Statement of Cash FlowsA statement of cash flows is a financial
statement which summarizes cash transactions of a business during a
given accounting period and classifies them under three heads,
namely, cash flows from operating, investing and financing
activities. It shows how cash moved during the period by indicating
whether a particular line item is a cash in-flow or a cash
out-flow. The term cash as used in the statement of cash flows
refers to both cash and cash equivalents. Cash flow statement
provides relevant information in assessing a company's liquidity,
quality of earnings and solvency.As stated above, a statement of
cash flows comprises of three sections:1. Cash Flows from Operating
ActivitiesThis section includes cash flows from the principal
revenue generation activities such as sale and purchase of goods
and services. Cash flows from operating activities can be computed
using two methods. One is theDirect Methodand the otherIndirect
Method.2. Cash Flows from Investing ActivitiesCash flows from
investing activitiesare cash in-flows and out-flows related to
activities that are intended to generate income and cash flows in
future. This includes cash in-flows and out-flows from sale and
purchase oflong-term assets.3. Cash Flows from Financing
ActivitiesCash flows from financing activitiesare the cash flows
related to transactions with stockholders and creditors such as
issuance of share capital, purchase of treasury stock, dividend
payments etc.Format and ExampleFollowing is a cash flow statement
prepared using indirect method:Company A, Inc.
Cash Flow Statement
For the Year Ended Dec 31, 2010
Cash Flows from Operating Activities:
Operating Income (EBIT)489,000
Depreciation Expense112,400
Loss on Sale of Equipment7,300
Gain on Sale of Land51,000
Increase in Accounts Receivable84,664
Decrease in Prepaid Expenses8,000
Decrease in Accounts Payable97,370
Decrease in Accrued Expenses113,860
Net Cash Flow from Operating Activities269,806
Cash Flows from Investing Activities:
Sale of Equipment89,000
Sale of Land247,000
Purchase of Equipment100,000
Net Cash Flow from Investing Activities136,000
Cash Flows from Financing Activities:
Payment of Dividends90,000
Payment of Bond Payable200,000
Net Cash Flow from Financing Activities290,000
Net Change in Cash115,806
Beginning Cash Balance319,730
Ending Cash Balance435,536
Cash Flow from Operating Activities: Direct MethodThe direct
method to calculate cash flow from operating activities involves
determination of various types of cash receipts and payments such
as cash receipts from customers, cash paid to suppliers, cash paid
for salaries, etc. and then putting them together under the cash
flow from operating section ofcash flow statement. These figures
are calculated using the beginning and ending balances of various
accounts of the business and the net increase or decrease in the
account. The exact formulas to calculate various cash inflows and
outflows vary. The most important ones are given below:FormulasCash
Receipts from Customers =
+Net Sales
+Beginning Accounts Receivable
Ending Accounts Receivable
Cash Payments to Suppliers =
+Purchases
+EndingInventory
Beginning Inventory
+Beginning Accounts Payable
Ending Accounts Payable
Cash Payments to Employees =
+Beginning Salaries Payable
Ending Salaries Payable
+SalariesExpense
Cash Payments for Purchase of Prepaid Assets =
+Ending Prepaid Rent, Prepaid Insurance etc.
+Expired Rent, Expired Insurance etc.
Beginning Prepaid Rent, Prepaid Insurance etc.
Interest Payments =
+Beginning Interest Payable
Ending Interest Payable
+Interest Expense
Income Tax Payments =
+Beginning Income Tax Payable
Ending Income Tax Payable
+Income Tax Expense
In the formulas given above it is assumed that accounts
receivable are only used for credit sales. It is also assumed that
all sales are on credit. If there are cash sales as well, then
receipts from cash sales must be included in the cash receipts from
customers to obtain a correct figure of cash flow from operating
activities.Similarly, it is assumed that accounts payable are used
merely for purchases on account and that all purchases are on
credit. If there are cash purchases as well, thencashpayments for
them must be included in the cash paid to suppliers. It is
important to note that here may be receipts & payments other
than those discussed above.Once the all the cash inflows and
outflows from operating activities are calculated, they are added
in the operating section of cashflows to obtain the net cashflow
from operating activities.The following example shows the format
and calculation of cash flows from operating activities using
direct method.ExamplePrepare the cash flows from operating
activities section of cash flow statement by direct method using
the following information:December 3120112010
Accounts Receivable34,13028,410
Prepaid Rent20,00025,000
Prepaid Insurance6,8006,000
Inventory23,03015,450
Accounts Payable14,59031,300
Salaries Payable8,3105,120
Interest Payable700360
Income Tax Payable2,3400
Year Ended December 312011
Net Sales64,970
Salaries Expense8,610
Rent Expense5,000
Insurance Expense3,200
Interest Expense1,650
Solution:Cash Flow from Operating Activities:
Cash Receipts
From Customers (1)59,250
Cash Payments
To Suppliers (2)24,290
To Employees (3)5,420
For Purchase of Prepaid Assets (4)4,000
Interest (5)1,310
Income Tax (6)0
NetCash Flowfrom Operating Activities24,230
Working Notes1) 64,970 + 28,410 - 34,130
2) 23,030 - 15,450 + 31,300 - 14,590
3) 5,120 - 8,310 + 8,610
4) 20,000 + 6,800 + 5,000 + 3,200 - 25,000 - 6,000
5) 360 - 700 + 1,650
6) 0 - 2,340 + 2,340
