Chapter 11: Statement of Cash Flows – Financial Accounting Study Notes

Statement of Cash Flows

Introduction

The Statement of Cash Flows is a key financial statement that reports a company's cash inflows and outflows over a specific period. It provides essential information about the sources and uses of cash, helping users assess the company's liquidity, financial flexibility, and overall financial health.

Purposes of the Statement of Cash Flows

Reporting Cash Flows

• Cash receipts: Inflows of cash from various activities.

• Cash payments: Outflows of cash for expenses, investments, and financing.

• Time span: Covers a period such as a month, quarter, or year.

Four Main Purposes

• Predicts future cash flows: Helps users forecast the company's ability to generate cash.

• Evaluates management decisions: Assesses how management's choices impact cash position.

• Determines ability to pay dividends and interest: Indicates whether the company can meet its obligations to shareholders and creditors.

• Shows relationship of net income to cash flows: Explains differences between accrual-based net income and actual cash movements.

Timing of Financial Statements

Exhibit 11-1: Timing Overview

• Balance Sheet: Reports financial position at a specific point in time.

• Income Statement, Statement of Stockholders' Equity, Statement of Cash Flows: Report activities over a period of time.

Types of Business Activities

Operating, Investing, and Financing Activities

• Operating Activities: Transactions that create revenues, expenses, gains, and losses, resulting in net income.

• Investing Activities: Transactions that increase or decrease long-term assets (e.g., purchase or sale of equipment).

• Financing Activities: Transactions related to long-term liabilities and owners' equity (e.g., issuing stock, borrowing, repaying debt).

Exhibit 11-2: Effects on the Balance Sheet

• Operating Cash Flows: Affect current assets and current liabilities.

• Investing Cash Flows: Affect long-term assets.

• Financing Cash Flows: Affect long-term liabilities and stockholders' equity.

Formats for Operating Activities

Indirect vs. Direct Method

• Indirect Method: Reconciles net income to net cash provided by operating activities by adjusting for non-cash items and changes in working capital.

• Direct Method: Reports all cash receipts and cash payments from operating activities directly.

Indirect Method	Direct Method
Net income: $600 Adjustments: Depreciation, etc.: $300 Net cash provided by operating activities: $900	Collections from customers: $2,000 Deductions: Payments to suppliers, etc.: ($1,100) Net cash provided by operating activities: $900

Preparing the Statement of Cash Flows (Indirect Method)

Key Components

• Transactions that make up net income (from the income statement): - Net income - Depreciation, depletion, amortization expense - Gains and losses on sale of long-term assets

• Changes in current assets and current liabilities (from comparative balance sheets): - Increase or decrease in each current asset - Increase or decrease in each current liability

Depreciation, Depletion, and Amortization Expenses

• Added back to net income to convert net income to cash flow.

• No effect on cash, but decreases net income.

• Add-back cancels the deduction on the income statement.

• Example: TRRS reports depreciation expense of $18,000.

Gains and Losses on Sale of Long-Term Assets

• Adjust net income by subtracting gains and adding losses.

• Example: Equipment sold for $62,000, book value $54,000, gain of $8,000.

Changes in Current Assets and Liabilities (Excluding Cash)

• Increase in noncash current asset: Decreases cash (e.g., Accounts Receivable +$15,000, Prepaid Expenses +$1,000).

• Decrease in noncash current asset: Increases cash (e.g., Inventory -$3,000).

• Increase in current liability: Increases cash (e.g., Accounts Payable +$34,000).

• Decrease in current liability: Decreases cash (e.g., Salary and Wages Payable -$2,000, Accrued Liabilities -$2,000).

Exhibit 11-6: Statement of Cash Flows—Operating Activities—Indirect Method

Item	Amount (in thousands)
Net income	53
Depreciation	18
Gain on sale of plant assets	(8)
Increase in accounts receivable	(15)
Increase in prepaid expenses	(1)
Decrease in inventory	3
Increase in accounts payable	34
Decrease in salary and wage payable	(2)
Decrease in accrued liabilities	(2)
Net cash provided by operating activities	84

Cash Flows from Investing Activities

Definition and Examples

• Affect long-term assets such as plant assets and long-term investments.

• Increase: Purchase of long-term assets (decreases cash).

• Decrease: Sale of long-term assets (increases cash).

Exhibit 11-8: Computing Cash Flows from Investing Activities

Activity	Receipts	Payments
Plant assets	Sale of plant assets	Acquisition of plant assets
Investments	Collection of loans	Loan to another company

Cash Flows from Financing Activities

Definition and Examples

• Affect liabilities and stockholders' equity (e.g., Notes Payable, Bonds Payable, Long-Term Debt, Common Stock, Paid-in Capital, Retained Earnings).

• Most data are obtained from the balance sheet.

• Increases in these accounts are offset by increases in cash; decreases are offset by decreases in cash.

Exhibit 11-9: Computing Cash Flows from Financing Activities

Receipts	Payments
Issuance of long-term debt Issuance of stock	Payment of debt Payment of dividends

Noncash Investing and Financing Activities

Definition and Examples

• Significant investing and financing activities that do not affect cash directly (e.g., acquiring assets by issuing stock).

• Reported in a separate schedule or in the notes to the financial statements.

Noncash Investing and Financing Activities	Amount (Thousands)
Acquisition of building by issuing common stock	300
Acquisition of land by issuing note payable	100
Payment of long-term debt by issuing common stock	70
Total noncash investing and financing activities	470

Preparing the Statement of Cash Flows (Direct Method)

Overview

• Preferred by FASB and IASB for its clarity regarding sources and uses of cash.

• Rarely used in practice due to complexity and required computations.

• Investing and financing cash flows are unaffected by the method used.

Template and Example (Exhibit 11-13)

Receipts	Amount (in thousands)
Collections from customers	288
Interest received	2
Total cash receipts	290
Payments	Amount (in thousands)
To suppliers	(133)
To employees	(59)
For interest	(7)
For income taxes	(15)
Other operating payments	(17)
Total cash payments	(231)
Net cash provided by operating activities	59

Cash Flows from Investing and Financing Activities (Direct Method)

Investing Activities	Amount (in thousands)
Acquisition of plant assets	(196)
Loan to another company	(21)
Proceeds from sale of plant assets	62
Net cash used for investing activities	(155)
Financing Activities	Amount (in thousands)
Proceeds from issuance of long-term debt	94
Proceeds from issuance of common stock	4
Payment of long-term debt	(11)
Payment of dividends	(17)
Net cash provided by financing activities	70

Summary of TRRS's 2024 Transactions (Exhibit 11-12)

• Operating Activities: Sales, collections, interest, cost of goods sold, payments, salaries, depreciation, other expenses, taxes, interest.

• Investing Activities: Payments to acquire assets, loans, proceeds from sales.

• Financing Activities: Issuance of debt and stock, payments of debt and dividends.

Computing Cash Flows (Direct Method)

Cash Collections from Customers

• Formula: $\text{Beginning Accounts Receivable} + \text{Sales} - \text{Collections} = \text{Ending Accounts Receivable}$

• Example: $81,000 + 303,000 - X = 96,000 \implies X = 288,000$

Cash Receipts of Interest and Dividends

• Interest and dividends received are reported as cash inflows.

• Example: $2,000$ interest revenue; no dividend revenue.

Key Points and Academic Context

• Depreciation, depletion, and amortization are non-cash expenses and do not appear on the direct-method statement.

• Noncash investing and financing activities must be disclosed separately.

• Direct method provides more transparent information but is less commonly used due to complexity.

• Indirect method is more widely used and starts with net income, adjusting for non-cash items and changes in working capital.

Summary Table: Comparison of Direct and Indirect Methods

Feature	Direct Method	Indirect Method
Starting Point	Cash receipts/payments	Net income
Adjustments	Not required for non-cash items	Adjust for non-cash items and working capital
Transparency	High	Moderate
Usage	Rare	Common

Formulas and Equations

• Cash Collections from Customers: $\text{Beginning Accounts Receivable} + \text{Sales} - \text{Collections} = \text{Ending Accounts Receivable}$

• Net Cash Provided by Operating Activities (Indirect Method): $\text{Net Income} + \text{Non-cash Expenses} - \text{Gains} + \text{Losses} + \text{Decrease in Current Assets} - \text{Increase in Current Assets} + \text{Increase in Current Liabilities} - \text{Decrease in Current Liabilities}$

Additional info: These notes expand on the provided slides with definitions, formulas, and examples for clarity and completeness, suitable for exam preparation in a Financial Accounting college course.