1. Accounting, Fifth Edition12
STATEMENT OF CASH FLOWS
Accounting, Fifth Edition

2. Learning Objectives
After studying this chapter, you should be able to:
Indicate the usefulness of the statement of cash flows.*
Distinguish among operating, investing, and financing activities.*
Explain the impact of the product life cycle on a company’s cash flows.
Prepare a statement of cash flows using the indirect method.
Use the statement of cash flows to evaluate a company.*
*Self-study topics.

3. Cash is KING. Collect Quick, Pay Slow
Usefulness and Format
Usefulness of the Statement of Cash Flows
Provides information to help assess:
Entity’s ability to generate future cash flows.
Entity’s ability to pay dividends and obligations.
Reasons for difference between net income and net cash provided (used) by operating activities.
Cash investing and financing transactions during the period.
Cash is KING.
Collect Quick, Pay Slow
LO 1 Indicate the usefulness of the statement of cash flows.

4. Usefulness and Format Classification of Cash Flows
Operating Activities
Investing Activities
Financing Activities
Income Statement Items
Changes in Investments and Long-Term Asset
Changes in Long-Term Liabilities and Stockholders’ Equity
LO 2 Distinguish among operating, investing, and financing activities.

5. Operating Activities Inflows Outflows Income Statement items
Receipts from customers
Cash dividends received
Interest from borrowers
Other.
Outflows
Salaries and wages
Payments to suppliers
Taxes and fines
Interest paid to lenders
Other
The Operating Activities Section includes cash inflows and cash outflows that result from the operations of the business and some incidental business transactions. Operating cash inflows include cash received from customers in payment of goods sold. It also includes cash received as dividends and interest. Operating cash outflows include cash payments for salaries, supplies, inventory, taxes, and interest.
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6. Investing Activities Inflows Outflows
Changes in Investments & LT Assets
Inflows
Selling long-term productive assets
Selling equity investments
Collecting principal on loans
Other
Outflows
Purchasing long-term productive assets
Purchasing equity investments
Purchasing debt investments
Other
The Investing Activities Section includes cash inflows and cash outflows that result from the sale and purchase of fixed assets and investments. If a company purchases a piece of equipment, it would be classified as a cash outflow in the investing section. If a company has excess cash and invests it in the stock of another company, it would also be classified as a cash outflow in the investing section. If, in the future, this equity investment is sold, it would be classified as a cash inflow in the investing section.
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7. Financing Activities Inflows Outflows
Changes in LT Liabilities & Shareholders’ Equity
Inflows
Issuing its own equity securities
Issuing bonds and notes
Issuing short- and long-term liabilities
Outflows
Pay dividends
Purchasing treasury stock
Repaying cash loans
The Financing Activities Section includes cash inflows and cash outflows that result from transactions with the company’s creditors and stockholders. If a company borrows money from a bank, it would be classified as a cash inflow in the financing section. If, in the future, this debt is repaid, the amount of the principal payment would be classified as a cash outflow in the financing section. Remember that the interest payment is classified as a cash outflow in the operating section. If a company issues stock of the company, it would be classified as a cash inflow in the financing section.
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8. BE 12-2, p 663

9. of product life cycle on
The Corporate Life Cycle
Illustration 12-3
Impact
of product life cycle on
cash flows.
LO 3 Explain the impact of the product life cycle on a company’s cash flows.

11. Format of the Statement of Cash Flows
Illustration 12-2
LO 2 Distinguish among operating, investing, and financing activities.

12. Usefulness and Format Format of the Statement of Cash Flows
Order of Presentation:
Operating activities.
Investing activities.
Financing activities.
Direct Method
Indirect Method
LO 2 Distinguish among operating, investing, and financing activities.

13. Operating Activities – Direct vs Indirect
There are two acceptable methods to determine Cash Flows from Operating Activities:
Direct Method Separately list each major item of operating cash payments (I.e. cash paid for merchandise) and operating cash receipts (I.e. cash from customers). Recommended by FASB but more difficult to prepare. Used by less than 2% of all companies.
Indirect Method - reports net income and then adjusts for items necessary to determine the net cash provided or used by operating activities. Focuses on differences between net income and net cash flow from operating activities. Easier to prepare and used by nearly all companies.
There are two acceptable formats for preparing the Cash Flows from Operating Activities:
 The Direct Method.
 The Indirect Method.
While each method uses a different format to arrive at Net Cash Provided (Used) by Operating Activities, the end result is the same under each method. In other words, they may use a different path to get to the end, but in the end, they both arrive at the same answer.
Both methods result in the same bottom line for the
Operating Activities section.
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14. Preparing the Statement of Cash Flows
Three Sources of Information:
Comparative balance sheets
Current income statement
Additional information
LO 3 Explain the impact of the product life cycle on a company’s cash flows.

15. Operating Activities – Indirect Method
Net Income
Cash Flows from Operating Activities
Changes in current assets and current liabilities*
+ Losses and - Gains
+ Noncash expenses such as depreciation and amortization.
*See next slide
The indirect method is used by almost all companies. The indirect method starts with the accrual based net income and makes certain adjustments to arrive at Cash Flows from Operating Activities. Adjustments to the accrual based net income include adding back any noncash items that are included to arrive at net income, such as depreciation and amortization. Adding these back on the Statement of Cash Flows basically cancels out the fact that they were originally subtracted to arrive at net income. Since these items do not represent cash outlays, we would not want them included in the Statement of Cash Flows.
Other items on the income statement to consider are gains and losses. Gains and losses result from the sale of an asset. Gains are added on the income statement and losses are subtracted on the income statement to arrive at net income. Since the gain and loss do not represent an operating cash flow, we cancel out gains by subtracting them and cancel out losses by adding them to net income in the operating section. The actual cash flow from the sale of the asset will be properly reported, in most cases, in the investing section. We also have to make appropriate adjustments to reflect the change from accrual based revenues and expenses reported on the income statement to cash based revenues and expenses. This is accomplished by analyzing the changes in noncash current assets and current liabilities.
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16. Use this table when adjusting Net Income to Operating Cash Flows.
Indirect Method – Changes In
Current Assets & Liabilities
This chart explains how to treat a change in a noncash current asset or current liability in the operating section of the statement of cash flows. Maybe a couple of examples will help you see how this table works. Let’s start with current assets. If Accounts Receivable, a current asset, decreased during the year, this decrease would be added to net income. A decrease in Accounts Receivable means that customer cash payments on account exceeded customer charges on account during the period. This excess of cash payments over charges is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period. Similarly, if Accounts Receivable increased during the year, this increase would be subtracted from net income. An increase in Accounts Receivable means that customer charges on account exceeded customer cash payments on account during the period. This excess of charges over cash payments is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period. Now, let’s look at how to treat changes in current liabilities. If Salaries Payable, a current liability, decreased during the year, this decrease would be subtracted from net income. A decrease in Salaries Payable means that the company paid off more in salaries than it charged during the period. This excess of cash payments over charges is used to adjust the accrual based expense reported on the income statement to report the total cash paid for salaries during the period. Similarly, if Salaries Payable increased during the year, this increase would be added to net income. An increase in Salaries Payable means the company charged more than it paid off during the period. This excess of charges over cash payments is used to adjust the accrual based expense reported on the income statement to report the total cash paid for salaries during the period.
Use this table when adjusting Net Income to Operating Cash Flows.
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17. Cash Flows Practice Problem
Day 1: Do-It! 12-2, p 665
Day 2: E12-6, p 667
In your book, next to each line, determine mark each item as:
O – Operating
I – Investing
F – Financing
Next to each O, I or F, indicate it as a + or – to Cash.
Prepare a properly formatted Statement of Cash Flows using the Indirect Method (p 641).

18. Using Cash Flows to Evaluate a Company
Free Cash Flow
Illustration 12-15
Free cash flow describes the cash remaining from operations after adjustment for capital expenditures and dividends.
LO 5 Use the statement of cash flows to evaluate a company.

19. Using Cash Flows to Evaluate a Company
Illustration 12-16
Illustration
Required: Calculate Microsoft’s free cash flow.
Illustration 12-17
Net cash provided by operating activities $37,529
Less: Expenditures on PP&E and intangibles 7,452
Dividends paid 0
Free cash flow $30,077
LO 5 Use the statement of cash flows to evaluate a company.

20. Using Cash Flows to Evaluate a Company
Assessing Liquidity and Solvency
Solvency is the ability of a company to survive over the long term.
Illustration 12-19
A ratio below .20 times is cause for additional investigation.
LO 5 Use the statement of cash flows to evaluate a company.