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Class 11
Statement of Cash Flows
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Agenda

 Statement of Cash Flows

 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
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Statement of Cash Flows

 Statement of Cash Flows shows the sources and uses of cash during the
period.
▪ Where did cash come from during the period?
▪ Where did cash go during the period?
▪ How do we interpret the change in the cash balance from the beginning
to the end of the period.
 SCF: (1) Reports the cash receipts and cash payments from the operating,
investing, and financing activities during a period, (2) in a format that
reconciles the beginning and ending cash balances
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Statement of Cash Flows

 But isn’t accrual-based accounting better than cash-based?

▪ Yes! But…
• Income isn’t Everything
• Income AND cash flows together are better predictors of future income
and cash flows than either individually.
• Source of cash is important.

• Assess the reliability of accrual-basis net income

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Different Business Activities

Investing Activities Financing Activities

Operating Activities
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Statement of Cash Flows

 Statement of Cash Flows splits activities that affect cash into three categories:

1. Cash Flows from Operations

2. Cash Flows from Investing

3. Cash Flows from Financing

 Cash Flows from Investing and Financing are easiest to define

 Cash flows from Operations include everything that’s left over

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Cash Flows From Investing Activities

 Change in noncurrent assets, PPE, intangible assets, and investment in other companies.
 Includes Four Activities:
▪ Acquiring Property, Plant, & Equipment, Intangibles, and Natural Resources with cash
▪ Disposing of Property, Plant, & Equipment, Intangibles, and Natural Resources for cash
▪ Acquiring Investments (Equities/Debts(bonds)) with cash
▪ Disposing of Investments (Equities/Debts(bonds)) for cash

 Does NOT include:

▪ Interest Paid or Received (________)
▪ Dividends Paid (________)
▪ Dividend Received (________)
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Cash Flows from Investing: Example

The following data is from the Nelson Company for 2018:

Loss on Sale of Equipment $4,000
Purchase of Enfield Corp. Bonds for Cash $375,000
Cash Proceeds from the Sale of Equipment $200,000
Dividends Paid $25,000
Proceeds from the Issuance of Nelson stock $100,000

What amount should be reported as net cash flows from investing activities?
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Cash Flows from Financing Activities

 Relates to noncurrent liabilities and shareholders’ equity

 Includes:
▪ Issuing long-term debt to financial institutions and debt investors for cash
▪ Retiring long-term debt to financial institutions and debt investors with cash
▪ Issuing stock for cash
▪ Retiring stock with cash
▪ Payment of cash dividends

 Does NOT include:

▪ Interest Paid or Received (________)
▪ Dividends Received (________)
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Cash Flows from Financing: Example

The following data is from the Nelson Company for 2018:

Loss on Sale of Equipment $4,000
Purchase of Enfield Corp. Bonds for Cash $375,000
Cash Proceeds from the Sale of Equipment $200,000
Dividends Paid $25,000
Proceeds from the Issuance of Nelson stock $100,000

What amount should be reported as net cash flows from financing activities?
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Cash Flows from Operations

Includes: Everything that’s not Investing or Financing

Cash Collections Cash Payments
• from customers • to suppliers
• of interest • to employees
• of dividends • for interest
• to the Government (taxes)

 Direct Method
▪ Directly record cash inflows and outflows for the period
 Indirect Method (our focus)
▪ Reconciliation of Net Income to Cash from Operating Activities
▪ Used by the majority of companies
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Exercise

Classify each item as an operating, investing, or financing activity. Assume all

items involve cash unless there is information to the contrary.
(a) Purchase of equipment:
(b) Sale of building:
(c) Redemption of bonds:
(d) Payment of dividends:
(e) Issuance of Capital stock:
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Exercise

Classify each item as an operating, investing, or financing activity. Assume all items involve
cash unless there is information to the contrary.

a) Issued 100,000 shares of $5 par value common stock for $800,000 cash:
b) Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest:
c) Purchased two semi-trailer trucks for $170,000 cash:
d) Paid employees $12,000 for salaries and wages:
e) Collected $20,000 cash for services performed:
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Agenda

 Content and Format

 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
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Different Approaches

 Suppose you are given a series of numbers: 2, 3, 5, 7, and 8. What’s the sum
of the prime numbers in the sequence?
 What’s the sum of the sequence? Which number is not prime number?

 Which numbers are prime number? What’s the sum of them?

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Different Approaches
Both approaches will give us the same value
- they’re just different methods of getting there

Indirect Method Direct Method

Cash Received from Operating

Net Income
Sources

Adjust for Non-Cash and Cash Paid for

Non-Operating Transactions Operating Resources

Net Cash Flows from Net Cash Flows from

Operations Operations
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Indirect Method
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Indirect Method

Starting with Net Income (NI), we adjust for:

 Items that Affected Net Income, but had No Cash Effects
▪ Depreciation
▪ Amortization
 Items that Affected Both Net Income AND Cash, but not from an Operating
Activity
▪ Gains on Sale of PP&E and Other Investing Assets
▪ Losses on Sale of PP&E and Other Investing Assets
 Operating Items for which Income Effect differs from Cash Flow Effect (non-cash
current assets and current liabilities)
▪ Increases in current liabilities and decreases in current assets
▪ Increases in current assets and decreases in current liabilities
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Indirect Method

Why add back Depreciation and Amortization?

 Remember the journal entry for depreciation expense:

Dr. Depreciation Expense (+E, -SE) XXXX

Cr. Accumulated Depreciation (+xA) XXXX

 Recording this entry:

▪ Reduced Net Income
▪ Did not affect cash
▪ Did not affect non-cash current assets or liabilities
 If we want to reconcile Net Income to the change in cash, we need to remove the
effects of depreciation and amortization expense (by adding them back)
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Indirect Method

Why subtract Gains and add back Losses from the sale of PPE and other investing
items?
 Remember the journal entry for sales of PP&E (at a gain):
Dr. Cash (+A) XXXX
Dr. Accumulated Depreciation (-xA) XXXX
Cr. Gain on Sale of PP&E(+R, +SE) XXXX
Cr. PP&E (-A) XXXX
 Recording this entry:
▪ Increased Net Income
▪ Increased Cash (____________________________________)
The cash inflow related to “gain” is already included in investing cash flows. Thus, we need to
subtract the gain from NI.
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Indirect Method

Why add decreases and subtract increases in non-cash current assets?

Example: Accounts Receivable
Sale for Cash Sale on Account Cash Collection
Cash A/R Cash
Journal Entry
Revenue Revenue A/R
Effect on Net Income Increase
Effect on Cash Increase
Effect on Non-Cash
No Effect
Current Assets
Subtract the Increase in Add the Decrease in
Adjustment None Non-Cash Assets from NI Non-Cash Assets to NI
to Get to Cash to Get to Cash
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Indirect Method

Why add increases and subtract decreases in current liabilities?

Example: Wages Payable
Cash Purchases Purchase on Account Cash Collection
Expense Wages Expense Wages payable
Journal Entry
Cash Wages Payable Cash
Effect on Net Income Decrease
Effect on Cash Decrease
Effect on Current
No Effect
Liabilities
Add the Increase in Subtract the Decrease in
Adjustment None Current Liabilities to Current Liabilities to NI
NI to Get to Cash to Get to Cash
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Indirect Method Change in Account Balance
During Year
Increase Decrease
Current Subtract from Add to
Cash Flows from Operations:
Assets Net Income Net Income
Net Income Current Add to Subtract from
Liabilities Net Income Net Income
1 + Depreciation and Amortization

+ Losses on Sales of Investing Assets

2
─ Gains on Sales of Investing Assets

+ Decreases in Non-Cash Current Assets

─ Increases in Non-Cash Current Assets
3 + Increases in Current Liabilities
─ Decreases in Current Liabilities

Cash Flow From Operations

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Group Exercise

The following information has been provided by Salcha Company. What is Salcha’s net
cash flow from operating activities?

Net Income $100,000

Amortization of Patent $9,400
Depreciation Expense $20,000
Decrease in Inventory $7,500
Decrease in Accts. Payable $38,000
Increase in Accts. Receivable $8,000
Increase in PP&E $75,000
Increase in Income Taxes Payable $6,000
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Agenda

 Content and Format

 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
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Direct Method

 IAS 7 prefers the direct method for cash flows of operating activities.
▪ Provides clearer information about the sources and users of cash
▪ However, very few companies actually use the direct method
▪ Requires more computations than the indirect method
▪ Method used does not influence investing and financing cash flows.
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Direct Method

 E.g. Cash collection from customers

▪ Focus on change in Accounts Receivable
▪ Beginning Balance + Sales – Cash Collection = Ending Balance
▪ Cash Collection = Sales – (Ending Balance – Beginning Balance)
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Direct Method

Payment for Inventory:

▪ Inventory: Beginning balance + Purchase – Cost of goods sold = Ending balance
▪ A/P: Beginning balance + Purchase – Payment for inventory = Ending balance
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Direct Method
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Operating
Activities
(Indirect Method)

Investing
And
Financing
Activities
(Direct Method)
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Cash Flows from Investing Activities

 Receipts of Cash
▪ Sale of PPE
▪ Sale of Investment
▪ Collection of Notes Receivable
 Payments of Cash
▪ Acquisition of PPE
▪ Purchase of Investment
▪ New loans made
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Cash Flows from Financing Activities

 Receipts of Cash
▪ Issuance of long-term debt (bonds)
▪ Issuance of Share
 Payments of Cash
▪ Payment of long-term debt
▪ Purchase of treasury stocks
▪ Payment of dividends
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Group Exercise

 Asay Company purchased a piece of equipment on 1/1/2017 for $100,000,

that will be depreciated equally over an estimated useful life of 10 years
(Residual value is 0).

1) What would be recorded gain or loss if Asay sells the equipment on 31st Dec
2018 for $95,000 cash?
2) Assuming this is the only transaction for Asay in 2018 and Net Income is
$5,000, construct the 2018 SCF for Asay.
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Group Exercise

 Asay Company purchased a piece of equipment on 1/1/2017 for $100,000, that

will be depreciated equally over an estimated useful life of 10 years.
1) What would be recorded gain or loss if Asay sells the equipment on 31st Dec 2018
for $95,000 cash?
What Journal Entries have been made so far?
1/1/17:

12/31/17:

12/31/18:

What Journal Entry is used to record the sale?

12/31/18:
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Group Exercise

2) Assuming this is the only transaction for Asay in 2018 and Net Income is
$5,000, construct the 2018 SCF for Asay.

Operating Activities:
Net Income
+ Depreciation Expense
- Gains
Net Cash Flow from Operating Activities

Investing Activities:
Sale of equipment
Net Cash Flow from Investing Activities ____

Financing Activities:
Net Cash Flow from Financing Activities

Net Increase in Cash

 The Boeing Company and Subsidiaries
Consolidated Statements of Financial Position 36
Group Exercise (Dollars in millions, except per share data)
December 31, 2018 2017
Assets
Cash and Cash Equivalents $ 7,637 $ 8,813
Accounts Receivable 13,904 11,088
Below are (heavily) adapted financial Inventories 62,567 61,388
statement data from Boeing’s Feb. 8, Other Current Assets 3,722 3,905
2019 10-K Filing. Using the information Total Current Assets 87,830 85,194

provided, prepare Boeing’s 2018 Property, Plant and Equipment, gross 31,213 30,313
Statement of Cash Flows Accumulated Depreciation (18,568) (17,641)
Total Assets $ 100,475 $ 97,866

Financial Statement Highlights Liabilities

Current Liabilities:
• 2018 Net Income was $10,535 Accounts Payable $ 12,916 $ 12,202
Accrued Liabilities $ 14,808 $ 13,069
• Depreciation on PP&E was $927 Total Current Liabilities 27,724 25,271
• Purchased equipment for $1,900. Long-Term Debt 10,657 9,782
Immediately sold $1,000 of this Total Liabilities 38,381 35,053
equipment for $1,075 cash. Stockholders' Equity
• Borrowed a new long-term note of Contributed Capital 21,236 18,865
$875 Retained Earnings 40,858 43,948
• Received $2,371 for issuance of new Total Stockholders' Equity 62,094 62,813
shares of common stock Total Liabilities and Stockholders' Equity $ 100,475 $ 97,866
Step 1: Mark Balance Sheet Accounts O, I, or F and Compute Δ
The Boeing Company and Subsidiaries
Consolidated Statements of Financial Position
(Dollars in millions, except per share data)
Related
SCF
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December 31, 2018 2017 Change Section(s)
Assets
Cash and Cash Equivalents $ 7,637 $ 8,813
Accounts Receivable 13,904 11,088 2,816 O
Inventories 62,567 61,388 1,179 O
Other Current Assets 3,722 3,905 (183) O
Total Current Assets 87,830 85,194
Property, Plant and Equipment, gross 31,213 30,313 900 I
Accumulated Depreciation (18,568) (17,641) (927) O
Total Assets $ 100,475 $ 97,866
Liabilities
Current Liabilities:
Accounts Payable $ 12,916 $ 12,202 714 O
Accrued Liabilities $ 14,808 $ 13,069 1,739 O
Total Current Liabilities 27,724 25,271
Long-Term Debt 10,657 9,782 875 F
Total Liabilities 38,381 35,053
Stockholders' Equity
Contributed Capital 21,236 18,865 2,371 F
Retained Earnings 40,858 43,948 (3,090) O&F
Total Stockholders' Equity 62,094 62,813
Total Liabilities and Stockholders' Equity $ 100,475 $ 97,866
Step 2: Start with Operating Section
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The Boeing Company and Subsidiaries

Consolidated Statement of Cash Flows
(Dollars in millions, except per share data)
Year ended December 31, 2018
Cash flows - operating activities:
Net earnings $ 10,535
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Non-cash items -
Depreciation 927
(Gain)/loss on dispositions, net (75)
Changes in assets and liabilities -
Accounts receivable (2,816)
Inventories (1,179)
Other current assets 183
Accounts payable 714
Accrued liabilities 1,739
Net cash provided by operating activities 10,028
Step 3: Complete Investing and Financing Sections 39

Cash flows - investing activities:

Purchase of Property, Plant, and Equipment (1,900)
Sale of Property, Plant, and Equipment 1,075
Net cash used by investing activities (825)

• Purchased $1,900 of Equipment for Cash

• Immediately Sold $1,000 of the Equipment, receiving $1,075 Cash

Note: Purchase of Equipment for $1,900 – Sale of Equipment with $1,000 BV ties to the
$900 increase in “Property, Plant, and Equipment, gross” on the Balance Sheet
Step 3: Complete Investing and Financing Sections 40

Cash flows - financing activities:

New borrowings 875
Proceeds from issuance of common shares 2,371
Dividends paid (13,625)
Net cash used by financing activities (10,379)
• Net (decrease)/increase
Borrowed in cash
a new $875 Long-Term Note Payable (1,176)
• Received $2,371 for issuance of new shares of common stock

• Dividend?
Step 4: Reconcile – Ensure Total Change in Cash is Accounted for
The Boeing Company and Subsidiaries
Consolidated Statement of Cash Flows
(Dollars in millions, except per share data) 41
Year ended December 31, 2018
Cash flows - operating activities:
Net earnings $ 10,535
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Non-cash items -
Depreciation 927
(Gain)/loss on dispositions, net (75)
Changes in assets and liabilities -
Accounts receivable (2,816)
Inventories (1,179)
Other current assets 183
Accounts payable 714
Accrued liabilities 1,739
Net cash provided by operating activities 10,028
Cash flows - investing activities:
Purchase of Property, Plant, and Equipment (1,900)
Sale of Property, Plant, and Equipment 1,075
Net cash used by investing activities (825)
Cash flows - financing activities:
New borrowings 875
Proceeds from issuance of common shares 2,371
Dividends paid (13,625)
Net cash used by financing activities (10,379)
Net (decrease)/increase in cash (1,176)
Cash and cash equivalents - beginning of year 8,813
Cash and cash equivalents - end of year $ 7,637
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Agenda

 Content and Format

 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
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 Cash from operation less than Net Income.

 Major source of cash is the sale of PPE.
 Enix paid off more long-term debt than it did new borrowing.
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Useful Metrics

 Analysts find that the statements of cash flows are more useful in finding weaknesses
rather than gauging successes. Why?
 A shortage of cash can throw a company into bankruptcy. On the other hand, lots of
cash doesn’t guarantee success.
 Signs of a healthy company
▪ Operations are the major source of cash
▪ Investing activities include more purchases than sales of long-term assets
▪ Financing activities are not dominated by new loans and borrowings
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Useful Metrics

 Free Cash Flow

▪ FCF=Net cash provided by operating activities – Cash payment for investments in PPE
▪ The cash that a company generates after accounting for cash outflows to support
operations and maintain its capital assets