20 Cash Flow Statement Lecturer Assoc. prof. M.V. Leleka

The statement of cash flows is one of the major financial statements used by accountants and business owners. (The other major financial statements are the income statement, balance sheet, and statement of stockholders' equity)statement of cash flows income statement statement of stockholders' equity

The cash flow statement reports the cash generated and used during the time interval specified in its heading. The period of time that the statement covers is chosen by the company.

For example, the heading may state "For the Three Months Ended December 31, 2009" or "The Fiscal Year Ended September 30, 2009".

The official name for the cash flow statement is the statement of cash flows. We will use both names throughout Accounting. The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement, and statement of stockholders' equity.)

The cash flow statement organizes and reports the cash generated and used in the following categories: 1.1. Operating activities– converts the items reported on the income statement from the accrual basis of accounting to cash Investing activities– reports the purchase and sale of long-term investments and property, plant and equipment Financing activities– reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends Supplemental information – reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid.

Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid.

You 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 utilize this important financial statement.

Here are a few ways the statement of cash flows is used. The cash from operating activities is compared to the company's net income. If the 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 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. 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 increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value. Some financial models are based upon cash flow.

Matt is a college student who enjoys buying and selling merchandise using the Internet. On January 2, 2009, he decides to turn his hobby into a business called "Good Deal Co." Each month the Good Deal Co. will have one or two transactions.

At the end of each month we will prepare an income statement, balance sheet, and a statement of cash flows for the current month and for the year-to-date period. The purpose is to show how these transactions are reported on the cash flow statement.

On January 2, 2009 Matt invests $2,000 of his personal money into his sole proprietorship, Good Deal Co. On January 20, Good Deal buys 14 graphing calculators for $50 per calculator—this is about 50% less than the selling price Matt has observed at the retail stores. The total cost to Good Deal for all 14 calculators is $700. Good Deal has no other transactions during January. Matt prepares financial statements for his new business as of January 31, 2009:

Good Deal Co. Income Statement For the Month Ended January 31, 2009 Revenues$ 0 Expenses 0 Net Income$ 0

Good Deal Co. Balance Sheet January 31, 2009 Assets Liabilities & Owner's Equity Cash$1,300Liabilities$ 0 Inventory 700Owner's Equity Matt Jones, Capital 2,000 Total Assets $2,000 Total Liab. & Owner's Equity $2,000

Good Deal Co. Statement of Cash Flows For the Month Ended January 31, 2009 Operating Activities Net Income$ 0 Increase in InventoryInventory (700) Cash Provided (Used) in Operating Activities(700) Investing Activities0 Financing Activities Investment by Owner 2,000 Net Increase in Cash1,300 Cash at the beginning of the month 0 Cash at the end of the month$1,300

Good Deal's income statement for January showed no profit or loss, since it did not have any sales or expenses. However, the cash flow statement reports that Good Deal's operating activities resulted in a decrease in cash of $700. The decrease in cash occurred because the company increased its inventory by $700 during January. The financing activities section shows an increase in cash of $2,000 which corresponds to the increase in Matt Jones, Capital (Matt's investment in the business). The net change in the Cash account from the owner's investment and the cash outflow for inventory is a positive $1,300. Matt Jones, CapitalCash

This net change of a positive $1,300 is verified at the bottom of the cash flow statement and on the balance sheet. There was a $0 cash at January 1, but at January 31, the Cash balance is $1,300. 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.CashInventory

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.

On February 25, 2009, Good Deal sells 10 calculators to a nearby high school for $80 each. Matt delivers the calculators on February 25 and gives the school an $800 invoice due by March 10. Matt receives $800 from the school on March 8. Matt prepared financial statements for his new business as of February 28, 2009: Good Deal Co. Income Statement For the Month Ended Feb. 28, 2009 Revenues$800 Expenses 500 Net Income$300

The income statement for the month of February shows revenues (or sales) of $800. Under the accrual basis of accounting—revenue is recognized when title passes (at the time of shipment or time of delivery), not when the money is received.

Expenses (such as the cost of goods sold for $500) appear on the income statement when they best match up with revenues, not when the expenses or goods are paid for.

(Other expenses will also appear on the income statement when they are used, not when they are paid for.) As a result of the accrual basis of accounting, the income statement reports $300 of net income even though there was no cash inflow or cash outflow during February.

Good Deal Co. Statement of Cash Flows For the Month Ended February 28, 2009 Operating Activities Net Income$ 300 Increase in Accounts ReceivableAccounts Receivable(800) Decrease in InventoryInventory 500 Cash Provided (Used) in Operating Activities0 Investing Activities 0 Financing Activities Investment by Owner 0 Net Increase in Cash0 Cash at the beginning of the month 1,300 Cash at the end of the month$1,300

As you can see above, the cash flow statement for the month of February reports no change in cash. That agrees with the company's balance sheet that reported Cash of $1,300 on January 31 and will show $1,300 on 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.Matt Jones, Capital

Good Deal Co. Balance Sheet February 28, 2009 AssetsLiabilities & Owner's Equity Cash$1,300Liabilities$ 0 Accounts Receivable800Owner's Equity Inventory200 Matt Jones, CapitalMatt Jones, Capital (excl. net inc.) 2,000 Matt Jones, Curr Yr. Net Income 300 Total Owner's Equity 2,300 Total Assets$2,300 Total Liabilities & Owner's Equity $2,300