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STATEMENT OF CASH FLOW1

INTRODUCTION:
The primary purpose of the statement of cash flows is to provide information about an entity's cash receipts and cash payments during a period. A secondary objective is to provide information on a cash basis about its operating, investing, and financing activities. The statement of cash flows therefore reports cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities of an enterprise during a period, in a format that reconciles the beginning and ending cash balances. USEFULNESS OF THE STATEMENT OF CASH FLOWS The information in a statement of cash flows should help investors, creditors, and others assess the following: 1. The entity's ability to generate future cash flows. A primary objective of financial reporting is to provide information that makes it possible to predict the amounts timing, and uncertainty of future cash flows. By examining relationships between items such as sales and net cash flow from operating activities, or net cash flow from operating activities and increases or decreases in cash, it is possible to make better predictions of the amounts, timing, and uncertainty of future cash flows than is possible using accrual basis data. The entity's ability to pay dividends and meet obligations. Simply put, cash is essential. If a company does not have adequate cash, employees cannot be paid, debts cannot be settled, dividends cannot be paid, and equipment cannot be acquired. A statement of cash flows indicates how cash is used and where it comes from. Employees, creditors, stockholders, and customers should be particularly interested in this statement, because it alone shows the flows of cash in a business. The reasons for the difference between net income and net cash flow from operating activities. The net income number is important, because it provides information on the success or failure of a business enterprise from one period to another. But some people are critical of accrual basis net income because estimates must be made to arrive at it. As a result, the reliability of the number is often challenged. Such is not the case with cash. Thus, as illustrated in the opening story, readers of the financial statements benefit from knowing the reasons for the difference between net income and net cash flow from operating activities. Then they can assess for themselves the reliability of the income number. The cash and non-cash investing and financing transactions during the period. By examining a company's investing activities (purchase and sales of assets other than its products) and its financing transactions (borrowings and repayments of borrowings, investments by owners and distributions to owners), a financial statement reader can better understand why assets and liabilities increased or decreased during the period. For example, the following questions might be answered: How did cash increase when there was a net loss for the period? How were the proceeds of the bond issue used? How was the expansion in plant and equipment financed? Why were dividends not increased? How was the retirement of debt accomplished? How much money was borrowed during the year? Is cash flow greater or less than net income?

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CLASSIFICATION OF THE STATEMENT OF CASH FLOWS

The statement of cash flows classifies cash receipts and cash payments by operating, investing, and financing activities? Transactions and other events characteristic of each kind of activity are as follows: I. Operating Activities involve the cash effects of transactions that enter into the de-termination of net income, such as cash receipts from sales of goods and services and cash payments to suppliers and employees for acquisitions of inventory and expenses.

Adapted from Intermediate Accounting Kieso, Weygandt & Warfiled

CF-Page 2 of 5 II. Investing Activities generally involve long-term assets and include (a) making and collecting loans, and (b) acquiring and disposing of investments and productive long-lived assets. Financing Activities involve liability and stockholders' equity items and include (a) obtaining cash from creditors and repaying the amounts borrowed, and (b) obtaining capital from owners and providing them with a return on, and a return of, their investment. Generally, the layout of Statement of Cash flow is similar to the following layout: OPERATING (Generally, the following information obtained from Income Statement) Cash inflows From sales of goods or services. From returns on loans (interest) and on equity securities (dividends). Cash outflows To suppliers for inventory. To government for taxes. To lenders for interest. To others for expenses INVESTING (Generally, the following information obtained from Balance Sheet) Cash inflows From sale of property, plant, and equipment. From sale of debt or equity securities of other entities. From collection of principal on loans to other entities. Cash outflows To purchase property, plant, and equipment. To purchase debt or equity securities of other entities. To make loans to other entities. FINANCING (Generally, the following information obtained from Balance Sheet) Cash inflows From sale of equity securities. From issuance of debt (bonds and notes). Cash outflows To stockholders as dividends. To redeem long-term debt or reacquire capital stock. There are two methods to prepare the Cash flow Statement. Indirect Method The indirect method (or reconciliation method) starts with net income and converts it to net cash flow from operating activities. In other words, the indirect method adjusts net income for items that affected reported net income but did not affect cash. To compute net cash flow from operating activities, non-cash charges in the income statement are added back to net income and non-cash credits are deducted. Direct Method Under the direct method the statement of cash flows reports net cash flow from operating activities as major classes of operating cash receipts (e.g., cash collected from customers and cash received from interest and dividends) and cash disbursements (e.g., cash paid to suppliers for goods, to employees for services, to creditors for interest, and to government authorities for taxes).

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INDIRECT VERSUS DIRECT METHOD

The most contentious decision that the FASB faced in issuing Statement No. 95 was choosing between the direct method and the indirect method of determining net cash flow from operating activities. Companies lobbied against the direct method, urging adoption of the indirect method. Commercial lending officers expressed a strong preference to the FASB that the direct method be required.

CF-Page 3 of 5 In Favor of the Direct Method The principal advantage of the direct method is that it shows operating cash receipts and payments. That is, it is more consistent with the objective of a statement of cash flows to provide information about cash receipts and cash payments than the in-direct method, which does not report operating cash receipts and payments. Supporters of the direct method contend that knowledge of the specific sources of operating cash receipts and the purposes for which operating cash payments were made in past periods is useful in estimating future operating cash flows. Furthermore, in-formation about amounts of major classes of operating cash receipts and payments is more useful than information only about their arithmetic sum (the net cash flow from operating activities). Such information is more revealing of an enterprise's ability (1) to generate sufficient cash from operating activities to pay its debts, (2) to reinvest in its operations, and (3) to make distributions to its owners. Many corporate providers of financial statements say that they do not currently collect information in a manner that allows them to determine amounts such as cash received from customers or cash paid to suppliers directly from their accounting systems. But supporters of the direct method contend that the incremental cost of assimilating such operating cash receipts and payments data is not significant. In Favor of the Indirect Method The principal advantage of the indirect method is that it focuses on the differences between net income and net cash flow from operating activities. That is, it provides a useful link between the statement of cash flows and the income statement and balance sheet. Many providers of financial statements contend that it is less costly to adjust net income to net cash flow from operating activities (indirect) than it is to report gross operating cash receipts and payments (direct). Supporters of the indirect method also state that the direct method, which effectively reports income statement information on a cash rather than an accrual basis, may erroneously suggest that net cash flow from operating activities is as good as, or better than, net income as a measure of performance. Special Rules Applying to Direct and Indirect Methods Companies that use the direct method are required, at a minimum, to report separately the following classes of operating cash receipts and payments: Receipts Cash collected from customers (including lessees, licensees, etc.). Interest and dividends received. Other operating cash receipts, if any. Payments Cash paid to employees and suppliers of goods or services (including suppliers of insurance, advertising, etc.). Interest paid. Income taxes paid. Other operating cash payments, if any. Companies using the indirect method are required to disclose separately changes in inventory, receivables, and payables to reconcile net income to net cash flow from operating activities. In addition, interest paid (net of amount capitalized) and income taxes paid must be disclosed elsewhere in the financial statements or accompanying notes. The FASB requires these separate and additional disclosures so that users may approximate the direct method. Also, an acceptable alternative presentation of the in-direct method is to report net cash flow from operating activities as a single line item in the statement of cash flows and to present the reconciliation details elsewhere in the financial statements.

ADJUSTMENTS TO NET INCOME AND CHANGES IN BALANCE SHEET ACCOUNTS UNDER INDIRECT METHOD
Decrease in Accounts Receivable This decrease will be reported as increase of cash inflow (Added back as cash provided by Operating Activities.)

CF-Page 4 of 5 When accounts receivable decrease during the period, revenues on a cash basis are higher than revenues on an accrual basis, because cash collections are higher than revenues reported on an accrual basis. Increase in Accounts Receivable (Deducted since cash inflow did not generate cash inflow from Operating Activities.) The increase in accounts receivable using accrual basis then revenues is in excess of cash collections. The increase is deducted from net income to convert from the accrual basis to the cash basis. Increase in Inventories (Deducted since cash inflow did not generate cash inflow from Operating Activities.) The increase in inventories represents an operating use of cash for which an expense was not incurred. This amount is therefore deducted from net income to arrive at cash flow from operations. In other words, when inventory purchased exceeds inventory sold during a period, cost of goods sold on an accrual basis is lower than on a cash basis. Increase in Prepaid Expenses The increase in this account represents an increase of cash outflow (Deducted as cash outflow for Operating Activities.) When prepaid expenses (assets) increase during a period, expenses on an accrual basis income statement are lower than they are on a cash basis income statement. Expenditures (cash payments) have been made in the current period, but expenses (as charges to the income statement) have been deferred to future periods. Decrease in Prepaid Expenses (Added back to cash flow from Operating Activities.) The decrease in prepaid expenses represents a charge (expense) to the income statement is for which there was no cash outflow in the current period. The decrease is added back to net income to arrive at net cash flow from operating activities. Increase in Accounts Payable The increase in Accounts Payable did not require cash outflow (Added back as cash provided by Operating Activities.) An increase in accounts payable must be added to net income to convert to net cash flow from operating activities. A greater amount of expense was incurred than cash disbursed. Decrease in Accounts Payable (Deducted as cash flow for Operating Activities.) When accounts payable decrease during the year, cost of goods sold and expenses on a cash basis are higher than they are on an accrual basis, because on a cash basis the goods and expenses are recorded as expense when paid. To convert net income to net cash flow from operating activities, then any decrease in accounts payable must be deducted from net income. Increase Depreciation Expense (Increase in Accumulated Depreciation) This is an expense that did not require cash outflow (Added back as cash inflow from Operating Activities.) The depreciation expense (also represented by the increase in accumulated depreciation) is a noncash charge that is added back to net in-come to arrive at net cash flow from operating activities. Other charges to expense for a period that do not require the use of cash, such as the amortization of intangible assets and depletion expense are treated in the same manner as depreciation. Depreciation and similar non-cash charges are frequently listed in the statement as the first adjustments to net income. (Note: Decrease Depreciation Expense may represents sale of assets)

CF-Page 5 of 5 Increase in Land This is a capital expense that did not require cash outflow (Deducted as cash flow from Investing Activities.) This transaction is an investing activity that is not requires the out flow of cash (unless the payment made in cash). Decrease in Land This transaction resulted in cash inflow (Added as cash inflow from Investing Activities.) When Land account decreased indicates selling of land or an exchange. Assuming it is sale then it generated cash inflow. Increase in Building, Equipment, and all depreciable Assets. This is a capital expense that did not require cash outflow (Deducted as cash flow from Investing Activities.) Likewise, the increase in Land account is a cash outflow reported in the investing section but did not require an outflow of cash. The accumulated depreciation account increase is fully explained by the depreciation expense entry for the period. As indicated earlier, the reported depreciation expense has no effect on the amount of cash. Decrease in Building, Equipment and all depreciable Assets This transaction resulted in cash inflow (Added as cash inflow from Investing Activities.) When building, equipment and all depreciable assets accounts decreased, it is indication of selling an assets or an exchange. Assuming it is sale then it generated cash inflow. An analysis of the equipment account indicates the following: Loss on Sale of Assets To arrive at net cash flow from operating activities, it is necessary to add back to net income the loss on, for example, the sale of the equipment. The reason is that the loss is a non-cash charge to the income statement; it did not reduce cash but it did reduce net income. Increase in Bonds Payable This is a long-term liability that generates cash inflow (Added as cash inflow from Financing Activities.) The increase in bonds payable account. Cash received from the issuance of these bonds represents an inflow of cash from a financing activity. Decrease in Bonds Payable This is a liquidation long-term liability that generates cash inflow (Added as cash outflow from Financing Activities.) When Bonds payable account decreases, it represents redemption of bonds payable. Cash Dividends The payment of cash dividends constitutes cash outflow (Deducted as cash outflow from Financing Activities.) Increase in Common, Preferred Stock This is will increase the ownership generates cash inflow (Added as cash inflow from Financing Activities.) The increase in common and/or preferred stock accounts represent sale of new stocks which, will generate an inflow of cash from Financing Activities Decrease in Common Stock The decrease represents purchasing back common stock that generates cash outflow (Deducted as cash outflow from Financing Activities.)