Chapter 3:

Income Flows versus Cash Flows:

Understanding the Statement of Cash Flows

DR. OANH NGUYEN

 Learning objectives
the purpose of the statement & the importance of
1. Cash flows
understanding a firm’s cash flows.
2. CF statement Structure and interpretation

3. Analysing Analyze information in the statement of cash flows

4. Relations among the the statement of cash flows, the income
statement statement, and the balance sheet.
Prepare a statement of cash flows from balance
5. Preparation of CF
sheet and income statement
Statement
data.
6. Extra examiniaton Examine additional uses of cash flow information
Preparing the Statement of Cash Flows— Indirect Method
 01
Purpose of the Statement of Cash Flows
 The objective of the statement of cash flows is to assist users in
understanding the cash inflows and outflows that arise from a firm’s
primary activities.

 The primary purpose of the statement of cash flows is to provide financial

statement users with information about a firm’s cash receipts and payments that
cause the change in the cash balance on the balance sheet.
 Beginning Cash + Cash Receipts - Cash Expenditures = Ending Cash
Balance
 01
Purpose of the Statement of Cash Flows
The statement of cash flows

 reports all of the sources and uses of cash during a period.

 is logically organized into three sections (operating activities, investing

activities, and financing activities), which correspond to the primary
activities necessary to support a business and generate profits.

 provides useful information helpful in uncovering accounting discretion.

 01
Purpose of the Statement of Cash Flows
TFASB’s Codification Topic 230 and IASB’s International Accounting Standard 7:

 define cash flows in terms of their effect on the balance of cash and cash
equivalents.
 Cash equivalents include highly liquid short-term investments that are readily
convertible into cash, including very-short-term Treasury bills, commercial
paper, and money market funds.
 Both U.S. GAAP and IFRS indicate that a maturity date of three months or less
would generally qualify short-term investments as cash equivalents..
 02
Cash Flows versus Net Income
Firm’s cash flows will differ from net income each period because

 cash receipts from customers do not necessarily occur in the same period
the firm recognizes revenues.

 cash expenditures do not necessarily occur in the same period firms

recognize expenses.

 cash inflows and outflows from investing and financing activities do not
immediately flow through the income statement.
 Cash Flows and Financial Analysis

01
Identify the Economic
Characteristics of a Business
02 03
Identify the Strategy of Identify Nonrecurring, Unusual Items
the Firm and Provide Insight into the Use
of Accounting Discretion by
Managers

04 05 06
Analyze Profitability and Prepare Forecasted Value the Firm
Risk Financial Statements
Identify the Economic Characteristics of a Business

High-growth, capital- Mature companies

intensive firms can use cash flows from operations to
finance capital expenditures and to
experience insufficient cash
repay debt, pay dividends, or
flow from operations to finance
repurchase common stock (financing
capital expenditures (investing
activities).
activities); thus, they require
external sources of capital
(financing Purpose of the
Statement of Cash Flows
activities)
Identify the Strategy of the Firm

A firm opting for A firm growing by acquiring other firms

organic growth A firm growing by acquiring
other firms will report significant
A firm opting for organic
cash outflows for corporate
growth will exhibit large
acquisitions (investing activities)
positive cash flows from
and, perhaps, large cash inflows
operations, which it funnels
from financing activities to raise
into investing activitiest of
debt and equity capital to finance
Cash Flows activities)
the acquisitions.
The Relations among the Cash Flow Activities

Mature firm
it generates cash inflows and outflows
every day from its operating activities,
and continually reinvests cash by
investing it in long-term productive
assets; cash shortfalls trigger the need
for new financing, whereas excess
cash flows allow a firm to distribute
cash by paying off debt or paying
dividends to shareholders.
Start up firm
The firm first obtains cash
through financing activities,
like issuing equity and debt,
then the firm invests the cash
in productive assets, followed
by generating cash flows from
operating activities
Cash Flow Activities and a Firm’s Life Cycle
 02
Questions

Give examples of firms operating

in different industries that have
different life cycles?
Atlas African Industries Limited (Introduction Phase)
providing support services for oil and gas exploration and drilling, mining, and construction.
 Ambarella (Growth Phase)
Nasdaq: AMBA) was founded in 2004 and develops video and image products
 Cedar Fair L.P. (Maturity Phase)
NYSE: FUN) is among the largest amusement park companies in the world
 Warner Music Group (Decline Phase)
among the the world’s largest and most influential music content companies
 Understanding the Relations among Net Income, Balance
Sheets, and Cash Flows

To fully interpret and analyze the information in the statement of cash flows, you
need to understand the following three relations:

 The overall relations among the net cash flows from operating, investing, and
financing activities.
 The relation between the change in the cash balance on the balance sheet and
the net changes reflected on the statement of cash flows.
 The specific relation between net income and cash flows from operations.