1. The Statement of Cash Flows
-Understanding What and Why
-Learning the Mechanics to Effectively Configure and Analyze
Created by Patrick Badolato
Doctoral Student
Duke University’s Fuqua School of Business

2. What and Why…
The Balance Sheet and Income Statement are reported on an accrual basis; therefore, the SCF exists to provide a user of the Financial Statements with more information about how cash has been used (outflows) or received during a period (inflows)
Remember, accrual accounting reflects transactions as they occur in a legal/economic sense, not when the cash is received or paid out.
An accrual (generally defined) is a accounting entry to record an economic event that has no cash impact.
The SCF can assist in the valuation and understanding of a company as it effectively shows how a company’s earnings compare to the cash inflows or outflows.
Earnings, therefore (including both cash and accruals) are subject to managements discretion/expertise.
This additional information is useful in many ways. One way is valuation—a (simplified) valuation model equates a firm to the net present value of its cash flows.

3. Indirect Method
The more common method used by academics, covered in textbooks (like yours) and used by nearly all companies
The Direct Method is a different, less common method, but leads to the same result
the processes and line items differ when determining the Cash Flow from Operations
From here on I focus on the Indirect Method

4. The Components of the SCF
CFO-Cash Flows from Operating Activities
The cash transactions that result from the company’s day to day business (collecting from customers or paying expenses)
Effectively, a reconciliation of net income (which is determined from the accrual-based income statement) to the net amount of cash received or paid for operations during the reporting period

5. The Components of the SCF
CFI-Cash Flows from Investing Activities
The cash transactions from investments (i.e. non-current assets) made by the company to further or alter the business (buying a factory, selling land)
CFF-Cash Flows from Financing Activities
The cash transactions that result from exchanges with creditors and owners (issuing stock, borrowing from a bank)

6. Basic Breakdown from B/S
Current = Used within the course of the ordinary business cycle
Non-Current = Lasting longer than one ordinary business cycle

7. General Breakdown of the Accounts and Sections of the Balance Sheet…
0 = Operating, I = Investing, F = Financing

8. CHANGES in ASSETS An INCREASE in an ASSET is a USE OF CASH
and is SUBTRACTED on the SCF
A DECREASE in an ASSET is a
SOURCE OF CASH
and is ADDED on the SCF
Conceptualize with AR—if AR goes up (down) this represents less (more) cash that your customers have paid to you
Or, to buy an asset you spend cash, to sell an asset you receive cash

9. CHANGES in LIABILITIES
A DECREASE in an LIABILITY is a
USE OF CASH
and is SUBTRACTED on the SCF
An INCREASE in an LIABILITY is a
SOURCE OF CASH
and is ADDED on the SCF
Conceptualize with AP—if AP goes up (down) this represents less (more) cash that you have paid to your customers
Or, to pay your bill (reduce a liability) you spend cash, if you do not pay your bills, you should have more cash on hand…

10. Cash Flows From Operating (INDIRECT METHOD)
Begin with NET INCOME
Add in all non-cash expenses
Ex: Depreciation or Amortization
These are considered “Type 1” in the FSA textbook
Reverse out any non cash gains or losses related to the sale of non current assets
e.g. gain/loss portion of PPE or Marketable Securities
Add or subtract the changes in the “Working Capital Accounts”—the Operating (Current Non-Cash) Assets and Liabilities
Type 2 entries
VERY IMPORTANT !!!
DO NOT INCLUDE THE CHANGE IN CASH FROM THE BALANCE SHEET—This is the FINAL result.

11. Cash Flows from Investing
Add sale of investment-related assets
Subtract the purchase of investment assets
Do not include non-cash transactions or trades
Note: The Net PPE ending balance includes a reduction for the depreciation expense, which is added back when determining the amount of PPE that is purchased
(use a T-Account to calculate this)
(I strongly believe that T-Accounts are extremely helpful in determining relevant cash transactions related to PPE and RE)

12. Cash Flows from Financing Activities
Add in any proceeds from the sale of stock or the issuance of debt
Consider both Short and Long Term Portions of Debt
Subtract any cash paid in the purchase of treasury stock or re-acquisition of debt
Note that stock splits are non cash transactions
Dividends paid (by the company) are a Financing Activity
Use a T-Account (or algebra) to determine
Dividends = Ending RE – Net Income –
Beginning RE

13. Basic Process

14. Example: Balance Sheet Net Income = 200 Depreciation Expense = 100

15. Cash Flows from Operating Activities
Becomes…

16. Cash Flows from Investing Activities

17. Cash Flows from Financing Activities

18. The Statement of Cash Flows

19. Some Examples
How (and where) are these transactions dealt with on the SCF?
Firm has beginning balance of SE of 300, generates NI of 150 and has an ending SE balance of $350. During the year the firm issued additional stock for $200.
Plant sold for $100, this plant was bought for $120 and had accumulated depreciation of $40
Equipment sold for $50, which was bought for $90 and had accumulated depreciation of $30

20. Tips for making a SCF
When making a statement of cash flows, be sure to account for all Balance Sheet Items
DO NOT include the change in cash—this is the final check
Be aware that the “working capital ratio” is not the same as the source/use of cash from working capital accounts
Use the nature of the account to determine where you put it in the SCF
Be aware of the nature of all transactions:
Consider non cash transactions, and transactions that have a cash portion as well as a book gain or loss
Be careful with PPE and RE accounts
Use T-Accounts for these!