Indian Institute of Management Rohtak

Session 16

The Statement of Cash flows

By
Prof Archana Patro
 Why do we need a cash flow
statement?
• Balance sheet does not explain the changes
in assets, liabilities or equity
• Income statement –Accrual accounting –
does not show cash generated
 Third required financial statement.

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 Why do we need a cash flow
statement?

• Increasing use of cash flow statement

• Cash is reality
• No allocation & estimates
• Economic downturn
• Irrelevance of historical cost

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 Usefulness of the Statement of
Cash Flow
 The entity’s ability to generate future cash flows.
 The entity’s ability to pay dividends and meet
obligations.
 The reason for the difference between net
income and net cash provided (used) by
operating activities.
 The cash investing and financing transactions
during the period.

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 Statement of Cash Flows:
Categories of Activities
 Sources.
 Activities that generate cash.
 Uses.
 Activities that involve spending cash.

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 Cash Sources
 Operations.
 New borrowings.
 New stock issues.
 Sale of property, plant, and equipment.
 Sale of other non-current assets.

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 Cash Uses

 Cash dividends.
 Repayment of borrowings.
 Repurchase of stock.
 Purchase of property, plant, and equipment.
 Purchase of non-current assets.

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 Definition of Cash
 Cash.
 Cash equivalents.
 Short-term investments.
 Highly liquid.
 Convertible to known amounts of cash.
 Mature in no more than 90 days (GAAP).
 Subject to insignificant risk of changes in value
(IASB).

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 Structure of the Cash Flow
Statement
 Operating activities
 Investing activities.
 Financing activities.

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 Operating Activities
 All transactions that are not investing or
financing activity.
• Operating activities are the earning-related activities of
a company.
 Cash inflows associated with sales revenues.
 Cash outflows associated with operating
activities (e.g., payments to suppliers,
employees, taxes, interest on loans).

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 Investing Activities
 Outflows:
 Acquiring long-lived assets (e.g., property, plant,
equipment).
 Making investments in securities (i.e., other than
cash equivalents).
 Lending money.

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 Investing Activities
 Inflows:
 Disposing of long-lived assets (e.g., property,
plant, equipment).
 Disposing of investments in securities (i.e., other
than cash equivalents).
 Collecting loans.

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 Financing Activities
 Inflows:
 Borrowing of cash.
 Issuance of equity securities.
 Outflows:
 Repaying loans.
 Retiring equity securities.
 Payment of dividends.

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 Financing Activities
Examples of financing activities are :
 cash received from issuing share capital;
 cash proceeds from issuing bonds, loans, notes,
mortgages and other short or long-term borrowings;
 cash repayment of loans and other borrowings; and
 cash payments to shareholders as dividends.

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 Significant
Noncash Activities...
• That do NOT affect cash are NOT reported in
the body of the statement of cash flows.
• Are reported:
– In a separate schedule at the bottom of the
statement of cash flows or
– In a separate note or supplementary
schedule to the financial statements.
 Significant
Noncash Activities...
1. Issuance of common stock to purchase
assets.
2. Conversion of bonds into common stock.
3. Issuance of debt to purchase assets.
4. Exchanges of plant assets.

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 EXERCISE 1
Identify cash flow from operating activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds
 EXERCISE 1
Identify cash flow from investing activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds
 EXERCISE 1
Identify cash flow from financing activity.

1. Purchased patents 7. Redeemed bonds

2. Purchased buildings 8. Paid cash dividends
3. Purchased treasury stock 9. Sold long-term
4. Sold equipment investment
5. Net income 10. Issued common stock
6. Issued preferred stock 11. Issued bonds
 Problem 13.1 pg 482
• Classify each as an operating activity, investing activity,
financing activity, non-cash activity or none of the above.
• Deposited cash in current account.
– None of these
• Paid bonus to employees.
– Operating activity
• Acquired equipment on credit.
– Non-cash activity
• Paid cash on maturity of bills payable.
– Operating activity
• Paid Income tax.
– Operating activity
• Paid cash to settle a suit for trademark infringement.
– Operating activity
• Purchased a 60 day certificate of deposit.
– None of these
• Issued equity shares on conversion of debentures.
– Non-cash activity
• Acquired a machine on hire purchase.
– Non-cash activity
• Issued equity shares at par.
– Financing activity
• Wrote off a receivable when a customer became
insolvent.
– Non-cash activity
• Issued equity shares in exchange for preference
share.
– Non-cash activity
• Received cash on maturity of bills receivable.
– Operating activity
 Problem 13.8-485 pg.
• Classify each as an operating activity, investing activity, financing
activity, non-cash activity or none of the above.
• Paid suppliers.
– Operating activity
• Received dividends from an associate.
– Investing activity
• Sold investments at a gain.
– Investing activity
• Purchased copyrights with cash.
– Investing activity
• Issued debentures in exchange for equipment.
– Non-cash activity
• Paid interest on bank overdraft.
– Financing activity
• Converted debentures into equity shares.
– Non-cash activity
• Received payments from customers.
– Operating activity
• Purchased investments with cash.
– Investing activity
• Purchased a 60 day certificate of deposit with cash.
– None of these
• Paid advance to a supplier of equipment.
– Investing activity
• Sold a 90 day treasury bill.
– None of these
• Collected instalment payments for the sale of an old
plant.
– Investing activity
• Earned net profit.
– Operating activity
• Sold machinery at a gain.
– Investing activity
Format of Statement of
Cash Flows

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 Usefulness and Format

Preparing the Statement of Cash Flows

Three Sources of Information:

1. Comparative balance sheets

2. Current income statement

3. Additional information

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Preparing the Cash flow statement

• Page 463-Textbook Compass company

Determining the Net Cash Flow
from Operating activity
Usefulness and Format

Format of the Statement of Cash Flows

Order of Presentation:
1. Operating activities.
Direct Method

2. Investing activities. Indirect Method

3. Financing activities.
 Direct method - Example

Cash receipts from customers 30,150

Cash paid to suppliers and employees (27,600)

Cash generated from main operations 2,550

Income taxes paid (1170)

Net cash flow from operating activities 1,380

 Cash received from customers
• Cash received from customers
= Credit Sales+Decrese(-increase)in gross
trade receivables –Bad debts written off.
 Cash paid to Suppliers and
employees
• Cash paid to suppliers and employees=Cost
of goods sold + Selling and admin expenses-
Depreciation expenses-Bad debt expense+
Increase (-Decrease )in inventories+
Increase(-Decrease) in prepaid expenses+
Decrease(-Increase)in trade payables

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 Income tax paid
• Income tax paid=Income tax expense+
Decrease(-increase) in Tax payables

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 Cash flow from operating activity

Cash receipts from customers 883000

Cash paid to suppliers and employees (797000)

Cash generated from main operations 86000

Income taxes paid (12000)

Net cash flow from operating activities 74000

 Indirect method
• Non-cash items
• Non-operating items
• Changes in working capital items

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 Converting Net profit to Cash Flow

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 Indirect method
Cash flow from operating activity
Net profit before tax
Adjustments for:
Depreciation
Bad debt expense
Gain on sale of plant and machinery
Loss on sale of investments
Interest expense
Interest income
Operating profit Before working capital changes
Increase in trade receivables(including bad debts written off)
Increase in inventories
Decrease in prepaid expenses
Decrease in trade payables
Cash generated from main operations
Income taxes paid
Net cash flow from operating activities
 Indirect method
Cash flow from operating activity
Net profit before tax 70000
Adjustments for:
Depreciation 98000
Bad debt expense 12000
Gain on sale of plant and machinery (6000)
Loss on sale of investments 9000
Interest expense 22000
Interest income 7000
Operating profit Before working capital changes 198000
Increase in trade receivables(including bad debts written off) (42000)
Increase in inventories (58000)
Decrease in prepaid expenses 2000
Decrease in trade payables (14000)
Cash generated from main operations 86000
Income taxes paid 12000
Net cash flow from operating activities 74000
 Cash Flow from investing activity

Purchase of plant and Machinery

Proceeds from sale of plant and Machinery

Purchase of investments

Proceeds from sale of investments

Interest received

Net Cash Used in investing Activity

 Cash Flow from investing activity

Purchase of plant and Machinery (173000)

Proceeds from sale of plant and Machinery 22000

Purchase of investments (26000)

Proceeds from sale of investments 42000

Interest received 7000

Net Cash Used in investing Activity 128000

 Cash Flows from Financing
activities
Proceeds from issue of share capital

Dividends paid

Redemption of Debentures

Repayment of Short term loan

Interest paid

Net Cash provided by Financing activity

 Cash Flows from Financing
activities
Proceeds from issue of share capital 100000

Dividends paid (25000)

Redemption of Debentures (27000)

Repayment of Short term loan (1000)

Interest paid (22000)

Net Cash provided by Financing activity 25000

 Reporting Cash Flows
Operating activities
- Direct method
-Indirect method
Investing activities
Financing activities
Net cash flow
Change in cash and cash equivalents

Non-cash investing and financing activities

 Reporting Cash Flows
Operating activities
Direct method 72000
Indirect method
Investing activities (128000
Financing activities 25000
Net decrease in Cash and cash
equivalent (31000

Change in cash and cash equivalents 51000

Non-cash investing and financing
activities 20000
TABLES AND FIGURES FOR
UNDERSTANDING
Computing Cash Flows from Investing Activities
Cash Receipts:
From sales of plant assets:
Beginning + Acquisition - Depreciation - Book value = Ending
plant expense of asset sold plant
asset, net assets, net
Cash = Book value + Gain on sale
receipt of asset or
sold
- Loss on sale
Cash Payments:
For acquisitions of plant assets:
Beginning + Acquisition - Depreciation - Book value = Ending
plant expense of asset sold plant
asset, net assets, net
Computing Cash Flows from Financing Activities
Cash Receipts:
From issuance of notes payable:
Beginning + Cash receipt - Payment of = Ending
notes from issuance note payable notes
payable of note payable
payable
From issuance of stock:
Beginning + Cash receipt from = Ending stock
stock issuance of stock
 Computing Cash Flows from Financing Activities

Cash Payments:
Of notes payable:
Beginning + Cash receipt - Payment of = Ending
notes from issuance note payable notes
payable of note payable
payable
To purchase treasury stock:
Beginning + Cost of treasury stock = Ending treasury stock
treasury stock purchases
Of Dividends
Beginning + Net - Dividends = Ending Retained
Retained Income earnings
earnings
 Direct Method
Income Statement Cash Flow Statement
Collections from
Sales
customers

Cost of goods sold Payments to suppliers

Salaries expense Payments to employees

Interest payments
Interest expense

Income tax expense Income tax paid

 Converting Income Statement
Amounts to Cash Flows
Cash receipts:
Collection from = Sales + Decrease in accounts receivable
customers or
- Increase in accounts receivable
Cash payments:
To suppliers = Cost of + Increase in + Decrease in
goods sold inventory accounts
A payable
or N or
- Decrease D - Increase in
in inventory accounts
payable
Cash payments:
For other = Operating + Increase + Decrease in
operating expenses in prepaid accrued
expenses expenses A liabilities
or N Or
- Decrease D - Increase in
in prepaid accrued
expenses liabilities
For interest = Interest + Decrease in interest payable
expense or
- Increase in interest payable
For income taxes = Income tax + Decrease in income tax payable
expense or
- Increase in income tax payable
Indirect Method-Working capital
changes

Current Assets Current Liabilities

Subtract from Add to
Increase
net income. net income.
Add to Subtract from
Decrease
net income. net income.
 Two general rules are revealed:
1.Always add back the amount of depreciation subtracted in
the Income Statement to convert Net Income to Cash Flow
from Operating Activities.
2.When Accounts Receivable increases, Sales Revenue is
greater than cash received, so subtract the increase to convert
Net Income to Cash Flow from Operating Activities.

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 • The Inventory decrease indicates that Cost of Goods Sold
(deducted in the Income Statement) was more than the
cash paid to purchase Inventory.
• In other words, the company sold Inventory but did not
replace it, creating a net cash inflow for the period.

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 The Wages Payable increase is added because more wages
were subtracted when calculating net income than actually paid.

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 Loss on Sale of Equipment

• Companies report as a source of cash in the

investing activities section the actual amount of
cash received from the sale.

 Any loss on sale is added to net income in

the operating section.

 Any gain on sale is deducted from net

income in the operating section.
• When Accounts Payable increases, the company
received more in goods than it actually paid for. The
increase is added to net income to determine net cash
provided by operating activities.

• When Income Tax Payable decreases, the income tax

expense reported on the income statement was less
than the amount of taxes paid during the period. The
decrease is subtracted from net income to determine
net cash provided by operating activities

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 Free Cash Flow

Free cash flow

Cash payments planned for

Net cash provided by
investments in long-term
operating activities
assets
 CRYSTAL MEADOWS OF
TAHOE,INC.-CASE ANLAYSIS

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