Financial Ch. 14 - The Statement of Cash Flows | Horngren's Accounting

Statement of Cash Flows Report Scope

Reports on a business’s cash receipts and cash payments for a specific period, covering a span of time and dated the same as the income statement.

Purpose of the Statement of Cash Flows (Net Income)

Explains why net income reported on the income statement does not equal the change in the cash balance.

Purpose of the Statement of Cash Flows (Analysis)

Helps predict future cash flows, evaluate management, and predict the ability to pay debts and dividends.

Three Basic Types of Cash Flows

Operating activities, Investing activities, and Financing activities.

Operating Activities Section

The first section on the statement of cash flows, reporting on activities that create revenue or expense in the entity’s business, often considered the most important category.

Operating Cash Inflows

Cash received from customers for the sales of merchandise inventory and services, and cash for interest revenue and dividend income.

Operating Cash Outflows

Cash paid for the purchase of merchandise inventory, payment of operating expenses, interest expense, and income tax expense.

Investing Activities Section

The second category listed, reporting cash receipts and cash payments that increase or decrease long-term assets.

Investing Activities Covered Accounts

Affects long-term assets, such as Plant Assets, Investments, and Notes Receivable.

Investing Cash Inflows

Cash from the sale of property, plant, equipment, and investments, and cash from the collection of long-term notes receivable.

Investing Cash Outflows

Cash used to purchase property, plant, equipment, and investments, and cash used for loans made to borrowers.

Financing Activities Section

The last category listed, including cash inflows and outflows involved in long-term liabilities and equity.

Financing Activities Covered Accounts

Affects Long-term Notes Payable, Bonds Payable, Common Stock, and Retained Earnings.

Financing Cash Inflows

Cash from issuance of stock, selling treasury stock, and receipt of borrowing money.

Financing Cash Outflows

Cash used for payment of dividends, buying treasury stock, and repayments of loans.

Non-Cash Investing and Financing Activities

Transactions that make investments but do not require cash. These transactions appear as a separate schedule at the bottom of the statement of cash flows or in the notes to the financial statements.

Example of Non-Cash Activity 1

Acquiring a building by issuing common stock.

Example of Non-Cash Activity 2

Acquiring land by issuing notes payable.

Indirect Method (Operating Activities)

Starts with accrual income and adjusts it to net cash, using account relationships to determine changes in cash.

Direct Method (Operating Activities)

Restates the income in terms of cash and shows actual cash receipts and cash payments.

Starting Point of Indirect Method

Accrual-basis net income or loss is used and adjusted to reconcile to a cash number.

Depreciation, Depletion, and Amortization Adjustment

These expenses do not affect cash and must be added back to net income to reconcile net income to net cash flow from operating activities.

Adjustment for Gains on Non-operating Activities

Gains must be removed from net income, resulting in a decrease adjustment on the statement of cash flows (operating section).

Adjustment for Losses on Non-operating Activities

Losses must be removed from net income, resulting in an increase adjustment on the statement of cash flows (operating section).

Adjustment for Increase in Current Assets (other than Cash)

Decrease adjustment to Net Income.

Adjustment for Decrease in Current Assets (other than Cash)

Increase adjustment to Net Income.

Adjustment for Increase in Current Liabilities

Increase adjustment to Net Income.

Adjustment for Decrease in Current Liabilities

Decrease adjustment to Net Income.

Calculation of Cash Received from Asset Disposal

Cost - Accumulated Depreciation + Gain - Loss.

Calculation of Dividends Paid

Calculated by analyzing the Retained Earnings account, using the formula: Ending Retained Earnings = Beginning Retained Earnings + Net Income (or - Net loss) - Dividends.

Requirement for Dividend Reporting

Only cash dividends paid are reported on the statement of cash flows.

Free Cash Flow Definition

The amount of cash available from operating activities after paying for planned investments in long-term assets and after paying dividends.

Free Cash Flow Purpose

Used by investors to know how much cash a company can “free up” for new opportunities.

Free Cash Flow Formula

Net cash provided by operating activities - Cash payments planned for investments in long-term assets - Cash dividends.