Financial

Accounting:1
Tools for Business DecisionMaking
Fifth Canadian Edition

Prepared By:
Debbie Musil
Kwantlen Polytechnic
University

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C H APT ER

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Cash Flow Statement

Study Objectives

1.

Describe the purpose and content of the statement of cash flows.

2.

Prepare the operating activities section of a statement of cash flows

using one of two approaches: (a) the indirect method or (b) the direct
method.

3.

Prepare the investing activities section of a statement of cash flows.

4.

Prepare the financing activities section of a statement of cash flows.

5.

Complete the statement of cash flows.

6.

Use the statement of cash flows to evaluate a companys liquidity and

solvency.
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Purpose of the Statement of

Cash Flows

Helps users assess:

A companys ability to generate cash
A companys needs in using this cash

This is useful in determining:

Companys ability to generate future cash flows
Investing and financing transactions during the
period, and effect upon capital structure
And for making comparisons with other
companies
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Definition of Cash
1
Cash may include cash equivalents
Short-term, highly liquid investments that are
readily converted to cash within a short period
of time (usually within three months)
May not be included in future depending on
outcome of IASB/FASB joint project

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Classification of Cash Flows

1
Operating activities
Investing activities

Financing activities

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Operating Activities
1
Cash effects of transactions that create
revenues and expenses that enter into
determination of profit
Includes relevant (i.e., the related account is
an income statement account) noncash
current assets and current liabilities on the
statement of financial position

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Investing Activities
1
Purchasing and disposing of long-term
investments and productive long-lived
assets using cash
Lending money and collecting the loans

Generally includes non-current asset items

(e.g., long-term investments, property, plant,
and equipment) on the statement of
financial position

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Financing Activities
1
Obtaining cash from issuing debt and
repaying the amounts borrowed
Obtaining cash from selling common and
preferred shares and paying dividends

Generally includes non-current liabilities,

and shareholders equity items on the
statement of financial position

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Significant Noncash Activities

1
If it does not affect cash, do NOT report in
statement of cash flows
Report in separate note or supplementary
schedule to the financial statements

Examples:
Issue of debt to purchase assets
Issue of shares to purchase assets
Conversion of debt to equity
Exchange of property, plant, and equipment
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Discussion Question
1
How would the following transaction be
reported in the statement of cash flows?
A company acquired a piece of equipment by
issuing common shares for part of the cost
and obtaining a bank loan for the remainder

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Format of Cash Flow Statement

1

Illustration 13-2

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Preparing the Statement of

Cash Flows

Step 1: Prepare operating activities section

Step 2: Prepare investing activities section

Step 3: Prepare financing activities section
Step 4: Complete the statement of cash
flows

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Step 1:
Operating Activities

Determine the net cash provided (used) by

operating activities by converting profit
from an accrual basis to a cash basis
Conversion may be done by either the
indirect method or the direct method
Both methods arrive at the same amount of net
cash provided by (used in) operating activities
Direct method is preferred by standard-setters
Indirect method is preferred by most companies
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Indirect Method
1
Most companies favour the indirect method
for the following reasons
Easier to prepare
Reveals less information to competitors

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Convert Profit to Net Cash Provided

(Used) by Operating Activities
1
Start with profit and add or deduct items
not affecting cash to arrive at net cash
provided (used) by operating activities
+ Noncash expenses and/or noncash revenues
on the income statement
+ Losses and/or gains on the income
statement
+/- Changes in relevant noncash current assets
and current liabilities on the statement of
financial position
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Convert Profit to Net Cash Provided

(Used) by Operating Activities:
Indirect Method

16

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Net Cash Provided (Used)

by Operating Activities
Illustration 13-6

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Indirect Method

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Direct Method
1
Standard setters prefer the direct method
but allow the use of either method
Details cash receipts and payments
Similar to indirect method:
Adjusts income statement from accrual basis to
cash basis in order to arrive at net cash provided
(used) by operating activities
However, whereas indirect method adjusts total
profit, direct method adjusts each individual
revenue and expense account
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Discussion Question
1
Why is the direct method preferred by
standard setters? Which method do you
prefer?

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Cash Receipts from Customers

1
The relationship among cash receipts from
customers, revenues from sales, and
changes in accounts receivable is:

If other cash receipts (such as interest),

these must be adjusted for any receivable
amounts as was done above
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Cash Payments to Suppliers

1
The relationship among cash payments to
suppliers, cost of goods sold, changes in
inventory, and changes in accounts payable
is:

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Cash Payments for Operating

Expenses
1
The relationship among cash payments for
operating expenses, changes in prepaid
expenses, and changes in accrued expenses
payable is:

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Cash Payments to Employees

1
Some companies report payments to
employees with operating expenses
If reported separately, the relationship
among cash payments to employees,
salaries expense, and changes in salaries
payable is:
Cash payments to
employees

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Salaries expense

+ Decrease in salaries payable

or
- Increase in salaries payable

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Cash Payments for Interest

1
The relationship among cash payments for
interest, interest expense, and changes in
interest payable is:

Cash payments for

interest

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Interest expense

+ Decrease in interest payable

or
- Increase in interest payable

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Cash Payments for Income Tax

1
The relationship among cash payments for
income tax, income tax expense, and
changes in income tax payable is:

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Summary of Conversion of Net Cash

Provided (Used) by Operating Activities
Direct Method

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Net Cash Provided (Used)

by Operating Activities
Direct Method

Illustration 13-12

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Step 2:
Investing Activities

Determine the net cash provided (used) by

investing activities by analyzing changes in
non-current asset accounts
Reported the same under both direct and
indirect methods
Asset acquisitions are uses of cash;
disposals are sources of cash (for the
proceeds of disposition)
Depreciation expense is a noncash charge
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Step 3:
Financing Activities

Determine the net cash provided (used) by

financing activities by analyzing changes in
non-current liability and shareholders equity
accounts
Changes to notes, loans, and bonds payable are
analyzed to determine cause of change
Amortization of premium or discount (if any) are
noncash charges and have no effect

Analyze share capital and retained earnings

accounts for changes and their cause
Profit is reported in the operating activities section
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Step 4:
The Statement of Cash Flows
1
Complete the statement of cash flows

Determine increase (decrease) in cash

Ensure ending cash balance agrees to that
reported on statement of financial position

Identify any noncash disclosures

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Statement of Cash Flows

Illustration 13-15

31

Direct Method

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Statement of Cash Flows (Continued)

Illustration 13-15

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Direct Method

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Using Cash Flows to

Evaluate a Company

Liquidity
Cash current debt coverage ratio

Solvency
Cash total debt coverage ratio
Free cash flow

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Cash Current Debt Coverage Ratio

1
Measures short-term debt paying ability
(cash basis)
Cash provided (used) by operating activities
Average current liabilities

Higher is better

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Cash Total Debt Coverage Ratio

1
Measures long-term debt paying ability
(cash basis)
Cash provided (used) by operating activities
Average total liabilities

Higher is better

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Free Cash Flow

1
Measures discretionary cash flow remaining
from operating activities available to use to
expand operations, reduce debt, go after
new opportunities, or pay additional
dividends, among other alternatives
Net cash provided (used) by operating activities
net capital expenditures dividends paid

Higher is better
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Discussion Question
1
What accrual-based ratios should the cash
coverage ratios be compared to?

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Comparing IFRS and ASPE

1

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Copyright Notice

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