In-depth Notes on Statement of Cash Flows
Statement of Cash Flows Overview
The Statement of Cash Flows (SCF) is one of the four main financial statements included in the annual report.
It provides detailed information about cash receipts, cash payments, and the net change in cash during a specific period.
SCF helps users assess:
The company's ability to generate future cash flows.
Needs in utilizing cash.
Overall investing and financing transactions and their effects on the capital structure.
Allows for comparisons with other firms.
Types of Cash Flows
Operating Activities
Day-to-day business activities involving current assets and liabilities (e.g., cash, Accounts Receivable (A/R), Accounts Payable (A/P)).
Investing Activities
Purchasing or selling long-term assets used for business operations (e.g., property, equipment).
Financing Activities
Borrowing and repaying funds for business operations, which typically involve long-term liabilities or equity (e.g., debt or equity financing).
Operating Activities Cash Inflows and Out flows
Inflows:
Cash sales.
Collections from Accounts Receivable.
Interest received.
Cash from sales of trading securities.
Outflows:
Payments to suppliers, employees, and tax authorities.
Interest payments.
Investing Activities
Inflow:
Cash received from selling long-term investments or assets (e.g., depreciation recovery).
Outflow:
Cash spent to purchase long-term assets.
This affects changes in non-current assets.
Financing Activities
Inflow:
Cash from issuing debt or equity (shares).
Outflow:
Repayment of borrowings.
Payment of dividends.
This accounts for changes in non-current liabilities and equity.
Reporting Significant Non-Cash Activities
If activities do not affect cash, they should not be reported in the SCF.
Such activities should be reported in a separate note or supplement, e.g.:
Issuing debt to acquire assets.
Issuing shares to purchase assets.
Converting debt to equity.
Format of Cash Flow Statement
Components include:
Operating activities: cash provided (used) by operations.
Investing activities: cash provided (used) by investing.
Financing activities: cash provided (used) by financing.
Reconciliation of beginning and ending cash balances.
Closing cash on balance sheet = closing cash on SCF.
Methods for Reporting Cash Flows from Operations
Direct Method:
Lists specific cash inflows/outflows.
Indirect Method:
Adjusts net income for changes in assets and liabilities, and non-cash expenses.
Both methods arrive at the same net cash from operating activities.
Differences Between Direct and Indirect Methods
Direct Method
Lists individual cash receipts and payments, emphasizing cash flow from operations.
Indirect Method
Adjusts net income for non-cash items to arrive at net cash from operations.
Adjustments to Net Income (Indirect Method)
Adjustments include:
Adding noncash expenses (e.g., depreciation, amortization).
Deducting gains and adding losses.
Changes in current asset/liability accounts affecting cash flow (changes in A/R, A/P, inventories).
Example of Indirect Method (Computer Services Corp.)
Year Ended December 31, 2012
Profit: $145,000
Adjustments:
Depreciation expense: $9,000
Loss on sale of equipment: $3,000
Change in A/R: $10,000 decrease
Net cash provided by operating activities: $172,000
Free Cash Flow
A measure that helps understand discretionary cash remaining for a company after covering its obligations.
Calculated as:
Key Ratios Relevant to Cash Flow
Cash Current Debt Coverage Ratio
Measures ability to cover short-term debts.
Cash Total Debt Coverage Ratio
Measures ability to cover total liabilities.
Conclusion
The SCF is crucial for analyzing a company’s cash flows, financial health, and operational efficiency.
Understanding the components and methods of preparation is essential for accurate financial reporting and analysis.