Lecture-21

Cash Flow Statement

ACC 501- Accounting

for Managers

Dr. ARPIT SIDHU

(Ph.D, UGC-NET, HP-SET, MBA,
MCOM, BCOM)
 Poll from the last lecture
•  In cash flows, when a firm invests in fixed assets and short-term
financial investments results in
• A) Increased Equity
• B) Increased Liabilities
• C) Decreased Cash
• D) Increased Cash
•C
Objectives of the Chapter

To comprehend how the statement of cash flows is prepared

To be able to interpret the information presented in the cash flow

statement
WHAT IS CASH?
 FORMS OF CASH

 Cash in hand
 Cash in bank
 Cash equivalents - highly liquid, short-term investments that
can be converted into cash with little delay
THREE CASH FLOWACTIVITIES
CASH FLOW FROM
OPERATING
ACTIVITIES
CASH FLOWFROM
OPERATING
ACTIVITIES
 MORE ON OPERATING
ACTIVITIES
Operating activities are normal and core activities
within a business that generate cash inflows and
outflows. They include:
Total sales of goods and services collected during a
period;
Payments made to suppliers of goods and services
used in production settled during a period;
Payments to employees or other expenses made
during a period.
 DEFINITION OF OPERATING
ACTIVITIES
 An accounting item indicating the money a company brings
in from ongoing, regular business activities, such as
manufacturing and selling goods or providing a service.
Cash flow from operating activities does not include long-
term capital or investment costs. It does include earnings
before interest and taxes plus depreciation minus taxes.
CASH FLOW FROM
INVESTING
ACTIVITIES
CASH FLOW FROM
INVESTING
ACTIVITIES
 DEFINITION OF INVESTING
ACTIVITIES
An item on the cash flow statement that reports the
aggregate change in a company's cash position
resulting from any gains (or losses) from investments
in the financial markets and operating subsidiaries,
and changes resulting from amounts spent on
investments in capital assets such as plant and
equipment.
INFLOW OR OUTFLOW OF
CASH
 Examples of Inflows:

Proceeds from disposal of property, plant

and equipment
Cash receipts from disposal of debt instruments of
other entities
Receipts from sale of equity instruments of other
entities
 Examples of Outflows:
 Payments for acquisition of property, plant and
equipment
 Payments for purchase of debt instruments of
other entities
 Payments for purchase of equity instruments of
other entities
 Sales/maturities of investments
 Includes purchasing and selling long- term assets
and other investments.
 CASH FLOW FROM FINANCING
ACTIVITIE
S
 A category in a company’s cash flow statement that accounts for external activities
that allow a firm to raise capital and repay investors, such as issuing cash
dividends, adding or changing loans or issuing more stock.

 Cash flow from financing activities shows investors the company’s financial
strength.
 A company that frequently turns to new debt or equity for cash, for example,
could have problems if the capital markets become less liquid.
 FORMULA: Cash received from issuing stock or debt - cash paid as dividends and
Re-acquisition of debt/stock.
 Two Formats for
Operating Activities
 INDIRECT METHOD

 Indirect method reconciles from

net income to net cash provided by
operating activities
 DIRECT METHOD

Direct method reports all cash

receipts and cash payments
from operating activities
DIFFERENCE BETWEEN INDIRECT &
DIRECT METHOD

” The only difference between the two

methods is, how cash flows from
operating activities are calculated.”
FORMAT OF INDIRECT METHOD

 Net Income
 + Depreciation exp (noncash exp)

 + Losses from sale of assets

 (full amount of sale already
included in investing section)
 - Gains from sale of assets
 (full amount of sale already
included in investing section)
 - increases in current assets
 + decreases in current assets

 + increases in current liabilities

 - decreases in current liabilities
 = Net cash from operating activities
FORMAT OF DIRECT METHOD
 + Cash Received from Customers
 - Cash paid for inventory
 - Cash paid for operating expenses
 - Cash paid for income taxes
 - Cash paid for interest
 + Cash received from dividends and
interest
 = Net cash from operating activities
8 STEPS OF CONSTRUCTING CASH
FLOW
STEP 1:
Start with Net Income
STEP 2:
Adjust Net Income for non-cash expenses and
gains
STEP 3:
Recognize cash inflows (outflows) from
changes in current assets and liabilities
STEP 4:
Sum to yield net cash flows from operations
STEP 5:
Changes in long-term assets yield net cash flows from
investing activities
STEP 6:
Changes in long-term liabilities & equity accounts yield
net cash flows from financing activities
STEP 7:
Sum cash flows from operations,
investing, and financing activities to
yield net change in cash
STEP 8:
Add net change in cash to the beginning cash
balance to yield ending cash
EXAMPLES OF CASH FLOW
STATEMENTS OF SOME
FAMOUS BRANDS
COMPARATIVE
CASH FLOW
STATEMENT
OF COCA-COLA
FOR YEAR 2011, 2012 &
2013
 JOHNSON
AND
JOHNSON’S
CASH
FLOW
STATEMEN
` T
J&J: OPERATING
ACTIVITIES
J&J: INVESTING
ACTIVITIES
J&J: FINANCING
ACTIVITIES
DISADVANTAGES OF
CASH FLOW
STATEMENT
Limitations of Cash Flow
Statement

1. One of the potential disadvantages of the cash flow

statement is that it does not take into consideration
any future growth. When looking at the statement of
cash flows, you are essentially looking at information
from the past business operations.
For example: If the company is in the process of
developing a ground-breaking piece of technology, it
could be about to generate a large amount of cash. If
you just look at the cash flow statement, you may not
evaluate the future potential of the company
correctly.
2. Another potential problem with the statement of cash flows
is that interpreting data may be difficult. The information on a
cash flow statement is not necessarily easy to interpret. You
can see where all of the cash flow is going, but you may not
know if it should be going there.
For example, it may be difficult to gauge whether the
company should be investing more in a plant or paying off
debt. You have to take all of the information presented
and make the best assumptions you can make.
3. Cash flow statements are not suitable for judging the
profitability of a firm, as non-cash charges are ignored
while calculating cash flows from operating activities.
4. As a cash flow statement is based on a cash basis of
accounting, it ignores the basic accounting concept of
accrual.
WHAT IS ACCURAL-BASED ACCOUNTING?
A method that records income items when they are
earned and records deductions when expenses are
incurred.
5. Business owners who experience cash flow
difficultiesare likely to make late payments for
business supplies and other expenses. An honest and
creative business owner who is on good terms with
his suppliers will likely develop strategies for
managing these situations.
For Example: A restaurant owner who offers his
produce vendor a free meal while explaining that his
payment will be late. A cash flow statement cannot
capture these negotiations and agreements, but they
are nonetheless a very real part of doing business.
 AT THE
END...

A cash flow statement is a document depicting a

company's liquidity, or its ability to meet current
expenses using currently available resources. Cash
flow statements are useful for providing a business
with a general idea of how it will make ends meet in
the short term. But cash flow statements do not
show the full complexity of a business' strategies and
resources for staying afloat or growing, and they
depend on assumptions that are not always accurate.
 THANK YOU

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