This document discusses the statement of cash flows, including its basic elements, structure, and how to develop it using both the direct and indirect methods. It covers cash flows from operating, investing and financing activities. It also discusses how the statement of cash flows can be used to calculate financial ratios and evaluate a firm's liquidity, ability to pay debts, cover dividends, and make capital expenditures.

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otherwise on a password-protected website for classroom use.

2. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
Chapter
10
Statement of Cash Flows

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product or service or otherwise on a password-protected website for classroom use.
• Uses a concept of cash that includes not only
cash but also short-term, highly liquid
investments
– Referred to as the cash and cash equivalent focus
• Explains the changes in focus accounts
Basic Elements of the Statement of
Cash Flows

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product or service or otherwise on a password-protected website for classroom use.
• Uses of the statement of cash flows
– Internal (management) users
• Determine dividend policy
• Evaluate cash generated by operations
• Review investing and financing policy
– External users
• Determine a firm’s ability to increase dividends
• Determine a firm’s ability to pay debt from operations
• Determine the percentage of cash from operations in relation
to the cash from financing
Basic Elements of the Statement of
Cash Flows—Continued

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product or service or otherwise on a password-protected website for classroom use.
Structure of the Statement of Cash
Flows
Cash Flows from Operating Activities
Add:Cash Flows from Investing Activities
Add:Cash Flows from Financing Activities
Change in Cash
Beginning Cash Balance
Add: Change in cash
Ending Cash Balance
Supplemental disclosure: Noncash investing
and financing activities

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Operating Activities
• Cash inflows from
– Sale of goods or
services
– Returns on loans
(interest)
– Return on equity
securities (dividends)
• Cash outflows for
payments
– For acquisitions of
inventory
– To employees
– For taxes
– For interest expenses
– For other expenses
Include the cash effects of events that enter into
the determination of net income

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Investing Activities
• Cash inflows from
– Receipts from loans
collected
– Sales of debt or equity
securities of other
corporations
– Sale of property, plant,
and equipment
• Cash outflows for
– Loans to other entities
– Investment in debt or
equity securities of
other entities
– Purchase of property,
plant, and equipment
Lending and collecting money and acquiring and
selling investments and long-term assets

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product or service or otherwise on a password-protected website for classroom use.
Financing Activities
• Cash inflows from
– Sale of equity
securities
– Sale of bonds,
mortgages, notes, and
other short- and long-
term borrowings
• Cash outflows for
– Payment of dividends
– Reacquisition of
capital stock
– Payment of amounts
borrowed
Include cash flows relating to liability and owners’
equity

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product or service or otherwise on a password-protected website for classroom use.
• Direct method
– Converts the income statement from accrual basis to
a cash basis
– Supplemental information required
• Reconciliation of net income to cash provided by operations
• Indirect method
– Adjusts net income for items that affected net income
but did not affect cash
– Supplemental information required
• Cash paid for income taxes and for interest
Presentation of Cash Flows From
Operations

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product or service or otherwise on a password-protected website for classroom use.
Exhibit 10-1—Statement of Cash
Flows: Direct Method

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product or service or otherwise on a password-protected website for classroom use.
Exhibit 10-1—Statement of Cash
Flows: Direct Method

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product or service or otherwise on a password-protected website for classroom use.
Exhibit 10-1—Statement of Cash
Flows: Indirect Method

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product or service or otherwise on a password-protected website for classroom use.
Exhibit 10-1—Statement of Cash
Flows: Indirect Method

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product or service or otherwise on a password-protected website for classroom use.
• Traditional ratios related income statement
item(s) to a balance sheet item(s)
Cash flow financial ratios were slowly developed
– Operating cash flow to current maturities of debt
– Operating cash flow to total debt
– Operating cash flow per share
– Operating cash flow to cash dividends
Financial Ratios and the
Statement of Cash Flows

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product or service or otherwise on a password-protected website for classroom use.
• Indicates a firm’s ability to meet its current
maturities of debt
• Higher ratio indicates better liquidity
Operating Cash Flow to Current
Maturities of Debt
Operating Cash Flow
Current Maturities of Long-Term Debt and Current Note Payable

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product or service or otherwise on a password-protected website for classroom use.
• Indicates a firm’s ability to cover total debt with
the yearly operating cash flow
• The higher the ratio, the better the firm’s ability
to carry its total debt
• Conservative approach is to include all possible
balance sheet debt
Operating Cash Flow to Total Debt
Operating Cash Flow
Total Debt

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product or service or otherwise on a password-protected website for classroom use.
• Indicates the funds flow per common share
outstanding
• Higher than earnings per share as depreciation
is not deducted
Operating Cash Flow per Share
Operating Cash Operating Cash Flow Preferred Dividends
=
Flow per Share Diluted Weighted Average Common
Shares Outstanding
  
 
 

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product or service or otherwise on a password-protected website for classroom use.
• A better indication of a firm’s ability to make
capital expenditure decisions and pay dividends
than is earnings per share
• Does not reflect firm’s profitability
– Firms are prohibited from reporting this on financial
statements
Operating Cash Flow per Share—
Continued

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• Indicates a firm’s ability to cover cash dividends
with the yearly operating cash flow
• Higher the ratio, the better the firm’s ability to
cover cash dividends
Operating Cash Flow to Cash
Dividends
Operating Cash Flows
Cash Dividends

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product or service or otherwise on a password-protected website for classroom use.
• Analyze all balance sheet accounts other than
cash and cash equivalents.
Procedures to Develop the
Statement of Cash Flows
Increase Decrease
Current assets Operating outflow Operating inflow
Noncurrent assets Investing outflow Investing inflow
Current liabilities Operating inflow Operating outflow
Long-term liabilities Financing inflow Financing outflow
Stockholders’ equity Financing inflow Financing outflow

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product or service or otherwise on a password-protected website for classroom use.
• Operating section describes income statement
accounts in terms of receipts or payments
• Cash receipts
– From customers
– From other operating sources
• Cash payments
– For merchandise
– To employees
– For other operating expenses
Procedures to Develop Operating
Cash Flows: Direct Approach

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product or service or otherwise on a password-protected website for classroom use.
• Begin with net income
• Add or deduct adjustments to change accrual
basis net income to cash basis net income
– Changes in current noncash assets
– Changes in noncash assets go in the inverse
direction of changes in cash
– Changes in current liabilities
– Changes in noncash liabilities go in the same
direction of changes in cash
Procedures to Develop Operating
Cash Flows: Indirect Approach

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product or service or otherwise on a password-protected website for classroom use.
• Adjust net income (loss) for noncash expenses
(like depreciation expense) and noncash
revenues
• Eliminate non cash gains and losses that relate
to investing and financing activities
Procedures to Develop Operating
Cash Flows: Indirect Approach