?

2. When a company purchases inventory (merchandise purchased in order to be resold) what will happen to its Cash account?

3. What happens to the company’s Cash account if it borrows money from the bank by signing a note payable?

4. What happens to a company’s Cash account if it declares and pays a dividend on its shares of stock?

5. What is the effect on its Cash account when a company pays some of its Accounts Payable?

6. What is the effect on its Cash account when a company prepays a 6-month insurance premium?

7. What is the effect on its Cash account when a company sells merchandise, but allows the customer to pay in 30 days?

8. What is the effect on its Cash account when a company receives payment from one of its customers 30 days after the sale was recorded?

9. If a company’s Accounts Payable account decreased, what is the likely effect this will have on Cash?

10. If the asset account Prepaid Insurance increased, what is the likely effect on Cash?

11. If the asset account Land increased, what’s the likely effect on Cash?

12. If the asset account Land decreased, what’s the likely effect on Cash?

13. If the liability account Bonds Payable increases, what is the likely effect on Cash?

14. If the liability account Bonds Payable decreases, what is the likely effect on Cash?


Much of what you learned in the practice questions is common sense. For example, when you use cash to buy a book, you now own the book (you’ve increased your “assets”) but you also have less money (you’ve decreased your cash). Based on what you learned, you can make the following general assumptions:

• When an asset (other than cash) increases, the Cash account decreases.• When an asset (other than cash) decreases, the Cash account increases.• When a liability increases, the Cash account increases.• When a liability decreases, the Cash account decreases.• When owner’s equity increases, the Cash account increases.• When owner’s equity decreases, the Cash account decreases.

Format of the Statement of Cash Flows

The statement of cash flows has four distinct sections:

1. Cash involving operating activities2. Cash involving investing activities3. Cash involving financing activities4. Supplemental information/disclosures

Assuming that the cash flow statement is prepared using the indirect method (the method used by most companies) the differences in a company’s balance sheet accounts will provide much of the needed information. For example, if the statement of cash flows is for the year 2019, the balance sheet accounts at December 31, 2019 will be compared to the balance sheet accounts at December 31, 2018. The changes or differences in these account balances will likely be entered in one of the sections of the statement of cash flows.

Shown below is each of the four sections of the statement of cash flows, followed by a list of those balance sheet accounts which affect it.

Here’s a Tip

For a change in assets (other than cash), the change in the Cash account is in the opposite direction.

For a change in liabilities and owner's equity, the change in the Cash account is in the same direction.


1. Cash Provided From or Used By Operating Activities

This section of the cash flow statement reports the company’s net income and then converts it from the accrual basis to the cash basis by using the changes in the balances of the current asset and current liability accounts, such as:

Accounts ReceivableInventorySuppliesPrepaid InsuranceOther Current AssetsAccounts PayableWages PayablePayroll Taxes PayableInterest PayableIncome Taxes PayableUnearned RevenuesOther Current Liabilities

In addition to using the changes in current assets and current liabilities, the operating activities section of the SCF also includes adjustments for depreciation and amortization expense, gains and losses on the sale of long-term assets, stock-based compensation, deferred income taxes, and others.

Note that the changes in the current liability accounts for short-term loans will be part of a company’s financing activities.

2. Cash Provided From or Used By Investing Activities

This section of the cash flow statement reports the cash flows causing the balances of long-term asset accounts to change. Examples of long-term (or noncurrent) assets include:

Long-term InvestmentsLandBuildingsEquipmentFurniture & FixturesVehicles

In short, investing activities involve the purchase and/or sale of long-term investments and property, plant, and equipment.

3. Cash Provided From or Used By Financing Activities

This section of the cash flow statement reports the cash flows causing the balances of the long-term liability accounts, the stockholders’ equity accounts, and the short-term loans payable accounts to change. Examples of these accounts include:


Short-term Notes or Loans PayableLong-term Notes or Loans PayableBonds PayableDeferred Income TaxesPreferred StockPaid-in Capital in Excess of Par-Preferred StockCommon StockPaid-in Capital in Excess of Par-Common StockPaid-in Capital from Treasury StockRetained EarningsTreasury Stock

In short, financing activities involve the issuance and/or the repurchase of a company’s own bonds or stock as well as short-term and long-term borrowings and repayments. Cash dividends paid to stockholders are also reported in this section.

4. Supplemental Information

This section of the cash flow statement discloses the amount that a company actually paid in interest and income taxes. The amounts appearing on the income statement are usually not the amounts paid.

Also reported in this section are the significant exchanges not involving cash. For example, the exchange of company stock for company bonds will be reported in this section.

Where To Enter The Balance Sheet Changes

Take a look at the summary below to see where the changes in the balance sheet accounts should be entered on the statement of cash flows:

Adjustments Within The Operating Activities Section

When the indirect method is used to prepare the statement of cash flows it begins with the amount of net income from the company’s income statement. Next, adjustments are listed to convert the net income amount to the cash amount.

A change in thisbalance sheet category

Current Assets* Current Liabilities**

Long-term Assets Long-term Liabilities**

Stockholders’ Equity

...is reported in this sectionof the cash flow statement

Operating ActivitiesOperating ActivitiesInvesting ActivtiesFinancing ActivitiesFinancing Activities

* This refers to current assets other than Cash ** Short-term Loans Payable are reported in Financing Activities


If all of a company’s revenues were cash sales (no credit sales), and if the company paid out cash for all of its expenses, then it’s possible that the company’s net income would equal its net cash from operating activities. Since some of the revenues and expenses on the income statement were not cash transactions, we must list adjustments for depreciation, gain or losses on sales of assets, and the changes in current assets and current liabilities (except for short-term loans payable). These adjustments will be illustrated in the hypothetical story presented next.

Story To Illustrate

Matt is a college student who enjoys buying and selling merchandise using the Internet. On January 2, 2019, he decided to turn his hobby into a business called “Good Deal Co.” Each month the Good Deal Co. had one or two transactions. Matt wants to prepare an income statement, balance sheet, and a statement of cash flows for the current month and for the year-to-date period. He asks our help in preparing and understanding the SCF.

January Transactions and Financial Statements

On January 2, 2019 Matt invested $2,000 of his personal money into his sole proprietorship, Good Deal Co. On January 20, Good Deal buys 14 graphing calculators at a cost of $50 per calculator (which was about 50% of the selling price Matt has observed at the retail stores). The total cost to Good Deal for all 14 calculators was $700. Good Deal had no other transactions during January.

Matt prepared the income statement and balance sheet for his new business as of January 31, 2019 as shown below:

Note that the $50 cost of each calculator is not reported on the income statement as an expense until a sale occurs. (This is part of the accrual basis of accounting and the related matching principle.)

The cost of each unsold calculator is reported as the asset inventory on the company’s balance sheet. Therefore, the 14 calculators purchased at $50 each will appear as $700 of inventory. Later, when a calculator is sold, the inventory will be reduced by $50 and the $50 will appear as an expense (described as cost of goods sold) on the income statement. For example, if one of the calculators is sold for $80, the income statement will report revenues of $80 and an expense of $50.

RevenuesExpenses Net income

$ 00

$ 0

Good Deal Co.Income Statement

For the Month Ended January 31, 2019


From the information on the company’s income statement and balance sheet we prepared the statement of cash flows for the month of January:

Under the indirect method, the operating activities section of the statement of cash flows (SCF) begins with the company’s net income. Note that Good Deal Co.’s January net income of $0 appears as the first item in the operating activities section of the SCF. Since the net income was determined through the accrual basis of accounting, we will list the adjustments needed to convert the amount of net income to the net amount of cash that was provided or used by the company’s operating activities.

Next, the amount of cash provided or used by the company’s investing activities is shown, followed by the amount of cash provided or used by the company’s financing activities.

Keep in mind that the amounts on the SCF indicate how the company’s cash and cash equivalents were changed by the items listed. (However, accountants will simply use the word “cash” instead of “cash and cash equivalents”.) A positive amount tells us that the item listed was a favorable adjustment that is increasing the company’s cash. A negative amount tells us that the item listed was an unfavorable adjustment that is decreasing the company’s cash.

Good Deal Co.Balance Sheet

January 31, 2019

ASSETS LIABILITIES & OWNER’S EQUITY

CashInventory

Total assets

LiabilitiesOwner’s equity Matt Jones, capital Total liabilities & owner’s equity

$1,300700

$2,000

$ 0

2,000$2,000

Operating Activities Net income Increase in inventory Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the month

Cash at the end of the month

$ 0(700)(700)

0

2,000

1,3000

$1,300

Good Deal Co.Statement of Cash Flows

For the Month Ended January 31, 2019


For example, from the balance sheet we know that the company’s inventory increased from $0 at January 1 to $700 at January 31. Increasing inventory by $700 during January was not good for the company’s cash balance since the company will be paying out $700. Therefore, on Good Deal Co.’s SCF we note that the “Increase in inventory” had an unfavorable or negative effect on the company’s cash balance by reporting the amount as “(700)”. [Had the inventory decreased by $700, the adjustment would have been a positive 700. The reason is that by decreasing its inventory the company avoided purchasing some of the goods that were sold. Avoiding the purchase was good/positive for the company’s cash balance.]

Again, amounts in parentheses can be viewed as not good or had a negative effect on the company’s cash balance. An amount in parentheses can also be viewed as a cash outflow or cash was used.

Amounts without parentheses are amounts that had a positive effect on the company’s cash balance. An amount without parentheses can also be viewed as a cash inflow or cash that was provided.

On the company’s SCF for January, the financing activities section shows “Investment by owner” which had a positive effect of “1,300” on the company’s cash. This amount could be discovered by examining the change in the owner’s capital account between the two balance sheet dates. Again, you can view the positive $1,300 as cash that flowed in or was good for the company’s cash balance.

The net increase in cash of $1,300 (which is the combination of the $700 cash outflow from operating activities and the $2,000 cash inflow from financing activities) is shown at the bottom of the SCF. The net increase of $1,300 agrees with the change in the cash balances reported on the balance sheet: at January 1 the balance was $0 and at January 31 the balance was $1,300.

February Transactions and Financial Statements

On February 25, 2019, Good Deal sold 10 calculators to a nearby high school for $80 each. Matt delivered the calculators on February 25 and gave the school an $800 invoice due by March 10. Matt received $800 from the school on March 8.

Matt prepared an income statement for the month of February:

Here’s a Tip

For a change in assets (other than cash), the change in the Cash account is in the opposite direction. Recall that when Inventory increased by $700, Cash decreased by $700.

For a change in liabilities and owner's equity, the change in the Cash account is in the same direction. Recall that when the owner invested cash in the company Cash increased and Owner’s Equity increased.


Under the accrual basis of accounting, revenues (such as sales of products) are reported on the income statement in the period in which a sale occurs. Typically, the sale occurs when the products or goods are shipped or delivered to the buyer (or services are provided). As our example shows, revenues can occur before cash is received. Since Good Deal Co. delivered 10 calculators at a selling price of $80 each, it had earned revenues of $800.

Under the accrual basis of accounting, expenses should be matched with revenues when possible. For instance, a retailer should match its cost of goods sold with its sales. In the case of Good Deal Co., it needs to match the cost of the 10 calculators sold with the revenues from selling 10 calculators. Therefore, its February income statement shows expenses of $500 (10 X $50) being subtracted from its revenues of $800. [Other expenses such as selling, general, administrative, and interest expenses must also be reported on the income statement when 1) they can be matched with the revenues, or 2) when a cost has expired, has been used up, or has no future value. If Good Deal Co. was renting a storage space for $50 per month, each month’s income statement would also list rent expense of $50.]

In summary, Good Deal Co. reported $800 of revenues, $500 of expenses, and $300 of net income even though no cash flowed in or out during February.


$ 800500

$ 300


For the Month Ended Feb. 28, 2019

Operating Activities Net income Increase in accounts receivable Decrease in inventory Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities Investment by owner



$ 300(800)500

00

0

01,300

$1,300


For the Month Ended February 28, 2019


The statement of cash flows (SCF) for the month of February begins with the accrual accounting net income of $300, which must be converted/adjusted to the net cash from operating activities. Recall that the income statement reported revenues of $800, but the balance sheets from January 31 and February 28 will indicate that accounts receivable increased from $0 to $800. This increase in accounts receivable of $800 indicates that the company did not collect $800 of the revenues that were reported on February’s income statement. Allowing accounts receivable to increase is not good for the company’s cash balance. When something is not good for the company’s cash balance, the amount is shown in parentheses. Again, the (800) indicates the negative effect on the company’s cash caused by the company’s failure to collect the cash from its credit sales.

When a company’s inventory decreases, it is good/positive for a company’s cash. The reason is the company is removing the items from its inventory instead of buying the goods during the current period. While Good Deal Co.’s income statement for the month of February reported “Expenses 500” for the cost of its goods sold, the company did not spend the $500 that was reported. Therefore, the company shows a positive $500 on its SCF as an adjustment to the net income amount. The $500 adjustment is not reporting what happened to the amount of inventory, it is reporting the necessary adjustment to convert the accrual accounting net income to the cash amount.

Next let’s look at the year-to-date financial statements covering the two-month period of January 1 through February 28:

The year-to-date net income of $300 increases the owner’s equity on the balance sheet. Please note the connection between the bottom line of the year-to-date income statement and the change in Matt Jones, Capital on the balance sheet. Matt Jones, Capital has increased from $2,000 to $2,300.


$ 800500

$ 300


For the Two Months Ended Feb. 28, 2019

Good Deal Co.Balance Sheet

February 28, 2019


CashAccounts receivableInventory

Total assets

LiabilitiesOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s equity

$1,300800200

$2,300

$ 0

2,000300

2,300$2,300


The SCF for the two months of January 1 through February 28, begins with the accrual accounting net income of $300. Since this is not the amount of cash from operating activities, the net income must be adjusted to the net amount of cash from operating activities.

During this two-month time period, the company’s accounts receivable increased from $0 to $800. An increase in accounts receivable means that the credit customers did not yet pay for all the credits sales that had been reported as revenues and net income on the income statement. Therefore, we must subtract the increase in accounts receivable from the company’s net income. Not having collected the total amount of past credit sales was not good for the company’s cash balance. For these reasons, the company’s accrual net income must be adjusted downward. Again, the reported (800) is the adjustment to the net income amount resulting from the “Increase in accounts receivable”.

During the two-month time period, the company’s inventory changed from $0 on January 1 to $200 at February 28. (Recall that the company had purchased 14 calculators at a cost of $50 each and then sold 10 calculators. That left 4 calculators in inventory at a cost of $50 each.) The increase in inventory from $0 to $200 during this two-month time period required the company to spend (have a cash outflow of) $200. The use of cash for adding goods to inventory is also viewed as not good for the company’s cash balance and is therefore reported on the SCF as (200).

Given these adjustments, the net cash flow from operating activities is a net cash outflow of $700. (The calculation is $300 cash inflow - $800 cash outflow - $200 cash outflow.) The net cash outflow will be presented as a negative amount and it is usually described as net cash used in operating activities.

The cash flow statement also shows $2,000 of financing by the owner. When this is combined with the negative $700 from operating activities, the net change in cash for the first two months is a positive $1,300. This agrees to the change in cash on the balance sheet—none on January 1 but $1,300 on February 28.

Operating Activities Net income Increase in accounts receivable Increase in inventory Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the yearCash at February 28, 2019

$ 300(800)(200)(700)

0

$2,000

1,3000

$1,300


For the Two Months Ended February 28, 2019


March Transactions and Financial Statements

On March 8 Good Deal receives $800 for the calculators sold to the school on February 25. No other transactions occurred in March. (Note that this $800 is a receipt but is not revenue. The revenue was earned and was reported on February’s income statement.)

The Good Deal financial statements dated March 31 are:

Note that the 3-month year-to-date net income causes the amount in the owner’s capital account (on the balance sheet) to increase from $2,000 to $2,300:


$ 00

$ 0


For the Month Ended March 31, 2019


$ 800500

$ 300


For the Three Months Ended March 31, 2019

Good Deal Co.Balance SheetMarch 31, 2019


CashAccounts receivableInventory

Total assets

LiabilitiesOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s equity

$2,1000

200

$2,300

$ 0

2,000300

2,300$2,300


The statement of cash flows (SCF) for the first three months of the business (January 1 through March 31) begins with the company’s accrual accounting net income of $300. This amount must be adjusted to show the net cash from operating activities (which are the company’s activities pertaining to the purchasing/producing of goods and selling of goods and/or providing services).

During the 3-month period of the SCF the company’s inventory went from $0 at January 1 to $200 at March 31. Therefore, we know that $200 of the company’s cash was used to increase its inventory. Recall that the use of cash, cash outflows, money spent, transactions having a negative effect on the company’s cash balance, etc. will be reported as a negative amount on the SCF. Therefore, the $200 increase in inventory must be shown as (200). [Had there been a decrease in inventory, the amount would have been a positive 200, since selling items from inventory would be positive/good for the company’s cash balance.]

Since the amount of the company’s accounts receivable was $0 at January 1 and $0 at March 31, there is no adjustment to the net income amount (and this line could have been omitted).

The combination of the positive net income of $300 and the adjustment for the cash used to increase inventory (200) results in the net cash provided by operating activities of a positive $100.

The owner’s $2,000 investment in January was a source of cash (hence it was a cash inflow, was good for the company’s cash balance, etc.) and listed as a positive $2,000 in the section described as cash flows from financing activities.

Finally, the combination of the amounts from the three sections of the SCF is $2,100. This agrees with the change in the amount of cash on the company’s balance sheets: $0 on January 1 and $2,100 on March 31.

Next, we will prepare a SCF for the month of March. To do this we will compare the company’s balance sheet of March 31 with its balance sheet of February 28.

Operating Activities Net income Increase in accounts receivable Increase in inventory Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the yearCash at March 31, 2019

$ 3000

(200)100

0

$2,000

2,1000

$2,100


For the Three Months Ended March 31, 2019


Focus on the “Change” column above. The first amount, a positive $800 change in the Cash account, will serve as a “check figure” for the bottom line of the cash flow statement for the month of March. In other words, the cash flow statement for March must end up explaining this $800 increase in the Cash account. The other amounts in the “Change” column will be used on the statement of cash flows to identify the reasons for the $800 increase in cash.

Since there were no revenues and no expenses in March, the income statement for the one month of March (see above) reported no net income. This $0 of net income is the first amount reported on the statement of cash flows. The changes in the balance sheet accounts from February 28 to March 31 provided the other information needed for the month of March:

Assets Cash Accounts receivable Inventory Total assets

Liabilities & Owner’s EquityLiabilitiesOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s equity

Change$ 800

(800)-0-

$ -0-

$ -0-

-0--0--0-

$ -0-

Good Deal Co.Balance Sheets

March 31 and February 28, 2019

2-28-19$1,300

800200

$2,300

$ -0-

2,000300

2,300$2,300

3-31-19$2,100

-0-200

$2,300

$ -0-

2,000300

2,300$2,300

(If you are wondering why March 31 is shown before February 28, it is because accountants usually place the most current amounts closest to the account names. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.)


Let’s review the cash flow statement for the month of March 2019:

• Net income for March is $0, since there were no revenues, gains, expenses, or losses.• Cash increased by $800 because $800 of accounts receivable were collected during March.• Inventory did not change, so Cash was not affected. (We could omit this line since it had no effect

on cash.)• There were no changes in long-term assets during March, so nothing is reported in the investing

activities section.• There were no changes in short-term loans payable, long-term liabilities, or owner’s equity; hence,

nothing is reported in the financing activities section.• The sum of the amounts on the statement of cash flows is a positive $800. This amount agrees to

the increase in the Cash account balance from $1,300 on February 28 to $2,100 on March 31.

April Transactions and Financial Statements

On April 28 Good Deal ordered $150 of supplies on account. The supplies arrived on April 30 along with an invoice showing that the full $150 is due by May 30. None of the supplies were used in April. This was the only transaction during April.

Matt prepared the following financial statements for Good Deal Co. as of April 30:


$ 00

$ 0


For the Month Ended April 30, 2019

Operating Activities Net income Decrease in accounts receivable Change in inventory Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities



$ 0800

0800

00

8001,300

$2,100


For the Month Ended March 31, 2019


Since no supplies were used in April, there is no Supplies Expense. The $150 is reported on the balance sheet in the asset account Supplies.


$ 800500

$ 300


For the Four Months Ended April 30, 2019

Good Deal Co.Balance SheetApril 30, 2019


CashAccounts receivableInventorySupplies

Total assets

Liabilities Accounts payableOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s equity

$2,1000

200150

$2,450

$ 150

2,000300

2,300$2,450

As you can see from the balance sheet the company added assets of $150 (Supplies) and added its first liability of $150 (Accounts Payable).

A balance sheet comparing April 30 to March 31 and the resulting differences or changes is shown below:


Assets Cash Accounts receivable Inventory Supplies Total assets

Liabilities & Owner’s EquityLiabilities Accounts payableOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s equity

Change$ 0

00

$ 150$ 150

$ 150

000

$ 150


April 30 and March 31, 2019

3-31-19$2,100

0200

0$2,300

$ 0

2,000300

2,300$2,300

4-30-19$2,100

0200150

$2,450

$ 150

2,000300

2,300$2,450

(If you are wondering why April 30 is shown before March 31, it is because accountants usually place the most current amounts closest to the account names. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.)

Operating Activities Net income Increase in supplies Increase in accounts payable Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities Investment by owner



$ 0(150)150

00

0

02,100

$2,100


For the Month Ended April 30, 2019

The cash flow statement for the month of April reports that there was no change in the Cash account from March 31 through April 30. The operating activities section reports the increase in Supplies, but also reports the increase in Accounts Payable.


Here’s a Tip

On the statement of cash flows, think of the positive amounts (the numbers not in parentheses) as good for your cash balance. For example, if you don't pay your bills, that's good for your cash balance (but bad for the liability Accounts Payable which increases).

Think of the negative amounts (the numbers within parentheses) as not good for cash. For example, if you pay a bill, that's not good for your cash balance (but good for the liability Accounts Payable which decreases).

Assets Cash Accounts receivable Inventory Supplies Total assets


Change $2,100

0200

150$2,450

$ 150

2,000300

2,300$2,450


April 30, 2019 and December 31, 2018

12-31-18$ 0

000

$ 0

$ 0

000

$ 0

4-30-19$2,100

0200150

$2,450

$ 150

2,000300

2,300$2,450

Operating Activities Net income Increase in inventory Increase in supplies Increase in accounts payable Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the monthCash at April 30, 2019

$ 300(200)(150)150100

0

2,000

2,1000

$2,100


For the Four Months Ended April 30, 2019


Let’s review the statement of cash flows for the four months ended April 30:

• The operating activities section of the SCF starts with the net income of $300 for the four-month period. The increase in Inventory is not good for cash, as shown by the negative $200. Similarly, increasing the amount of supplies on hand is not good for cash and it is reported as a negative $150. The increase in Accounts Payable is good for cash (since some bills were not paid); there-fore, the increase in Accounts Payable is a positive $150. Combining the amounts, the net change in cash that is explained by operating activities is a positive $100.

• There were no changes in long-term assets, hence no cash was involved in investing activities.• There were no changes in short-term loans payable or long-term liabilities. There was a change

in owner’s equity since December 31, and as a result the financing activities section reports the owner’s $2,000 investment in Good Deal Co.

• Combining the operating, investing, and financing activities, the cash flow statement reports a change in cash of $2,100. This agrees with the change in the Cash account from $0 on December 31, 2018 to $2,100 on April 30, 2019.

May Transactions and Financial Statements

On May 30 Good Deal pays its accounts payable of $150. On May 31 Good Deal purchases office equipment (a new computer and printer) that will be used exclusively in the business. The cost of the office equipment is $1,100 and is paid for in cash. The equipment is put into service on May 31. There were no other transactions in May.


$ 00

$ 0


For the Month Ended May 31, 2019


$ 800500

$ 300


For the Five Months Ended May 31, 2019


Good Deal Co.Balance SheetMay 31, 2019


CashAccounts receivableInventorySuppliesOffice equipment

Total assets

Liabilities Accounts payableOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s equity

$ 8500

200150

1,100

$2,300

$ 0

2,000300

2,300$2,300

A balance sheet comparing May 31 to April 30 and the resulting differences or changes is shown below:

Assets Cash Accounts receivable Inventory Supplies Office equipment Total assets


Change $(1,250)

00

01,100$ (150)

$ (150)

000

$ (150)


May 31 and April 30, 2019

4-30-19 $2,100

0200150

0$2,450

$ 150

2,000300

2,300$2,450

5-31-19$ 850

0200150

1,100$2,300

$ 0

2,000300

2,300$2,300


Operating Activities Net income Decrease in accounts payable Net cash provided (used) in operating activitiesInvesting Activities Purchase of office equipmentFinancing Activities

Net increase in cashCash at the beginning of the monthCash at the end of the month

$ 0(150)(150)

(1,100)0

(1,250)2,100

$ 850


For the Month Ended May 31, 2019

Assets Cash Accounts receivable Inventory Supplies Office equipment Total assets

Liabilities & Owner’s EquityLiabilities Accounts payableOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total owner’s equityTotal liabilities & owner’s Equity

Change $ 850

0200

1501,100

$2,300

$ 0

2,000300

$ 2,300$2,300


May 31, 2019 and December 31, 2018

12-31-18 $ 0

0000

$ 0

$ 0

000

$ 0

5-31-19$ 850

0200150

1,100$2,300

$ 0

2,000300

2,300$2,300


Operating Activities Net income Increase in inventory Increase in supplies Net cash provided (used) in operating activitiesInvesting Activities Purchase of office equipmentFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the yearCash at May 31, 2019

$ 300(200)(150)

(50)

(1,100)

2,000

8500

$ 850


For the Five Months Ended May 31, 2019

Let’s review the cash flow statement for the five months ended May 31:

• The operating activities section starts with the net income of $300 for the five-month period. The increase in Inventory was not good for cash, as shown by the negative $200. Similarly, the in-crease in Supplies was not good for cash and it is reported as a negative $150. Combining the amounts, the net change in cash that is explained by operating activities is a negative $50.

• The increase in long-term assets is reported under investing activities as (1,100) since it was a cash outflow of $1,100.

• There were no changes in short-term loans payable or long-term liabilities. There was a change in owner’s equity since December 31, and as a result the financing activities section of the cash flow statement reports the owner’s investment of $2,000 in the Good Deal Co.

• Combining the operating, investing, and financing activities, the statement of cash flows reports an increase in cash of $850. This agrees with the change in the Cash account as shown on the balance sheets from December 31, 2018 (or January 1, 2019) and May 31, 2019.

Depreciation Expense

Depreciation moves the cost of an asset to Depreciation Expense in a systematic manner during the asset’s useful life. The accounts involved in recording depreciation are Depreciation Expense and Accumulated Depreciation. As you see, cash is not involved. In other words, depreciation reduces net income on the income statement, but it does not reduce the Cash account on the balance sheet.

Because we begin preparing the statement of cash flows using the net income figure taken from the income statement, we need to adjust the amount of net income so it is not reduced by Depreciation Expense. This is done by adding back the amount of the Depreciation Expense.


Depletion Expense and Amortization Expense are accounts similar to Depreciation Expense, as all three involve allocating the cost of a long-term asset to an expense over the useful life of the asset. There is no cash involved.

Let’s illustrate how a depreciation expense is handled by continuing with the Good Deal Co.

June Transactions and Financial Statements

The only transaction recorded by Good Deal during June was the depreciation of the office equipment. Recall that on May 31 Good Deal purchased the office equipment (a new computer and printer) for $1,100 and it was put into service on the same day. Let’s assume that depreciation expense of $20 per month is recorded by Good Deal. As a result, Good Deal’s financial statements at June 30 will be as follows:

RevenuesExpenses Depreciation ExpenseNet income

$ 0

20$ (20)


For the Month Ended June 30, 2019

RevenuesExpenses Cost of goods sold Depreciation expense Total expenseNet income

$ 800

50020

520$ 280


For the Six Months Ended June 30, 2019

Here’s a Tip

In the operating activities section of the cash flow statement, add back expenses that did not require the use of cash. Examples are depreciation, depletion, and amortization expense.


Good Deal Co.Balance SheetJune 30, 2019


CashAccounts receivableInventorySuppliesOffice equipmentLess: Accumulated depreciation Total assets

Liabilities Accounts payableOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total Matt Jones, capitalTotal liabilities & owner’s equity

$ 8500

200150

1,100(20)

$2,280

$ 0

2,000280

2,280$2,280

A balance sheet comparing June 30 to May 31 and the resulting differences or changes is shown below:

Assets Cash Accounts receivable Inventory Supplies Office equipment Less: Accumulated depreciation Total assets

Liabilities & Owner’s EquityLiabilities Accounts payableOwner’s equity Matt Jones, capital (excl. net inc.) Matt Jones, curr yr. net income Total Matt Jones, capital Total liabilities & owner’s equity

Change $ 0

00

00

(20)$ (20)

$ 0

0(20)(20)

$(20)


June 30 and May 31, 2019

5-31-19 $ 850

0200150

1,1000

$ 2,300

$ 0

2,000300

2,300$2,300

6-30-19$ 850

0200150

1,100(20)

$2,280

$ 0

2,000280

2,280$2,280

(If you are wondering why June 30 is shown before May 31, it is because accountants usually place the most current amounts closest to the account names. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.)


Operating Activities Net income Add: Depreciation expense Net cash provided (used) in operating activitiesInvesting ActivitiesFinancing Activities


$ (20)20

000

0850

$ 850


For the Month Ended June 30, 2019

The cash flow statement for the month of June illustrates why depreciation expense needs to be added back to net income. Good Deal did not spend any cash in June, however, the entry in the Depreciation Expense account resulted in a net loss on the income statement. On the SCF, we convert the bottom line of the income statement (a loss of $20) to the net amount of cash provided or used in operating activities by adding back the $20 of depreciation expense.



Change $ 850

0200

1501,100

(20)$2,280

$ 0

2,000280

2,280$2,280


June 30, 2019 and December 31, 2018

12-31-18 $ 0

00000

$ 0

$ 0

000

$ 0

6-30-19$ 850

0200150

1,100(20)

$2,280

$ 0

2,000280

2,280$2,280


Operating Activities Net income Add back: Depreciation expense Increase in inventory Increase in supplies Net cash provided (used) in operating activitiesInvesting Activities Increase in office equipmentFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the yearCash at June 30, 2019

$ 28020

(200)(150)

(50)

(1,100)

2,000

8500

$ 850


For the Six Months Ended June 30, 2019

Let’s review the cash flow statement for the six months ended June 30:

• The operating activities section began with the net income of $280 for the six-month period. Depreciation expense is added back to net income because it was a noncash transaction (net income was reduced, but there was no cash outflow for depreciation). The increase in the Inventory account was not good for cash, as shown by the negative $200. Similarly, the increase in Supplies was not good for cash and it is reported as a negative $150. Combining the amounts, the net change in cash that is explained by operating activities is a negative $50.

• The increase in long-term assets caused a cash outflow of $1,100 which is reported in the investing activities section.

• There were no changes in short-term loans payable or long-term liabilities. There was a change in owner’s equity since December 31, and as a result the financing activities section reports the owner’s $2,000 investment in the Good Deal Co.

• Combining the operating, investing, and financing activities, the statement of cash flows reports an increase in cash of $850. This agrees with the change in the Cash account as shown on the balance sheets from December 31, 2018 and June 30, 2019.

Disposal of Assets

If a company disposes of (sells) a long-term asset for an amount different from the amount in the company’s accounting records (its book value), an adjustment must be made to net income shown as the first amount on the cash flow statement.

For example, let’s say a company sells one of its delivery trucks for $3,000. That truck is shown in the company’s records at its original cost of $20,000 less its accumulated depreciation of $18,000. When these two amounts are combined, their net amount is known as the book value (or the carrying value) of the asset. In this example, the book value of the truck is $2,000 ($20,000 - $18,000).


Because the cash received/proceeds from the sale of the truck was $3,000 and the book value was $2,000 the difference of $1,000 is recorded in the account Gain on Sale of Truck—an income statement account which increases the company’s net income. [If the truck had sold for $1,500 ($500 less than its $2,000 book value), the difference of $500 would be reported in the account Loss on Sale of Truck and would reduce the company’s net income.]

One of the rules in preparing a statement of cash flows is that the entire proceeds received from the sale of a long-term asset must be reported in the section of the SCF entitled investing activities. This presents a problem because any gain or loss on the sale of an asset is also included in the company’s net income which is reported in the SCF section entitled operating activities. To avoid double counting, each gain is deducted from the net income and each loss is added to the net income listed as the first item in the operating activities section of the cash flow statement.

Let’s illustrate this by returning to Good Deal Co.’s activities.

July Transactions and Financial Statements

On July 1 Matt decides that his company no longer needs its office equipment. Good Deal used the equipment for one month (May 31 through June 30) and had recorded one month’s depreciation of $20. This means the book value of the equipment is $1,080 (the original cost of $1,100 less the $20 of accumulated depreciation). On July 1 Good Deal sells the equipment for $900 in cash and records a loss of $180 in the account Loss on Sale of Equipment on its income statement. There were no other transactions in July.

The income statement and the SCF for the month of July illustrate how the disposal of the equipment is reported:

RevenuesExpenses Loss on sale of equipmentNet income

$ 0

180$(180)


For the Month Ended July 31, 2019


RevenuesExpenses Cost of goods sold Depreciation expense Loss on sale of equipment Total expenseNet income

$800

50020

180700

$100


For the Seven Months Ended July 31, 2019



Change $ 900

00

0(1,100)

20$ (180)

$ 0

0(180)(180)

$ (180)


July 31, 2019 and June 30, 2019

6-30-19 $850

0200150

1,100(20)

$2,280

$ 0

2,000280

2,280$2,280

7-31-19$ 1,750

0200150

00

$ 2,100

$ 0

2,000100

2,100$ 2,100


Let’s review the cash flow statement for the month of July 2019:

• Net income for July was a net loss of $180. There were no revenues, expenses, or gains, but there was an entry of $180 in the account loss on sale of equipment.

• There was no depreciation expense in July because the asset was sold on July 1. Also, the current assets and current liabilities did not change in July, so cash was not affected. (We could have omitted the line “Depreciation Expense”.)

• The net amount of cash provided or used by operating activities was $0.• Good Deal received $900 from the sale of its office equipment.• There was no change in short-term loans payable, long-term liabilities, or owner’s equity during

July (other than the $180 loss on sale of equipment).

The sum of the amounts on the SCF for the one month of July was a positive cash inflow of $900. This amount agrees to our check figure—the increase in the Cash account balance from June 30 to July 31.

Operating Activities Net income Add back: Depreciation expense Add back: Loss on sale of equipment Net cash provided (used) in operating activitiesInvesting Activities Proceeds from sale of office equipmentFinancing Activities


$ (180)0

1800

9000

900850

$1,750


For the Month Ended July 31, 2019


Let’s review the cash flow statement for the seven months of January through July 2019:

• Net income for the seven months was $100. This includes the company’s revenues, gains, expenses, and losses.

• Included in the net income for the seven months is $20 of depreciation expense. This expense reduced net income but did not reduce the Cash account; therefore on the SCF we add the $20 depreciation expense to the $100 of net income.



Change $ 1,750

0200

15000

$ 2,100

$ 0

2,000100

2,100$ 2,100


July 31, 2019 and December 31, 2018

12-31-18 $ 0

00000

$ 0

0

000

$ 0

7-31-19$ 1,750

0200150

00

$ 2,100

$ 0

2,000100

2,100$ 2,100

Operating Activities Net income Add back: Depreciation expense Add back: Loss on sale of equipment Increase in inventory Increase in supplies Net cash provided (used) in operating activitiesInvesting Activities Purchase of office equipment Proceeds from sale of office equipment Cash provided (used) for investing activitiesFinancing Activities Investment by owner

Net increase in cashCash at the beginning of the yearCash at July 31, 2019

$ 10020

180(200)(150)

(50)

(1,100)900

(200)

2,000

1,7500

$1,750


For the Seven Months Ended July 31, 2019


• Also included in the net income was the $180 entry into the Loss on Sale of Equipment account. This loss was reported on the income statement thereby reducing net income. However, cash was not reduced. Cash of $900 was actually received from the sale of the equipment and it appears in its entirety in the investing activities section of the cash flow statement.

• Inventory on July 31 is $200 (4 calculators at a cost of $50 each). Since the company began with no inventory, this increase in the Inventory account means that $200 of cash was used to increase inventory.

• Supplies increased from none to $150. The increase in the Supplies account is assumed to have had a negative effect of $150 on the Cash account.

• Combining the amounts so far, we see that the net amount of cash from operating activities is a negative $50. In other words, rather than providing cash, the operating activities used a net $50 of cash.

• There is cash outflow (or payment) of $1,100 to purchase the office equipment on May 31. There was also a $900 cash inflow (or receipt) from the sale of the office equipment on July 1. Combining these two amounts results in the net outflow (“cash used in investing activities”) of $200.

• There was an owner’s investment of $2,000 made on January 2.

The SCF’s bottom line amount of a positive $1,750 results from combining the amount totals of the three sections—operating, investing, and financing activities. This $1,750 agrees to the check figure—the increase in the Cash account balance from the beginning of January to July 31.

Conclusion

You should consider our materials to be an introduction to selected accounting and bookkeeping topics, and realize that some complexities (including differences between financial statement reporting and income tax reporting) are not presented. Therefore, always consult with accounting and tax professionals for assistance with your specific circumstances.

Attached Practice Answers

1. The Cash account increases, and because of the double-entry system, the owner’s equity account Mary Smith, Capital also increases.

2. The Cash account decreases, and because of the double-entry system, the asset account Inventory increases.

3. The Cash account increases, and because of the double-entry system, the liability account Notes Payable increases.

4. When the company pays a dividend the Cash account decreases. Because of the double-entry system, the stockholders’ equity account Retained Earnings also decreases.

5. The Cash account decreases, and because of the double-entry system, the liability account Accounts Payable is decreased.


6. The Cash account decreases, and because of the double-entry system, the asset account Prepaid Insurance increases.

7. There is no effect on the Cash account. The transaction does, however, result in a debit to the asset account Accounts Receivable and a credit to the income statement account Sales, which has the effect of increasing sales and net income on the income statement. The transaction changes nothing on the statement of cash flows since there is no cash involved at this time (the cash will be received in 30 days).

8. On the day the cash is received, the Cash account increases, and because of the double-entry system, the asset account Accounts Receivable is decreased. (Be aware that this transaction has no effect on the income statement—there is no increase in Sales and no increase in net income.)

9. If Accounts Payable decreased, we assume that the company paid some of its bills, therefore we assume that the Cash account also decreased.

10. If the asset account Prepaid Insurance increased, we assume that the company paid an insurance premium that covered more than the current month. Therefore, we assume that the Cash account decreased. Consider the general journal entry for this transaction:

Prepaid Insurance xxx Cash xxx

11. If the asset account Land increased, we assume that the company paid cash to purchase the land, therefore, the Cash account decreased. Consider the general journal entry for this transaction:

Land xxx Cash xxx

12. The Cash account increased because we assume that the company receives cash from the sale of any and all assets. Consider the general journal entry for this transaction:

Cash xxx Land xxx Gain on Sale of Land xxx

13. The Cash account increases because we assume the company receives cash when it issues bonds.

14. The Cash account decreases because we assume that the company used cash or paid cash to repurchase/redeem/reduce its bonds that are outstanding.

Documents

Cash Flow Statement - AccountingCoach.com 2020-01-28 · The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet,