Statement of Cash Flows

Management Accounting: The Cornerstone for

Business Decisions

Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

Learning Objectives

1. Explain the basic elements of a statement of cash flows.

2. Prepare a statement of cash flows using the indirect method.

3. Calculate operating cash flows using the direct method.

4. Prepare a statement of cash flows using a worksheet approach.

Define Cash

The Statement of Cash Flows

◙ Provides information regarding ◙ Sources of funds – Where funds

come from – referred to as Cash Inflows

◙ Uses of funds- Where they go – referred to as Cash Outflows

◙ They are organized into one of three groupings◙ Cash flows from operating activities◙ Cash flows from investing activities◙ Cash flows from financing activities

How to classify activities and identify them as

sources or uses of cash.Operating activities are the ongoing , day-to-

day, revenue generating activities of an organization. Cash inflows from operating activities come from the collection of sales revenues. Cash outflows are caused by the payment of operating costs. The difference between the two produces the net cash inflow (outflow) from operations.

Investing activities are those activities that involve the acquisition or sale of long-term assets. Long-term assets may be productive assets (e.g., acquiring new equipment) or long-term activities (e.g., acquiring stock in another company).

15-1

Financing activities are those activities that raise or (provide) cash from (to) creditors and owners. Although interest payments could be seen as financing outflows, the statement includes these payments in the operating activities.

REQUIRED: Classify the following major activities as belonging to the operating, investing, or financing categories. Identify them as sources or uses of cash.

How to classify activities and identify them as

sources or uses of cash.15-1

How to classify activities and identify them as

sources or uses of cash.Calculation:1. Issuing capital stock -

Financing - Source2. Retiring capital stock –

Financing - Use3. Purchasing long-term

assets – Investing - Use

4. Reporting unprofitable operations – Operating – Use

5. Issuing long-term debt- Financing - Source

6. Selling long-term assets (e.g., plant, equipment, and securities) – Investing - Source

7. Reporting profitable operations – Operating - Source

8. Reducing long-term debt – Financing - Use

9. Paying cash dividends – Financing - Use

15-1

Illustration of Sources and Uses of Cash

Define Indirect & Direct Method of Calculating Operating Cash Flows

◙ Indirect method◙ Computes operating cash flows by

adjusting net income for items that do not affect cash flows

◙ Direct method◙ Computes operating cash flows by

adjusting each line on the income statement to reflect it as if the income statement were prepared on a cash basis

What are the five steps to prepare the statement of

cash flows?1. Compute the change in cash for

the period2. Compute the cash from

operating activities3. Identify the cash flows from

investing activities4. Identify the cash flows from

financing activities5. Prepare the statement of cash

flows based on the previous four steps

Lemmons Company Comparative Balance

Sheetsfor the Years Ended December 31, 2008

and 2009      Net Change

  2008 2009 Debit Credit

Assets

Cash $175,000 $210,000 $ 35,000

A/R 112,500 127,500 15,000

Invent. 60,000 70,000 10,000

P & E 410,000 450,000 40,000

A/D (210,000) (235,000) 25,000

Land 287,500 287,500

Tot. Assets $835,000 $910,000

Lemmons Company Comparative Balance

Sheetsfor the Years Ended December 31,

2008 and 2009      Net Change

  2008 2009 Debit Credit

L & S. E.

A/P $ 95,000 $110,000 15,000

Mort. Pay 100,000 90,000 10,000

Comm. Stk 75,000 75,000

CCIEP 100,000 100,000

RE 465,000 535,000 - 70,000

Tot L&SE $835,000 $910,000 $110,000 $110,000

How to compute the change in cash flow.

From the prior two slides, we extract the information on cash and cash equivalents:

Net ChangesAssets 2008 2009 Debits CreditsCash $175,000 $210,000 $35,000REQUIRED: Calculate the change in cash flow.Calculation: The change in cash flow is simply the

difference in the ending and beginning cash flows. $210,000 - $175,000 = $35,000

15-2

Four Types of Adjustments

◙ Type A Adjustment◙ Decreases in non-cash current assets or

increases in current liabilities added to cash

◙ Type B Adjustment◙ Increases in non-cash current assets or

decreases in current liabilities deducted from cash

◙ Type C Adjustment◙ Expense deductions that do not require the

outlay of cash added as increases in cash (Add back non-cash items)

◙ Typed D Adjustment◙ Elimination of any income items that belong

in either the investing or financing section.

How to compute operating cash flows:

indirect method.1. Four types of adjustments from prior

slide.2. Current assets and liabilities

extracted from Lemmons CompanyNet Changes

CA 2008 2009 Debits CreditsA/R $112,500 $127,500 $15,000Invent. 60,000 70,000 10,000CLA/P $95,000$110,000

$15,000

15-3

Lemmons CompanyIncome Statement

For the Year Ended December 31, 2009Revenues $400,000Gain on sale of equipment 10,000Less: Cost of goods sold (230,000)Less: Depreciation expense (50,000)Less: Interest expense (10,000)

Net income $12,000

Dividends of $50,000 were paid.REQUIRED: Calculate operating cash flows using

the indirect method.

How to compute operating cash flows:

indirect method.15-3

Calculation:Operating net income $120,000Add (deduct) adjusting items:

Increase in A/R (15,000) (B)Increase in Inventories (10,000) (B)Increase in A/P 15,000 (A)Depreciation expense 50,000 (C)Gain on sale of equipment(10,000)(D)

Net cash from operating activities$150,000

How to compute operating cash flows:

indirect method.15-3

How to compute investing cash flows.

a. Equipment with a net book value of $75,000 was sold for $85,000 (original purchase price cost was $100,000). New equipment was purchased.

b. Information extracted from the comparative balance sheets of the Lemmons Company.

Long-Term Assets NetChanges2008 2009 Debit Credit

P & E $410,000 $450,000 $40,000A/D (210,000)(235,000) 25,000Land 287,500 287,500REQUIRED: Calculate the investing cash flows.

15-4

Calculation:Sale of equipment $ 85,000Purchase of equipment (140,000)

Net cash from investing activities$(55,000)

How to compute investing cash flows.15-4

Beginning P & E $410,000Purchase of Equipment ?Less: Sale of Equipment 100,000 Ending balance, P & E $450,000? = $450,000 + $100,000 - $410,000 = $140,000

How to compute financing cash flows.

a. Net income of $120,000 was earned, while cash dividends of $50,000 were paid in 2009.

b. Information extracted from the comparative balance sheets of the Lemmons Company.

NetChanges2008 2009 Debit Credit

Mort. Pay$100,000$90,000 $10,000CCIEP 100,000 100,000RE 465,000 535,000 70,000REQUIRED: Calculate the financing cash flows.

15-5

Calculation:Payment of mortgage principle$(10,000)Payment of dividends (50,000)

Net cash from financing activities$(60,000)

How to compute financing cash flows.15-5

Retained Earnings, End of 2008 $465,000Net income (2008) 120,000 Total $585,000Less: Retained Earnings, End of 2009 535,000

Dividends paid in 2009 $ 50,000

How to prepare the statement of cash

flows.Cornerstones 15-2; 15-3; 15-4; 15-5REQUIRED: Prepare a statement of

cash flows for the Lemmons Company.

Calculations:Lemmons Company

Statement of Cash FlowsFor the Year Ended December 31,

2009

15-6

How to prepare the statement of cash

flows.15-6

Cash flows from operating activities:

Net income $ 120,000

Add (deduct) adjusting items:

Increase in accounts receivable (15,000)

Increase in inventory (10,000)

Increase in accounts payable 15,000

Depreciation expense 50,000

Gain on sale of equipment (10,000)

Net operating cash $ 150,000

How to prepare the statement of cash

flows.15-6

Cash flows from investing activities

Sale of equipment

Purchase of equipment (140,000)

Net cash from investing activities (140,000)

Cash flows from financing activities

Payment of mortgage principle $ (10,000)

Payment of dividends

(50,000)

Net cash from financing activities (60,000)

Net increase in cash $ (50,000)

How to calculate cash flows using the direct

method.15-7a. Current assets and liabilities extracted

from Lemmons CompanyNet

ChangesCA 2008 2009 Debits

CreditsA/R $112,500 $127,500 $15,000Invent. 60,000 70,000 10,000CLA/P $95,000$110,000

$15,000

b. The income statement for Lemmons Company.

Lemmons CompanyIncome Statement

For the Year Ended December 31, 2009Revenues $400,000Gain on sale of equipment 10,000Less: Cost of goods sold (230,000)Less: Depreciation expense (50,000)Less: Interest expense (10,000)

Net income $12,000REQUIRED: Calculate operating cash

flows using the direct method.

How to calculate cash flows using the direct

method.15-7

Calculation: Income CashStatementAdjustments Flows

Revenues $400,000 ($15,000)$385,000Gain on Sale 10,000 (10,000)

Less: COGS (230,000) 15,000(225,000)

(10,000)Less: Depn. Exp.(50,000) 50,000Less: Int. Exp. (10,000) (10,000) Net income $120,000Net operating cash $150,000

How to calculate cash flows using the direct

method.15-7

Worksheet Approach to the Statement of Cash

Flows◙ As the transactions increase and

become more complex a worksheet is a handy tool to organize in preparing a statement of cash flows.

◙ It uses a spreadsheet format, that is efficient and logical means to organize the data to proceed from to prepare a statement of cash flows.

◙ It is a tool for preparing a statement of cash flows. It is not the actual statement of cash flows.