Statement of Cash Flows
we established the importance of cash flows to investors and creditors and that the cash flows of the company are an important consideration in investors' and creditors assessments of cash flows to them. As a result, a second set of information that is particularly important concerning how a company's financial position changed between two points in time is cash flow information.
cash flow direct and indirect method example
We can use the entire Cash column of the analysis in Exhibit 2-11 to create a statement of cash flows for Overnight Autos Service. The statement classifies the various cash flows into three categories operating, investing, and financing-and relates these categories to the beginning and ending cash balances. Cash flows from operating activities are the cash effects of revenue and expense transactions that are included in the income statement." Cash flows from investing activities are the cash effects of purchasing and selling assets, such as land and buildings. Cash flows from financing activities are the cash effects of the owners investing in the company and creditors loaning money to the company and the repayment of either or both.
The statement of cash flows for Overnight Auto Service for the period January 20-31 is presented in Exhibit 2-13. Notice that the operating, investing, and financing categories include both positive and negative cash flows. (The negative cash flows are in parentheses.) Also notice that the combined total of the three categories of the statement (increase of S16,600) explains the total change in cash from the beginning to the end of the period. On January 20, the beginning balance was zero because the company was started on that day. Several transactions and parts of transactions had no cash effects and, therefore, are not included in the statement of cash flows
For example, on January 22, Overnight purchased a building for $36,000, only S6,000 of which was paid in cash. The remaining $30,000 is not included in the statement of cash flows because it did not affect the amount of cash at the time the building was purchased. Similarly, on January 23, Overnight purchased tools and equipment for $13,800, paying nô cash at that
time. That transaction has no cash effect on January 23, although the cash payment of S6,800 n January 27, which is a continuation of that transaction, did affect cash and is included in the statement of cash flows.
Transactions that did not affect cash are called noncash investing and
" In this illustration, net cash. amounts provided by operating activities and net incóme are equal. This is because all of Overnight Auto Service's revenues and expenses were cash transactions. This will not always
be the case. As we learn more about the accrual method of accounting, you will see that revenues and expenses may be recorded in a different accounting penod than the period when cash is received or paid. This will cause net income and net cash from operating activities to be different amounts.
how to prepare cash flow statement
OVERNIGHT AUTO SERVICE
STATEMENT OF CASH FLOWS
FOR THE PERIOD JANUARY 20-31, 2015
Cash flows from operating activities:
$2,200
Cash received from revenue transactions
(1,400)
Cash paid for expenses
$ 800
Net cash provided.by operating activities
Cash flows from investing activities:
$(52,000)
Purchase of land.. .
(6,000)
Purchase of building.
Purchase of tools.
(6,800)
Sale of tools
600
Net cash used by investing activities..
(64,200)
Cash flows from financing activities:
Sale of capital stock..
80,000
Increase in cash for the period.
$16,600
Beginning cash balearica, January 20, 2015..
-0-
Ending cash balance, January 31, 2015
$16,600
CASE IN POINT
It is not unusual for a company. to report an increase in cash from operating activities, but a decrease in the total amount of cash: This outcome results when more cash is used for investing and financing activities than is generated from operations.
For example, in 2010 Carnival Corporation, which owns and operates cruise lines, reported cash provided by operating activities of over $3.8 billion but a decrease in total cash of $109 million. This was due primarily to large expenditures for property and equipment, such as cruise ships, which are presented as investing activities in the company is statement of cash flows. In addition, Carnival used a large amount of cash to reduce its debated financing transactions. In a formal statement of cash flows, these transactions are required to be noted as we explain later in this text, even though they do not affect the actual flow of cash into and out of the company
Relationships among Financial Statement
As our discussion of Overnight Auto Service indicates, the ,statement of financial position (balance sheet), the income statement, and the statement of cash flows are all based on the
same transactions, but they present different views" of the company. They should not be thought of as alternatives to each other, rather, all are important in terms of presenting key financial information about the company. The diagram in Exhibit 2-14 explains how the three financial statements relate to the period of time they cover. The horizontal line represents time (for example, a month of a year). At the beginning and ending points in time, the company prepares a statement of financial position (balance sheet) that gives a static look in financial terms of where the company stands.
The other two financial statements-the income statement and the statement of cash flows-cover the intervening period of time between the two balance sheets and help explain important changes that occurred during the period.
If we understand where a company stands financially at two points in time, and if we understand the changes that occurred during the intervening period in terms of the company's profit-seeking activities (income statement) and its cash activities (statement of cash flows), we know a great deal about the company that is valuable in assessing its future cash flows information that is useful to investors, creditors, management, and others. Because the balance sheet, income statement, and statement of cash flows are derived from the same underlying financial information, they are said to "articulate," meaning that they relate closely to each other. The diagram in Exhibit 2-15 indicates relationships that we have discussed in this chapter as we have introduced these three important financial statements. The dollar amounts are taken from the Overnight Auto Service example presented earlier in this chapter. In the balance sheet, the property, plant, and equipment amount of $100.000
represents the total of land ($52,000), building.($36,000), and tools and equipment ($12,000)
revenue and expense transactions. The resulting number, net income, represents an addition Of the owners equity in the enterprise.
how to prepare a statement of cash flows
The statement of cash flows explains ten way's
Cash Increased and decreased during the period ir terms of the enterprise' s operating, investing, and financing activities. while these three key financial statements present important information, they ao not incisurae ail possible information that might be presented about a company. For example, look again at Overnight's activities during the latter part of January. We could have prepared
Separate financial statement on how liabilities changed or hew the Tools and Equipment asset account changed. There is also important nonfinancial information that underlies the state-
mint of financial position, he income statement, 2nd the statement to cash idioms that could be presented and that would benefit users of the statements. Accountants have developed methods of dealing with these other types of information, which we will learn about later in this text. At this point, we have focused our attention on the three primary financial statements
that companies most often use to describe the activities that are capable of being captured in, financial terms
Deferred tax in cash flow statement direct method
Financial reporting, and financial statements in particular, can be thought of as a lens through which you can view a business. (See Exhibit 2-16.) A lens allows you to see things
from a distance that you would not otherwise be able to see; it also allows you to focus in greater detail on certain aspects of what you are l0oking at. Financial information, and particularly financial statements, allows you to do just that-focus in on certain financial aspects of the enterprise that are of particular interest to you in making important investing and credit decisions. Financial reporting encompasses financial statements, but it is not limited to financial statements.
Relationships among the three primary financial statements
Is provide the opportunity to learn a great deal about a company Overnight
by bringing information together in a meaningful way. In fact, $1 other some people believe that relationships in the financial statements are as important as the actual dollar figures in those building liquidity statements.
For example, take another look at the balance sheet in client
Notice that the company has S16,600 of cash pay and $1,200 of accounts receivable, a total of $17,800 in what the are sometimes referred to as current assets, denoting that they
menteither are cash or will soon become cash. Now look at the liabilities in the balance sheet and notice that the company has notes payable of $30,000 and accounts payable of S7,000 for a the ment)
total of $37,000 of liabilities. Because both types of liabilities are current liabilities, meaning that they will be due in the near future and can be expected to require the use of current
assets, Overnight Auto Service will have difficulty paying them because it does not have enough liquid assets to cover its liabilities. The company may need to seek additional capital or long-term financing of the S30,000 note payable on the building. The relationship of current assets to current liabilities is called the current ratio. For Overnight Auto Service it
statements
is a low48 ($17,800 divided by $37,000). This means that
company Overnight Auto Service has only 48 cents available for every
fact, $1 of liabilities that will come due in the near future. On the state-other hand, if the $30,000 notes payable resulting from the those building purchase is not due in the near future, the company's liquidity is much stronger and the company may have sufficient time to bring in enough cash through its operations to
cash pay the note when it is due.
what While the above refers exclusively to information found in
they the balance sheet, key information from one financial state-
ment often is combined with information from another financial statement. For example, we may be interested in knowing has
a the amount of cash provided by operations (cash flow state.
liabilities ment) relative to the amount of a company's currently maturing liabilities (balance sheet). Or we might wait to compare the company's net income (income statement) with the investment current in assets (balance sheet) that were used to generate that income. paying Many of the chapters in this text introduce you to various
cover types of financial analysis. We build on those introductory discussions in Chapter 14, Financial Statement Analysis, in which we provide a comprehensive treatment of how financial statements are used to inform investors and creditors.
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