1. Prepared by R. E. Harms CMA
Understanding
FINANCIAL accounting
Canadian Edition
CHAPTER 5
THE STATEMENT OF CASH FLOWS
Prepared by R. E. Harms CMA
John Wiley & Sons Canada, Ltd. ©2015

2. Learning Objectives
LO1 – Understand and explain why the statement of cash flows is of significance to users
LO2 – Explain how the statement of cash flows and the statement of income differ
LO3 – Identify the three major types of activities that are presented in the statement of cash flows and describe some of the typical transactions included in each category of activity
LO4 – Prepare a statement of cash flows using a comparative statement of financial position, statement of income and some additional information
LO5 – Interpret the statement of cash flows and develop potential solutions to any cash flow challenges identified
LO6 – Calculate and interpret a company’s cash flows to total liabilities ratio and determine the amount of net free cash flow being generated

3. Significance of the Cash Flow Statement
Information in the statements enable the user to retrospectively:
Assess company’s ability to generate cash flows from operations
Evaluate where cash has come from – debt or equity
Assess level and type of capital assets investments
Determine how much cash was used for debt repayment
Evaluate the distribution of cash dividends
LO1

4. Significance of the Cash Flow Statement
Information in the statements enable the user to prospectively:
Estimate the value of the company based on cash flows
Assess the company’s ability to repay debt in the future
Evaluate the potential for dividend payments in the future
Estimate the company’s future cash requirements and capital structure
LO1

5. Cash Flow versus Income
The statement of cash flows differs from the income statement because is:
Reflects the cash basis rather than the accrual basis of accounting
Focuses on more than just the operating activities – it includes investing and financing activities as well
LO2

6. The Cash Flow Statement
Measures the cash flow the company in three categories:
Operating Activities
Investing Activities
Financing Activities
LO3

7. The Cash Flow Statement
Operating activities
Sale of goods and services to customers
Changes to current assets and current liabilities
All other transactions not covered by financing or investing activities
Cash flows from operating activities are key because:
They are result of day to day business operations
They are the source for future debt repayment
They are the source for future dividend payments
L03

8. Cash Flow Statement Financing activities Investing activities
Obtaining and repaying resources from shareholders and lenders
Examples: shares, bonds, mortgages, notes, dividends
Investing activities
Investment, sale, or disposal of long-term assets
Examples: property, plant, equipment, long-term marketable securities
LO3

9. Cash Flow Transactions by Category

10. Definition of “Cash” Includes both cash and cash equivalents
Cash includes cash on hand together with demand deposits
Cash Equivalents include short term, highly liquid investments, for example:
Money market funds
Short term deposits
Treasury bills
LO4

11. The Cash Flow Statement
Companies may choose between the direct method and the indirect method
The only difference is how the cash flows from operating activities are determined – total cash flows are the same under both methods
The choice of method has NO effect on cash flows from investing or financing activities
LO4

12. Direct vs Indirect Method
Most companies prefer the indirect method for the following reasons:
Simpler to prepare
Uses information available in most accounting systems
Provides a link b/w profit and cash flows from operating activities
The indirect method is also known as the reconciliation method
Standards setters prefer the direct method; however, most public companies still use the indirect method
LO4

13. Preparing the Cash Flow Statement
In order to prepare the cash flow statement, a company requires the following information:
Comparative Statement of Financial Position, for the current and previous period
Statement of Income for the current period
Any additional relevant information
LO4

14. Comparative Statement of Financial Position
LO4

15. Statement of Income
LO4

16. Additional Information
LO4

17. Steps for Preparing the CF Statement
Step 1 – Determine the net change in cash during the period
Subtract the balance of cash and cash equivalents at the beginning of the period from the balance at the end of the period
Step 2 – Read the additional information provided and cross reference it the to the related statement of financial position accounts
LO4

18. Steps for Preparing the CF Statement
Step 3 – Using the statement of income:
record net income
adjust if for non cash items included in the statement, such as depreciation / amortizations,
and any items that do not involve operating activities, such as gains / losses from sale of capital assets and investments
This is the process under the Indirect method
LO4

19. Steps for Preparing the CF Statement
Step 4 – Determine the net change in cash in each current asset and currently liability account (other than cash and dividends payable) and record the impact of these change on cash
LO4

20. Steps for Preparing the CF Statement
Step 5 – Determine and record the cash proceeds received from selling and buying capital assets with cash during the year. In our example:
Equipment that originally cost $25,000 and had a net book value of $5,000 was sold for $8,900 during the year
A T-account may be useful in your analysis
LO4

21. Steps for Preparing the CF Statement
Reconstruct the transactions in the PPE account
Equipment
Beginning Balance ,000
25, Cost of Equipment sold
Balance after sale ,000
Of Equipment
Cost of Equipment ,000
Purchased
This is the missing amount, which will produce the ending balance
Ending Balance ,000
LO4

22. Steps for Preparing the CF Statement
Step 6 – Determine and record the cash proceeds from the sale of shares of other companies (investments) and the cost of any investments in other companies purchased with cash during the year
Step 7 – Determine the amount of cash dividends paid during the year
A T-account can help organize the data
LO4

23. Steps for Preparing the CF Statement
Reconstruct the transactions in the R/E account
Retained Earnings
23, Beginning Balance
86, Net Earnings for 2016
109,750
Dividends Declared ,200
This is the missing amount, which will produce the ending balance
106, Ending Balance
LO4

24. Steps for Preparing the CF Statement
Reconstruct the transactions in the Dividends Payable account
Dividends Payable
5, Beginning Balance
3, Dividends Declared
8,400
Dividends Paid during yr 5,200
This is the missing amount, which will produce the ending balance
3, Ending Balance
LO4

25. Steps for Preparing the CF Statement
Step 8 – Determine and record the cash received from borrowings (new loans or increases to existing loans) made during the year and the amount of cash principal repaid on loans during the year
A T-account can help organize the data
LO4

26. Steps for Preparing the CF Statement
Reconstruct the transactions in the Loan Payable account
Loan Payable
36, Beginning Balance
Balance after principal repayments
36,000
This is the missing amount, which will produce the ending balance
7, New Borrowings
43, Ending Balance
LO4

27. Steps for Preparing the CF Statement
Step 9 – Determine the cash received from shares issued during the period
Step 10 –Calculate the sum of the cash flows from operating, investing and financing activities. It should reconcile back to the amount in Step 1
Companies are also required to disclose:
Interest paid and received during the period
Dividends paid and received during the period
Income taxes paid during the period
LO4

28. Statement of Cash Flows

29. Statement of Cash Flows

30. Direct Method
The direct method differs only in the way the operating activities section of the cash flow statement is prepared. The direct method categorizes cash flows by cash receipts and cash payments.
These categories are as follows:
Receipts from customers
Payments to suppliers
Payments to employees
Payment to interest
Payments of income taxes
LO4

31. Using the Direct Method
LO4

32. Using the Direct Method
LO4

33. Investing / Financing Activities
It is possible to have activities that do NOT appear on the cash flow statement. For example:
Company purchased assets by assuming debt or issuing shares
Company acquired the shares of another company by assuming debt or issuing shares rather than paying cash
Company repaid debt by issuing shares rather than paying debt
Since there is no cash inflow or outflow needs only to be disclosed in the notes to the financial statements
LO4

34. Interpreting the CF Statement
The longer a company’s cash-to-cash cycle the more pressure it placed on cash flow
LO5

35. Mitigating Cash Flow Challenges
Companies can resolve common cash flow challenges by taking the following measures:
Reduce the rate of growth
Shorten the cash-to-cash cycle
Increase company’s capitalization
LO5

36. Cash Flow Patterns
LO5

37. Cash Flow Patterns

38. Financial Statement Analysis
Cash Flow to Total Liabilities
= Cash Flows from Operating Activities
Total Liabilities
This ratio measures the percentage of a company’s total liabilities that could be met with one year’s operating cash flows
LO6

39. Danier Leather Example
LO6

40. Financial Statement Analysis
Net Free Cash Flow is a Non IFRS financial measure, therefore is not standardized. Used to measure amount of cash generated from operations that is in excess of cash require to maintain the company’s productive capacity
LO6

41. Danier Leather Example
LO6

42. Copyright
Copyright © 2015 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.