ARELLANO UNIVERSITY

Jose Abad Santos Campus

Basic Education Department – Senior High School
3058 Taft Avenue Pasay City
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ACTIVITY NUMBER :4
SUBJECT : Fundamentals of Accountancy, Business and Management 2
TOPIC : Cash Flow Statement
LEARNING TARGET : The learners demonstrate an understanding of the components
and the structure of a CFS that will equip him / her in the
preparation of the said financial report.
REFERENCES : ABM Part 2 in Context Learning Module for Grade 12
TYPE OF ACTIVITY : Concept Notes

CASH FLOW STATEMENT

A Statement of Cash Flows (or Cash Flow Statement) shows the movement in the
Cash account of a company. It presents cash inflows (receipts) and outflows (payments) in the
three activities of business: operating, investing, and financing.

Accountants follow the accrual basis in measuring income and expenses. However, some
users are particularly interested in the cash transactions of the company; hence the need to
present a Statement of Cash Flows.

Parts of the Cash Flow Statement

Operating Activities – Activities that are directly related to the main revenue-producing
activities of the company such as cash from customers and cash paid to suppliers/employees

Investing Activities – Cash transactions related to purchase or sale of non-current assets

Financing Activities – Cash transactions related to changes in equity and borrowings.

Net change in cash or net cash flow (increase/decrease) – The net amount of change in cash
whether it is an increase or decrease for the current period. The total change brought by
operating, investing and financing activities.

Beginning Cash Balance – The balance of the cash account at the beginning of the accounting
period.

Ending Cash Balance – The balance of the cash account at the end of the accounting period
computed using the beginning balance plus the net change in cash for the current period

A Cash Flow Statement consists of three sections namely: Cash flow from operating
activities, Cash flow from investing activities, and Cash flow from financing activities.
 3 Sections of the Statement of Cash Flow

1. Operating Activities – refer to the main operations of the company such as rendering of
professional services, acquisition of inventories and supplies, selling of inventories for
merchandising and manufacturing concerns, collection of accounts, payment of accounts to
suppliers, and others. Generally, operating activities refer to those that involve current assets
and current liabilities.

Below are some transactions that represent operating activities:

Increases in Cash Decreases in Cash
Cash receipts from: Cash payments for:
 Sale of good or services  Purchases of inventory

 Sale of trading securities  Operating expenses

 Interest Income  Taxes

 Dividend Income  Interest expense (short-term)

 Purchase of trading securities

2. Investing activities may be summed up as: "where the company puts its money for long-term
purposes", such as acquisition of property, plant and equipment; and investment in long-term
securities. Selling these properties are also considered investing activities. In general, investing
activities include transactions that involve non-current assets.

Below are examples of investing activities:

Increases in Cash Decreases in Cash
Cash receipts from: Cash payments for:
 Sale of plant assets  Purchase of plant assets

 Sale of non-trading securities  Purchase of non-trading securities

 Sale of business segment  Making loans to other entities

 Collection of loans

3. Financing activities refer to: "where the company gets its funds", such as investment of the
owner/s, and cash proceeds from bank loan and other long-term payables. The payment of such
items (i.e. withdrawal of owner/s and payment of loans) are also financing activities. Generally,
financing activities include those that affect non-current liabilities and capital.

The financing activities are listed below:

Increases in Cash Decreases in Cash
Cash receipts from: Cash payments for:
 Owner’s investments  Owner’s drawings

 Borrowings  Payment of borrowings

 Direct Method versus Indirect Method of the Cash Flow Statement

Direct – The operating cash flow section of the CFS under the direct method would show each
major class of gross cash receipts and gross cash payments.

Indirect – The operating cash flow section of the CFS under the indirect method will reconcile
the net income/loss of the company with the total cash flows generated/used in operating
activities by adjusting the net income/loss for effects of non-cash transactions.

The two are only approaches and will yield the same amount of cash flow from operating
activities. Note that the Investing and Financing sections of the CFS are the same under the two
approaches.

3 Sections of the CFS Direct Method Indirect Method

Operating X X
Investing Same same
Financing Same same

Cash Flow from Operating Activities can be presented using:

a. Direct Method: The operating cash outflows are deducted from the operating cash inflows to
determine the net cash provided by (or used in) operating activities.
b. Indirect Method: N/I  Adjustments to reconcile net income to cash flows.

Using the Direct Method in Preparing the Operating Cash Flows

Cash inflows from operating activities:

1. Collections from customers.
2. Interest & dividends collected.
3. Other operating receipts.

Cash outflows from operating activities:

1. Payments to suppliers.
2. Payments to employees.
3. Payments of interest.
4. Other operating payments.
5. Payments of income taxes.

Using the Indirect Method in Preparing the Operating Cash Flows

Net income
+ Noncash expenses: depreciation, amortization, uncollectible account expense, etc.
+ Loss on sale of asset
+ Increases in current liabilities
+ Decreases in current assets (other than cash)
- Gain on sale of asset
- Decrease in current liabilities
- Increase in current assets (other than cash)
= Cash flow from operating activities
 DIRECT METHOD VS INDIRECT METHOD

The direct method converts each item on the income statement to a cash basis. For
instance, assume that sales are stated at 100,000 on an accrual basis. If accounts receivable
increased by 5,000, cash collections from customers would be 95,000, calculated as 100,000 –
5,000. The direct method also converts all remaining items on the income statement to a cash
basis.

The indirect method adjusts net income (rather than adjusting individual items in the
income statement) for (1) changes in current assets (other than cash) and current liabilities, and
(2) items that were included in net income but did not affect cash.

The most common example of an operating expense that does not affect cash is
depreciation expense. The journal entry to record depreciation debits an expense account and
credits an accumulated depreciation account. This transaction has no effect on cash and,
therefore, should not be included when measuring cash from operations. Because accountants
deduct depreciation in computing net income, net income understates cash from operations.
Under the indirect method, since net income is a starting point in measuring cash flows from
operating activities, depreciation expense must be added back to net income.

Losses from disposals of noncurrent assets: Assume that Quick Company sold a piece of
equipment for 6,000. The equipment had cost 10,000 and had accumulated depreciation of 3,000.
The book value of the equipment is 7,000 and we received 6,000 cash for the equipment. The
cash would be reported in the investing section since equipment is a long term asset. The
difference between our book value 7,000 and the cash received 6,000 is the loss of 1,000 which
represents receiving less than it is worth but does not equal cash. The journal entry to record the
sale is:

Debit Credit
Cash 6,000
Accumulated depreciation 3,000
Loss on sale of equipment 1,000
Equipment 10,000

Although Quick deducted the loss of 1,000 in calculating net income, it recognized the
total 6,000 effect on cash (which reflects the 1,000 loss) as resulting from an investing activity.
Thus, Quick must add the loss back to net income in converting net income to cash flows from
operating activities to avoid double-counting the loss.

The same process would apply to gains on sales of long term assets or retirement of debt
since the cash will be accounted for in later cash flow sections we want to remove the effect from
net income so any gains will be subtracted from net income.

To illustrate why we deduct the gain on the disposal of a noncurrent asset from net
income, assume that Quick sold the equipment just mentioned for 9,000. The journal entry to
record the sale is:

Debit Credit
Cash 9,000
Accumulated depreciation 3,000
Gain on sale of equipment 2,000
Equipment 10,000

Quick shows the 9,000 inflow from the sale of the equipment on its statement of cash
flows as a cash inflow from investing activities. Thus, it has already recognized the total 9,000
effect on cash (including the 2,000 gain) as resulting from an investing activity. Since the 2,000
gain is also included in calculating net income, Quick must deduct the gain in converting net
income to cash flows from operating activities to avoid double-counting the gain.
As a general rule, an increase in a current asset (other than cash) decreases cash inflow or
increases cash outflow. Thus, when accounts receivable increases, sales revenue on a cash basis
decreases (some customers who bought merchandise have not yet paid for it). When inventory
increases, cost of goods sold on a cash basis increases (increasing cash outflow). When a prepaid
expense increases, the related operating expense on a cash basis increases. (For example, a
company not only paid for insurance expense but also paid cash to increase prepaid insurance.)
The effect on cash flows is just the opposite for decreases in these other current assets.
Why do we not include cash? The purpose of our cash flow is to reconcile cash so we
will use the figure later.

An increase in a current liability increases cash inflow or decreases cash outflow. Thus,
when accounts payable increases, cost of goods sold on a cash basis decreases (instead of paying
cash, the purchase was made on credit). When an accrued liability (such as salaries payable)
increases, the related operating expense (salaries expense) on a cash basis decreases. (For
example, the company incurred more salaries than it paid.) Decreases in current liabilities have
just the opposite effect on cash flows. A short term notes payable from a bank would be treated
as a financing activity and not an operating activity.

Noncash Expenses Adjustments to Net Income

Depreciation Add

Gain / Loss on sale of assets Adjustments to Net Income

Gain on sale of assets Deduct
Loss on sale of assets Add

Change in Current assets / Current liabilities Adjustments to Net Income

Increase in current assets Deduct
Decrease in current assets Add
Increase in current liabilities Add
Decrease in current liabilities Deduct

A. DIRECT METHOD
Here is a sample cash flow statement for Santa Close Printing Services, a service type sole
proprietorship business. All amounts are assumed and simplified for illustration purposes.

Santa Close Printing Services

Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from Operating Activities

Receipts from Customers P 1,000,000
Payments to Suppliers and Employees (700,000)
Net Cash generated by Operating Activities P 300,000

Cash flows from Investing Activities

Purchases of Property and Equipment (P 150,000)
Net Cash used in Investing Activities (P 150,000)

Cash flows from Financing Activities

Long term loan from a bank P 300,000
Additional investment from owner 100,000
Withdrawals by owner (80,000)
Net cash generated by Financing Activities P 320,000
Net increase in cash and cash equivalents P 470,000
Cash, January 1, 2020 100,000
Cash, December 31, 2020 P 570,000
B. INDIRECT METHOD
Santa Close Printing Services
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from Operating Activities

Net Income P 250,000
Add: Depreciation 20,000
Loss on sale of property and equipment 10,000
Increase in Trade and Other Payables 60,000
Increase in Trade and Other Receivables - Net (40,000)
Net Cash generated by Operating Activities P 300,000

Cash flows from Investing Activities

Purchases of Property and Equipment (P 150,000)
Net Cash used in Investing Activities (P 150,000)

Cash flows from Financing Activities

Long term loan from a bank P 300,000
Additional investment from owner 100,000
Withdrawals by owner (80,000)
Net cash generated by Financing Activities P 320,000
Net increase in cash and cash equivalents P 470,000
Cash, January 1, 2020 100,000
Cash, December 31, 2020 P 570,000

EXPLANATION AND POINTERS

1. Statement of Cash Flows presents the inflows and outflows of cash in the different
activities of the business, the net increase or decrease in cash, and the resulting cash
balance at the end of the period. Cash inflows refer to receipts of cash while cash
outflows to payments or disbursements.

2. A typical cash flow statement starts with a heading which consists of three lines. The first
line presents the name of the company; the second describes the title of the report; and
the third states the period covered in the report.

3. Notice that the third line is worded "For the Year Ended..." This means that the
information included in the report covers a span of time. In the illustration above, the
report presents inflows and outflows of cash for 1 year, i.e. from January 1 to December
31, 2020.

4. Cash inflows and outflows are classified in three activities: operating, investing, and
financing.

5. All inflows are presented in positive figures while all outflows in negative (in
parentheses).

6. After inflows and outflows are presented, the net increase or decrease in cash is
computed. Then it is added to the beginning balance of cash to get the balance at the end.
In simple sense, this report presents the cash balance at the beginning of the period, the
changes during the period, and the resulting balance at the end of the period.

7. Notice that the cash balance at the end, 570,000, is the same as the cash balance
presented in the company's Balance Sheet.
 8. Good accounting form suggests that a single line is drawn every time an amount is
computed. It signifies that a mathematical operation has been completed. The computed
balance at the end of the report is double-ruled.
Formula of the Components of the Direct Method Operating Section of the SFC

Cash inflows from Operating Activities

1. Collection from credit sales / Collection from customers

AR, Beg. + Credit Sales – AR, End. = Collection from credit sales /Collection from customers
Or
Credit Sales + / – (Increase) / Decrease in AR

Excerpt from the 2 Statement of Financial Position:

December 31, 2020 December 31, 2019
Accounts Receivable 18,400 10,000

December 31, 2020 Statement of Comprehensive Income revealed the following:

Credit Sales 120,000
Cash Sales 8,100
Determine the collection from credit sales.

Collection from credit sales = AR, Beg. + Credit Sales – AR, End.
= 10,000 + 120,000 – 18,400
= 111,600

2. Interest collected

Interest Receivable, Beg. + Interest revenue – Interest Receivable, End. = Interest Collected
Or
Interest Revenue + / – (Increase) / Decrease in Interest Receivable

3. Dividend collected

Dividend Receivable, Beg. + Dividend revenue – Dividend Receivable, End. = Dividend

Collected
Or
Dividend Revenue + / – (Increase) / Decrease in Dividend Receivable

Cash outflows from Operating Activities

1. Payment to suppliers
Cost of Goods Sold + Ending Inventory – Beginning Inventory = Net Purchases
AP Beg. + Net Purchases – AP End. = Payment to Suppliers

The following are excerpts from the 2 SFPs:

December 31, 2020 December 31, 2019
Inventory 4,800 5,000
Accounts Payable 1,090 2,300

December 31, 2020 Income Statement revealed the following:

Cost of Goods Sold 37,690
Determine the amount paid to suppliers.

Net Purchases = Cost of Goods Sold + Ending Inventory – Beginning Inventory

= 37,690 + 4,800 – 5,000
= 37,490
Payment to Suppliers = AP Beg. + Net Purchases – AP End.
= 2,300 + 37,490 – 1,090
= 38,700
2. Payment to Employees

Salaries Payable Beg. + Salaries Expense – Salaries Payable End. = Payment to Employees
Or
Salaries Expense + / – (Increase) / Decrease in Salaries Payable

3. Payment of Utilities

Utilities Payable Beg. + Utilities Expense – Utilities Payable End. = Payment to Utilities
Or
Utilities Expense + / – (Increase) / Decrease in Utilities Payable

STATEMENT OF CASH FLOWS EXERCISES

ACTIVITY NUMBER 1
Categorize each cash flows as (O) for operating, (I) for investing, or (F) for financing.

_____1. Cash received from sale of a building.

_____2. Cash paid for salaries.
_____3. Cash received for interest on a note receivable.
_____4. Cash paid to acquire a new truck.
_____5. Cash loaned out to a customer in the form of a long-term note.
_____6. Cash received for services rendered.
_____7. Cash paid for interest.
_____8. Cash paid for insurance on equipment.
_____9. Cash received from a debtor representing payments of principal.
_____10. Cash paid out to acquire a building.

ACTIVITY NUMBER 2
Pansit’s sari-sari store had the following transactions during the year:

a. Purchase of goods. Paid cash. 100,000

b. Sale of goods. Received cash. 150,000
c. Paid utilities 30,000
d. Paid rent 10,000
e. Sold equipment for cash 100,000
f. Owner withdraws investment 10,000

Using the given above, prepare a Cash Flow Statement.

1. Compute for the net cash flow generated by/used in operating activities. ______________
2. Compute for the net cash flow generated by/used in investing activities. ______________
3. Compute for the net cash flow generated by/used in financing activities. ______________
4. Based on the given above, compute for the net change in cash for the year. ______________
5. Cash ending balance ______________