Chapter 12 – Reporting Cash Flows

Chapter Highlights

Statement of Cash Flows

 Income Statements are prepared on an accrual basis so they do not accurately reflect
the inflows and outflows of cash. Relying solely on Income Statements for analysis can
be very risky.
 Cash Flow Statements report cash inflows and cash outflows during a period of time
(month, quarter, and year).
 Information about cash flows influences managerial decisions: planning day-to-day
operations and making long-term investment decisions.
o Is a company able to pay its expenses with cash from operations, rather than
selling other assets?
o Will a company have enough cash on-hand to pay its debts?
o Does a company have enough cash on-hand to pay unexpected obligations or to
take advantage of unexpected opportunities?

Cash Flow Categories (4)

 Operating Activities – focuses on short-term (< 1 year) transactions and events that
determine Net Income. Examples include:
o Production and purchase of inventory.
o Sale of goods and services to customers.
o Expenditures to operate a business.

 Investing Activities – focuses on transactions and events that affect long-term assets.
Examples include:
o Purchase and sale of long-term assets (primarily fixed assets).
o Purchase of long-term investments.

 Financing Activities – focuses on transactions and events that affect long-term liabilities
and equity.
o Issuing debt and repaying amounts borrowed.
o Selling stock or paying dividends to stockholders.

 Noncash Investing and Financing Activities – transactions and events that do not affect
cash but should be disclosed because of their materiality (significance). Examples
include:
o Purchase of a long-term fixed asset using a long-term note payable (loan).
o Retirement of debt (bonds) by issuing stock.

Format of the Statement of Cash Flows – see Exhibit 12.6 on p. 537

Methods of Preparing the Statement of Cash Flows
 Direct method – separately lists each major type of operating cash receipts and
payments to determine cash provided or used from operating activities. More
difficult to prepare, not very common.
 Indirect method – starts with Net Income and backs into cash provided or used by
operating activities. Easier to prepare, most commonly used.
Note the difference between the two methods only relates to the Operating Activities
section; the other three sections of the report are the same.

Indirect Method
1. Need the balance sheets for the current year and for last year.
2. Calculate the change in each balance sheet account.
3. Identify each balance sheet account as ST (short-term) or LT (long-term).
4. Prepare the Operating Activities section as follows:

Net Income (or Loss)

Adjustments Examples
+ Non-cash expenses Depreciation, amortization, losses on fixed
- Non-cash revenues assets sales

+ Non-cash losses Gains on fixed asset sales

- Non-cash gains Losses on fixed asset sales

+ decrease in current asset accounts Cash, Acct Rec, Prepaid Expenses,

- increase in current asset accounts Inventory, etc.
+ increase in current liability accounts Accts Pay, Wages & Salaries Pay,
- decrease in current liability accounts Notes Payable (short-term), etc.

= Net Cash provided by

Operating Activities

5. Prepare the Investment Activities section.

6. Prepare the Financing Activities section.
7. Sum of these three activity sections should equal the change in Cash.