Unit V - Statement of Cash Flows

The basic financial statements we have presented so far provide only limited information about
the company’s asset “Cash”. For example, balance sheet shows how much cash the business
owns on the date the report was prepared but it does not indicate the amount of cash generated by
operating activities, or financing activities. The income statement may show expenses and
revenues that may have an effect to cash but will not provide reader of this report how these
income and expenses affected “Cash” account. The capital statement shows what happened to
the capital balance of the owner during the year. None of these statements presents a detailed
summary of where cash came from and how it was used.

Statement of Cash Flows Defined

The statement of cash flows reports the cash receipts, cash payments, and net change in cash
resulting from operating, investing, and financing activities during a period.

Usefulness of the Statement of Cash Flows

The information in a statement of cash flows should help investors, creditors, and others assess:

1. The entity’s ability to generate future cash flows. By examining relations between
items in the statement of cash flows, investors and others can make predictions of the
amounts, timing, and uncertainty of future cash flows better than they can from accrual
basis data.

2. The entity’s ability to pay dividends and meet obligations. If a company does not
have adequate cash, it cannot pay employees, settle debts, or pay dividends. Employees,
creditors, and stockholders should be particularly interested in statement, because it alone
shows the flows of cash in a business.

3. The reasons for the difference between net income and net cash provided (used) by
operating activities. Net income provides information on the success or failure of a
business enterprise. However, some are critical of accrual basis net income because it
requires many estimates. As a result, the reliability of number is often challenged. Such
is not the cash with cash. Many readers of statement of cash flows want to know the
reasons for the difference between net income and net cash provided by operating

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Cash Receipts Cash Payments
------------------------------------------------------ --------------------------------------------------
Collections from customers for sales of Payment to suppliers of merchandise
goods and services and services, including payments to
Interest and dividendsactivities.
received Then they can assess
Paymentsfor of interest the reliability of the income number.
themselves
Other receipts from operations; for Payments of income taxes
example, proceeds from settlement of Other expenditures relating to operations;
litigation for example, payments in settlement of
litigation 4. The cash investing and financing transactions during the period. By examining a
company’s investing and financing transactions, a financial statement reader can better
understand why assets and liabilities changed during the period.

Classification of Cash Flows

The cash flows shown in the statement are grouped into three major categories: (1) operating
activities. (2) investing activities, and (3) financing activities. We will now look briefly at the
way cash flows are classified among these three categories.

Operating Activities. The operating activities section shows the cash effects of revenue and
expense transactions. Stated another way, the operating activities section of the statement of cash
flows includes the cash effects of those transactions reported in the income statement. To
illustrate this concept, consider the effects of credit sales. Credit sales are reported in the income
statement in the period when the sales occur. But the cash effects occur later – when the
receivables are collected in cash. If these events occur in different accounting periods, the
income statement and the operating activities section of the statement of cash flows will differ.
Similar differences may exist between the recognition of an expense and the related cash
payment. Consider, for example, the expense of postretirement benefits earned by employees
during the current period. If this expense is not funded with a trustee, the cash payments may not
occur for many years – after today’s employees have retired.

Cash flows from operating activities include:

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Cash
Cash Receipts
Receipts Cash
Cash Payments
Payments
-----------------------------------------------------
------------------------------------------------------- --------------------------------------------------
--------------------------------------------------
Cash proceeds
Proceeds fromfrom
bothselling investments
short-term and
and long-term Payments
Repayment to acquire investments
of amounts borrowed and(excluding
plant
plant assets
borrowing assets
interest payments)
Cash
Cashproceeds
receivedfrom
fromcollecting principal
owners (for example, Amounts
Payments advanced to borrowers
to owners, such as cash withdrawals
Amounts onNotice
loans that receipts and payments of interest are classified as operating activities, not as
From investment)
investing or financing activities because these are shown in the income statement.

Investing Activities. Cash flows relating to investing activities present the cash effects of
transactions involving plant assets, intangible assets, and investments. They include:

Financing Activities. Cash flows classified as financing activities include the following items
that result from debt and equity financing transactions:

Repayment of amounts borrowed refers to repayment of loans, not to payments made on

accounts payable or accrued liabilities. Payments of accounts payable and of accrued liabilities
are considered payments to suppliers of merchandise and services and are classified as cash
outflows from operating activities. Also, remember that all interest payments are classified as
operating activities.

The following illustration lists typical cash receipts and cash payments within each of the
three classifications. Study the list carefully. It will prove very useful in solving homework

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exercises and problems.

0100090000037800000002001c00000000000400000003010800050000000b0200000000
050000000c02100e410f040000002e0118001c000000fb021000070000000000bc0200000000010
2022253797374656d000e410f0000691ee9846854110070838239f0b467030c020000040000002d
01000004000000020101001c000000fb029cff0000000000009001000000000440001254696d657
3204e657720526f6d616e0000000000000000000000000000000000040000002d0101000500000
00902000000020d000000320a5a00000001000400000000003c0f100e20db2d00040000002d010
000030000000000

Note the following general guidelines: (1) Operating activities involve income statement
items. (2) Investing activities involve cash flows resulting from changes in investment and long-
term asset items. (3) Financing activities involve cash flows resulting from changes in long-term
liability and owner’s equity items.

Some cash flows related to investing or financing activities are classified as operating
activities. For example, receipts of investment revenue (interest and dividends) are classified as
operating activities. So are payments of interest to lenders. Why are these considered operating
activities? Because these items are reported in the income statement, where results of
operations are shown.

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