Preparing CASH FLOW Statement
Preparing CASH FLOW Statement
Preparing CASH FLOW Statement
• An Overview 4
• Operating Activities 5
• Investing Activities 5
• Financing Activities 5
• Direct Method 10
• Indirect Method 11
Checklist 18
Resources 18
Notes 19
how to prepare a cash flow statement 3
what to expect
This Business Builder will introduce you to the cash flow statement and its importance
for financial management. Through the use of a worksheet, the Business Builder will
guide you through the construction of a cash flow statement for your business. The cash
flow statement is a complex financial statement and by necessity, this Business Builder
contains information on sophisticated accounting topics.
The cash flow statement’s primary purpose is to provide information regarding a company’s cash
receipts and cash payments. The statement complements the income statement and balance sheet. It is
important to note — cash flow is not the same as net income. Cash flow is the movement of money into
and out of your company, and it can be affected by several noncash transactions.
The cash flow statement became a requirement for publicly traded companies in 1987. There are
various rules governing how information is reported on cash flow statements, as determined by generally
accepted accounting principles (GAAP). While your business may not be a public company, a cash flow
statement is still important to measure and track the flow of cash into and out of your business.
This Business Builder is designed to show you how to create and understand your cash flow
statement. Cash flow, simply, is the movement of money in and out of your business, or the inflows and
outflows.
The cash flow statement reports the cash provided and used by the operating, investing, and financing
activities of a company during an accounting period. In 1987, the Financial Accounting Standards Board
issued Statement No. 95, which requires that a statement of cash flows accompany the income statement,
balance sheet and statement of retained earnings.
An Overview
The cash flow statement explains the change during the period in cash and cash equivalents.
Cash includes currency on hand and demand deposits. Cash equivalents are short-term, highly
liquid investments that are readily convertible to cash.
Statement No. 95 requires that cash receipts and payments be classified as operating, investing and
financing activities.
The cash flow statement will summarize the cash flows so that net cash provided or used by each of
the three types of activities is reported. Beginning and ending cash must be reconciled based on the net
effect of these activities. Here is an example of what a cash flow statement might look like.
The cash flow statement for the ABC Company shows there was a $205 cash shortfall in 200X. As
can be seen from the cash flow statement, the cash drain is primarily from the investment of $400 in
equipment. The statement also shows the cash flow from operations activity was a positive $165.
how to prepare a cash flow statement 5
Operating activities which generate cash inflows include customer collections from sales of their
primary products or services, receipts of interest and dividends, and other operating cash receipts.
Operating activities which create cash outflows include payments to suppliers, payments to employees,
interest payments, payment of income taxes and other operating cash payments.
Investing Activities
Investing activities include buying and selling noncurrent assets which will be used to generate
revenues over a long period of time; or buying and selling securities not classified as cash
equivalents.
Cash inflows generated by investing activities include sales of noncurrent assets such as property,
plant, and equipment. Investing activities can also include the purchase or sale of stock and securities.
Lending money and receiving loan payments would also be considered investing activities.
Financing Activities
Financing activities include borrowing and repaying money, issuing stock (equity) and paying
dividends.
For example, if you borrow funds to purchase equipment or pay off a loan, the cash flow statement will
enable you to determine how much cash was either generated or used as a result of those transactions.
Many revenues and expenses result from accruals and allocations that do not affect cash. A company
can operate at a profit and continually be short of cash. It can also generate huge inflows of cash from
operations and still report a loss. The statement of cash flows can explain how these situations might
occur. Answers to these questions cannot be found in the other financial statements.
There are two types of items that cause differences between income flows and outflows: noncash
income or expense and nonoperating income or expense.
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Additionally, there are two methods of calculating and reporting the net cash flow from operating
activities. Both methods result in identical figures for net cash flow from operating activities because the
underlying accounting concepts are the same.
• The direct method reports gross cash inflows and gross outflows from operating activities.
• The indirect method reconciles net income with net cash flow from operating activities by
adjusting net income for deferrals, accruals, and items that effect investing and financing
cash flows.
The first step in preparing the cash flow statement is to determine the net increase in cash and cash
equivalents for the period. This amount will be a control figure and the cash flow statement will reconcile
the inflows and outflows (sources and uses) to this figure.
The fictional company From the Roots Up will be used as the example throughout this booklet. The
current year income statement data is shown on Exhibit 1 and the balance sheets from the prior two years
have been combined on the cash flow worksheet as Exhibit 2. This is also referred to as the sources and
uses statement.
Begin with the balance sheet data by taking the cash balance of $223,000 from the most recent
balance sheet and subtracting the cash balance of $169,000 from the prior year, which results in an
increase in cash of $54,000. The cash flow statement must balance to this control number.
Next, determine the change in each balance sheet account. This is reflected in the Balance Change
column (Exhibit 2) of the worksheet. It is calculated by subtracting the prior year account balance from
the current year balance. For example, accounts receivable in 200Y was $884,000 compared to $705,000
in 200X, which resulted in a $179,000 increase in accounts receivable. This process is continued for each
of the balance sheet accounts.
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After calculating the account balance change, it is necessary to determine if the balance change is
an inflow or an outflow of cash or a source or use of cash. To make this task simple use Table I as a guide
to determine the effect of each balance change. The table shows a decrease in an asset balance and an
increase in a liability or equity account are cash inflows. The opposite holds true for increases in an asset
balance or a decrease in a liability or equity account, which results in a cash outflow.
To complete the cash flow worksheet (Exhibit 2), determine if each account balance change is an
operating, investing or financing activity. Using Table II as your guide, beginning with the asset section of
the cash flow worksheet, review each account. Remember, the change in cash and cash equivalents is
the control number to which you reconcile your cash flow statement.
Exhibit 1
Sales $8,158
Cost of Goods Sold (4,895)
Gross Profit 3,263
Exhibit 2
Comparative Balance Sheet Prior Year Current Year Balance Cash Source/ Activity
200X 200Y Change (Cash Use) Type
Assets
Cash $169 $233 $54 Control Cash
Net Accounts Receivable 705 884 (179) Use Operating
Bad Debt Reserve (14) (18) (4) Use Operating
Inventories 983 1,160 (177) Use Operating
Other Notes Receivable 130 214 (84) Use Investing
Plant and Equipment 512 552 (40) Use Investing
Accumulated Depreciation (102) (110) 8 Source Operating
Noncurrent Assets 72 68 4 Source Investing
Total Assets $2,455 $2,973
Table I
Table II
Inflows of Cash
Outflows of Cash
The first method performed will be the direct method of calculating cash flow. This method
combines information from both the Income Statement and the Cash Flow worksheet we created
using the Balance Sheet.
The result is an accurate indication of exactly what funds were collected in the form of cash, paid
in the form of cash, and if the company actually generated cash. You can use Table III as a guide for
calculating the cash flow on a direct basis.
Table III
Exibit 3
The second method used to calculate the Cash Flows from Operating Activities is referred to as
the Indirect Method. Using the Indirect Method, cash flows from Operating Activities are reported
by adjusting net income for revenues, expenses, gains, and losses that appear on the income
statement but do not have an effect on cash.
Using Table IV as a guide, and Table I and Table V to determine if the change is an inflow or outflow,
extract data from the Income Statement (Exhibit 1) and Cash Flow Worksheet (Exhibit 2) to prepare the
Cash Flows from Operating Activities using the Indirect Method. (Exhibit 4).
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Table IV
(+) Depreciation
(-) Amortization of Bond Premium
(+) Amortization of Bond Discount
(-) Gain on Sale of Equipment
(+) Loss on Sale of Equipment
(+) Decrease in Accounts Receivable
(-) Increase in Accounts Receivable
(+) Decrease in Inventory
(-) Increase in Inventory
(-) Decrease in Accounts Payable
(+) Increase in Accounts Payable
(-) Decrease in Accrued Expenses
(+) Increase in Accrued Expenses
(+) Decrease in Prepaid Expenses
(-) Increase in Prepaid Expenses
(-) Decrease in Taxes Payable
(+) Increase in Taxes Payable
Table V
Based on the formula provided in Table IV, reconcile From the Roots Up net income with net cash
provided by its Operating Activities (Exhibit 4).
how to prepare a cash flow statement 13
Exhibit 4
A comparison of the Direct Method with the Indirect Method indicates that either method will
generate the same results. The Operating Activities of From the Roots Up generated $142,000 in net cash
during 200Y.
Investing Activities
Cash flow from investing activities is the second part of both types of cash flow statements.
Investing activities are the changes to the cash position created by the buying or selling of
non-current assets. This includes selling and replacing equipment that wears out or acquiring a
new building or land to facilitate growth in a company.
Investing activities can also include the purchase or sale of stocks, bonds and securities. Lending
money and receiving loan payments are also considered investing activities. For a small business, the
investing activities section of a cash flow statement usually reports the following information:
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For a given period, there may not be much in the way of investing activities. But over time, it is an
important consideration for assessing how to choose to use the cash generated by your business.
Financing Activities
Financing activities on a cash flow statement reflect borrowing money and repaying money,
issuing stock, and paying dividends. The financing activities section of the cash flow statement
can be reduced to the following formula:
- Repayment of Loans
- Dividends/Distributions/Withdrawals Paid
As you can see, this section of the cash flow statement is registering inflows of cash from
loans received and loans repaid, and other cash inflows from outsiders and owners. If you have paid
dividends or taken money from the business, it should be reported here.
Our actual Cash Flow Statement can now be created by summarizing the results as follows:
how to prepare a cash flow statement 15
Once you have constructed a cash flow statement, you will be much closer to understanding
the financial position of your company. While a balance sheet and income statement are
tools for management, without a cash flow statement they are limited barometers and
may even be misleading.
Operating Activities
The cash flow statement will tell you where money came from and how it was used. When
analyzing cash flow, the first place to look is the cash flow from operating activities. It tells you
whether the firm generated cash or whether it needs a cash infusion.
A few periods of negative cash from operating activities is not by itself a reason for alarm if it is based
on plans for company growth or due to a planned increase in receivables or inventories. However, if a
negative cash flow from operating activities is a surprise to managers and owners, it may be undesirable.
Over time, if uncorrected, it can foretell business failure. Managers and owners should pay particular
attention to increases in accounts receivable. The cash flow statement gives the true picture of the
account. A large increase in accounts receivables may warrant new billing or collection procedures.
Investing Activities
The cash flow statement puts investing activities into perspective. At one glance, you can see
whether or not a surplus in operations is being used to grow the company.
A lack of investing activities, which is few purchases of new equipment or other assets, may indicate
stagnant growth or a diversion of funds away from the company.
Financing Activities
The financing activities section of the cash flow statement will show repayments of debt, borrowing
of funds, as well as injections of capital and the payment of dividends. As a company expands, this
area of the cash flow statement will become increasingly important. It will tell outsiders how the
company has grown and the financial strategies of management.
Together, the three sections of the cash flow statement show the net change in cash during the
period being examined. A comparison between past periods will give owners and managers a good
idea of the trend of their business. Positive trends in cash flow may encourage owners to consider
long-term financing as an aid to growth and increase their comfort level concerning the company’s ability
to generate cash for repayment. Strong cash flow will also make it easier to acquire financing and to
negotiate with lenders from a position of strength. Preparation of a cash flow statement is the first step
toward financial management for long-term success.
how to prepare a cash flow statement 17
Net Sales
Interest Expense
Dividends - Paid in Cash
Cash Paid for Dividends and Interest
NET CASH INCOME
Current Portion Long-Term Debt
CASH AFTER DEBT AMORTIZATION
Change in Net Fixed Assets
Change in Investments
Cash Paid for Plant and Investments
FINANCING SURPLUS (REQUIREMENTS)
Change in Short-Term Loans / Other Payables
Change in Long-Term and Sub Debt
Change in Other Non-Current Liabilities
Change in Capital
Total External Financing
CASH AFTER FINANCING*
Add: Beginning Cash & Equivalents
Ending Cash Equivalents
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checklist
Operating Activities
___ When you prepared the operating activities portion of the cash flow statement by the direct
method, did you also prepare it by the indirect method to reconcile net income to cash flow from
operating activities?
___ Has net income been adjusted for changes in accounts receivable, inventory, accounts
payable, wages payable, and income taxes?
Investing Activities
___ Is every cash transaction to purchase equipment or other assets represented?
___ If any loans were made by the company, are they reflected?
Financing Activities
___ Are all loan payments reported?
___ Are there any unreported cash inflows from owners or investors?
___ How do you expect the financing activities of your company to change in the next year and the
next two years?
resources
Books
Cash Flow Analysis, Financial Proformas, Inc., Fifth Edition, September 1995
Websites
The Trade Creditor’s Guide to the Statement of Cash Flows,
www.crfonline.org/orc/cro/cro-10.html
how to prepare a cash flow statement 19
notes
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b-4
Utah Idaho
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