Statement of Cash Flows

Intended learning outcomes

• To understand the nature and purpose of statement of cash flows.

• To understand the classifications of cash flows as operating, investing and financing.
• To be able to prepare a statement of cash flows using the direct method.
• To be able to prepare a statement of cash flows using the direct method.
• To be able to prepare a statement of cash flows using the indirect method.

Statement of cash flows

• A statement of cash flows is a component of financial statements summarizing the operating,
investing, and financing activities of an entity.
• In simple language, the statement of cash flows provides information about the cash receipts and cash
payments of an entity during a period.
• An entity shall prepare a statement of cash flows and present it as an integral part of the financial
statements for each period for which financial statements are presented.
• The primary purpose of a statement of cash flows is to provide relevant information about cash
receipts and cash payments of an entity during a period.
• The statement of cash flows is designed to provide information about the change in an entity’s cash
and cash equivalents.
• Cash flows are the inflows and outflows of cash and cash equivalents.

Classification of Cash Flows

I. Operating activities are the cash flows derived primarily from the principal revenue producing
activities of the entity.
In other words, operating activities generally result from transactions and other events that enter
into the determination of net income or loss.

Cash provided from or used by Operating Activities

• Accounts Receivable • Salaries Payable
• Inventory • Payroll taxes payable
• Supplies • Interest Payable
• Prepaid Insurance • Income taxes payable
• Other current Assets • Unearned Revenue
• Notes payable • Other Current Liabilities
• Accounts payable

Examples of cash flows from operating activities

• Cash receipts from sale of goods and rendering services.
• Cash receipts from royalties, rental fees, commission and other revenue.
• Cash payments to suppliers for goods and services.
• Cash payments for selling, administrative and other expenses
• Cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and
other policy benefits.
• Cash payments or refunds of income taxes unless they can be specifically identified with financing and
investing activities.
• Cash receipts and payments for securities held for dealing or trading purposes.
 II. Investing activities – are the cash flows derived from the acquisition and disposal of long term
assets and other investments not included in cash equivalent.
A simple guide, investing activities include cash flows from transactions involving non-operating
assets.

Cash provided from or used by Investing Activities

• Long-term investments • Equipment
• Land • Furniture and fixture
• Buildings • Vehicles
• In short, investing activities involve the purchase and/or sale of long-term investments and PPE.

Examples of cash flows from investing activities

• Cash payments to acquire property and equipment, intangibles and other long-term assets.
• Cash receipts from sales of property, plant and equipment, intangible and other long-term assets.
• Cash payment to acquire equity or debt instruments of other entities and interests in joint ventures
(current and long-term investments).
• Cash receipts from sale of equity or debt of other entities and interest in joint venture.
• Cash advances and loans to other parties (other than advances and loans made by financial institution)
• Cash receipts from repayment of advances and loans made to other parties.
• Cash payments for future contract, forward contracts, option contract and swap contract.
• Cash receipts for future contract, forward contracts, option contract and swap contract.

III. Financing activities – are the cash flows derived from the equity capital borrowings of the entity.
Cash flows that result from transactions between the entity and the owners (equity financing).
Between entity and the creditors (debt financing).
As a simple guide, Financing activities include cash flows from transactions involving nontrade
liabilities and equity of an entity.

Cash provided from or used by Financing Activities

• Notes payable • Cash investment by the owner
• Bonds payable • Cash withdrawal by the owner
• Deferred Income Taxes
• In short financing activities involve the short term and long-term borrowings and repayments including
investment and withdrawals by the owner.

Examples of cash flows from financing activities

• Cash receipt from issuing shares or other equity instruments for example, issuance of ordinary and
preference shares.
• Cash payments to owners to acquire or redeem the enterprises shares, for example, payment for
treasury shares.
• Cash receipt from issuing loans, notes, bonds, mortgages and other short term or long-term
borrowings
• Cash payment for amounts borrowed.
• Cash payment by a lessee for the reduction of the outstanding principal lease liability.
Illustration:

ABC Company reported the following comparative statement of financial position and income statement
for 2019.

Assets 2019 2018

Cash 3,000,000 2,000,000
Account Receivable 940,000 350,000
Inventory 175,000 100,000
Prepaid Insurance 15,000 20,000
PPE 2,000,0000 2,000,000
Accumulated depreciation (550,000) (500,000)
Patent 40,000 50,000
Total Assets 5,620,000 4,020,000
Liabilities and Equity
Accounts Payable 170,000 150,000
Accrued Salaries Payable 25,000 10,000
Accrued Interest Payable 10,000 15,000
Income Tax Payable 350,000 250,000
Unearned Rent Income 10,000 40,000
Mortgage Payable 500,000 500,000
Share Capital 2,000,000 2,000,000
Retained Earnings 2,555,000 1,055,000
Total Liabilities and Equity 5,620,000 4,020,000

ABC Company
Income Statement
December 31, 2019
Sales 6,500,000
Cost of Good Sold:
Inventory – January 1 100,000
Purchases 3,200,000
Good Available for sale 3,300,000
Inventory – December 31 (175,000) 3,125,000
Gross Income 3,375,000
Rent Income 80,000
Total Income 3,455,000
Expenses:
Salaries 950,000
Insurance 40,000
Other Expenses 500,000
Amortization of Patent 10,000
Interest Expense 55,000 1,605,000
Income before tax 1,850,000
Income tax 350,000
Net Income 1,500,000
DIRECT METHOD- OPERATING INDIRECT METHOD- OPERATING
Cash received from customer 5,910,000 Net Income 1,500,000
Rent received 50,000 Increase in Account Rec. (590,000)
Cash payment to merchandise creditors (3,180,000) Increase in inventory (75,000)
Salaries paid (35,000) Decrease in prepaid Insurance 5,000
Insurance paid (35,000) Increase in Account Payable 20,000
Other expenses paid (500,000) Increase in Accrued Salaries Payable 15,000
Cash generated from operations 1,310,000 Decrease in Accrued Interest Payable (5,000)
Interest paid (60,000) Increase in Income tax payable 100,000
Income tax paid (250,000) Decreased in unearned rent income (30,000)
Net Cash provided by operating activities 1,000,000 Depreciation 50,000
Amortization of patent 10,000
Net Cash provided by operating act. 1,000,000
I. Direct Method
 PAS 7, paragraph 18, provides that an entity shall report cash flows from operating activities using either
the direct method or indirect method.
 The direct method shows in detail or itemizes the major classes of gross cash receipts and gross cash
payments.
 The cash receipt are listed one by one, the cash payments are listed one by one, and the difference
represents the net cash flow from operating activities.
 In essence, the direct method is the cash basis income statement.
 Actually, the statement of cash flow is the conversion from the accrual basis to the cash basis of
accounting.

Some formulas for determining cash receipts and cash payments

1. Cash received from customer 5,910,000

Sales 6,500,00
Increase in Account Receivable (590,000)
Collection from customers 5,910,000
2. Rent received 50,000
Rent income 80,000
Decrease in Unearned Rent Income (30,000)
Rent Received 50,000

3. Cash payment to merchandise creditors (3,180,000)

Purchases 3,200,000
Increase in Accounts Payable (20,000)
3,180,000

4. Salaries paid (35,000)

Salaries 950,000
Increase in Accrued salaries payable (15,000)

5. Insurance paid (35,000)

Insurance 40,000
Increase in Prepaid Insurance (5,000)
35,000
 6. Interest paid (60,000)
Interest expense 55,000
Decrease in Accrued Interest payable 5,000
Interest paid 60,000

7. Income tax paid (250,000)

Income tax 350,000
Increase in income tax payable (100,000)
Income tax paid 250,000

II. Indirect Method

 The indirect method means that the net income or loss is adjusted for the effects of transactions of a
non-cash nature, any deferrals or accruals of past or future operating cash receipts and payments, and
items of income or expense associated with investing and financing activities.
 the indirect method of presenting the cash flow from operation begins with the accrual basis net income
and applies a series of adjustments to convert the income to a cash basis.
 The following general guidelines are offered for adjustments of net income to cash basis:
1. All increases in trade noncash current assets are deducted from net income
2. All decreases in trade noncash current assets are added to net income.
3. All increases in trade current liabilities are added to the net income.
4. All decreases in trade current liabilities are deducted to the net income.
5. Depreciation, Amortization and other noncash expenses are added back to the net income to
eliminate the effect they had on net income.
6. Any gain on disposal of property or gain on early retirement of nontrade liabilities is included in
net income but it is a non-operating item. Thus, it is deducted from net income.
7. Any loss on disposal of property or gain on early retirement of nontrade liabilities is included in net
income but it is a non-operating item. Thus, it is added from net income.
8. Other noncash income or gain is deducted from net income and other noncash expense or loss is
added to net income to eliminate the effect on net income.
 The direct method and indirect method are applicable only to operating activities.
 PAS 7, paragraph 21, provided that an entity shall report separately major classes of gross cash receipts
and gross cash payments arising from investing and financing activities using the direct method.
Example of Statement of Cash flows
Maestro Company
Statement of Cash Flows
December 31, 2019
Cash Flows from operating activities
Net income 1,000,000
Decrease in Account Receivable 130,000
Increase in inventory (80,000)
Decrease in prepaid expenses 20,000
Depreciation 340,000
Amortization of patent 50,000
Increase in accrued expenses 10,000
Decrease in accounts payable (60,000)
Net Cash provided by operating activities 1,410,000
Cash flow from investing activities:
Purchase of equipment (2,000,000)
Cash flows from financing activities:
Proceed of 5-year bank loan 1,000,000
Issuance of share capital 1,000,000
Payment of 60-day bank loan (200,000)
Payment of cash dividend ( 700,000)
Purchase of treasury share (240,000)
Net cash provided by financing activities 860,000
Increase in cash and cash equivalents 270,000
Cash and Cash Equivalent-January 1 880,000
Cash and Cash Equivalent -Dec 31 1,150,000

Comparative Statement of Finacial Position

Cash Provided (used)
2019 2018 Operating Investing Financing
Cash 1,150,000 880,000
Account Receivable 820,000 950,000 130,000
Inventory 1,180,000 1,100,000 (80,000)
Prepaid expenses 40,000 60,000 20,000
PPE 4,000,000 2,000,000 (2,000,000)
Accumulated Dep. (880,000) (540,000) 340,000
Patent 450,000 500,000 50,000
6,760,000 4,950,000

Accrued expenses 120,000 110,000 10,000

Accounts payable 540,000 600,000 (60,000)
Note payable
(60 day-bank loan) 600,000 800,000 (200,000)
Note payable
5 year loan 1,000,000 ---------- 1,000,000
Share Capital 3,000,000 2,500,000 500,000
Share premium 700,000 200,000 500,000
Retained earnings 1,040,000 740,000 1,000,000 (700,000)
Treasury shares (240,000) ---------- (240,000)
6,760,000 4,950,000

Net Cash provided (used) 1,410,000 (2,000,000) 860,000