Unit 10: Statement of Cash Flows
Now, let's explore how companies manage cash flow. Most companies use the revenues they generated yesterday to pay today's and tomorrow's expenses. For example, some companies manage their cash and maintain enough reserves to pay their expenses when they are due. Others must obtain capital loans to pay their bills, because they have highly seasonal sales or experience rapid growth and do not have enough savings to pay for the upfront costs to fund their expansion. While the company's income statement and balance sheet help monitor performance and their current financial condition, neither statement provides information about cash activity during a given time period.
Companies must manage their cash wisely to accommodate the lag time between revenues and expenses so they can pay their bills in a timely manner. In this unit, we focus on how to prepare a statement of cash flows, which will provide important information
about performance measures, cash-on-hand, and cash needed.
Completing this unit should take you approximately 5 hours.
Upon successful completion of this unit, you will be able to:
- explain the purpose of the statement of cash flows;
- explain what each of the three categories of cash flows (operating, investing, and financing) represents;
- prepare a statement of cash flows using the direct and indirect methods; and
- evaluate an organization's performance by analyzing its cash from operating activities.
10.1: Purpose of the Statement of Cash Flows
Read the Chapter 12 Introduction, then click "Next Section" to read Section 12.1. The CEO of Home Store wants to know “where has the money gone?" Home Store is profitable but there is no money in the bank. You will soon see a possible explanation. The statement of cash flow provides cash receipt and cash payment information and reconciles the change in beginning cash and ending cash over a period of time.
10.2: The Types of Cash Flows
Cash flow is essential. Because of this, it takes many forms and can be measured in numerous ways. This section considers the usual methods of describing cash flow.
Operating activities include cash activities related to net income (revenues and expenses are included in net income).
Investing includes cash activities related to noncurrent assets. Noncurrent assets include (1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to other entities.
Financing includes cash activities related to noncurrent liabilities and owners' equity. Noncurrent liabilities and owners' equity items include (1) the principal amount of long-term debt, (2) stock sales and repurchases, and (3) dividend payments.
10.3: Preparation of Cash Flow Statements
The statement of cash flows is based on cash only, and when used for accrual accounting based companies, adjustments must be made to convert accrual basis information to a cash basis. In addition to reconciling the three statement activities (the income statement, balance sheet, and statement of owners' equity), cash flows need to have certain adjustments made to them. One of the main ones is adjusting the statement for non-cash transactions like depreciation. There are four steps to creating a cash flow statement.
We now look at Home Store and the CEO's question. Where's the money? The information needed to prepare Home Store's statement of cash flows includes the balance sheet, income statement, and other selected data.
This video explains how to prepare the investing and financing sections of a cash flow statement.
10.4: Cash Flow Analysis
Investing activities focus on the effect that changes in noncurrent assets have on cash. Noncurrent asset balances found on the balance sheet, coupled with other information (like cash proceeds from the sale of equipment), are used to perform this step. The financing activities section focuses on the effect changes in noncurrent liabilities and owners' equity have on cash. Noncurrent liabilities and owners' equity balances found on the balance sheet, coupled with other information (like cash dividends paid), are used to perform this step.
This video finishes the cash flow work on Turner Inc. by doing a rudimentary analysis of the company's cash flow statements.
The same four steps apply to preparing a statement of cash flows in both the direct and indirect methods. The only difference is how the operating activities section is presented in step one; all other steps are the same. Although the presentation of the operating activities section differs with each method, the result is the same.
This video finishes the cash flow work on Turner Inc. by doing a rudimentary analysis of the company's cash flow statements.