Unit V - Statement of Cash Flows
The basic financial statements we have presented so far provide only limited information about the company’s company’s asset “Cash”. For example, example, balance sheet shows how much cash the business business owns on the date the report was prepared but it does not indicate the amount of cash generated by operat operating ing activit activities ies,, or financ financing ing activi activitie ties. s. The income income statem statement ent may show show expense expensess and revenues that may have an effect to cash but will not provide reader of this report how these income and and expenses affected affected “Cash” “Cash” account. account. The capital capital statement statement shows shows what happened happened to the capital balance of the owner during the year. one of these statements presents a detailed summary of where cash came from and a nd how it was used.
Statement of Cash Flows Defined
The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities during a period.
Usefulness of the Statement of Cash Flows
The information in a statement of cash flows should help investors, creditors, and others assess! ". The entity’s ability to generate future cash flows. #y examinin examining g relations relations between between items in the statement of cash flows, investors and others can ma$e predictions of the amounts, timing, and uncertainty of future cash flows better than they can from accrual basis data.
%. The entity’s ability to pay diidends and meet obligations. &f a company company does not have ade'uate cash, it cannot pay employees, settle debts, or pay dividends. (mployees, creditors, and stoc$holders should be particularly interested in statement, because it alone shows the flows of cash in a business.
). The reasons for the difference between net income and net cash proided !used" by operating actiities. et income provides provides informa information tion on the success success or failure failure of a business enterprise. ente rprise. *owever, some are critical of accrual basis net income because it re'uires many estimates. +s a result, result, the reliability of number is often often challenged. uch is not the cash with cash. -any readers readers of statement statement of cash flows want to $now the reason reasonss for the differ differenc encee betwee between n net income income and net cash provid provided ed by operati operating ng
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Cash #eceipts 000000000000000000000000000000000000000000000000000000 Collections from customers for sales of goods and services &nterest and dividends received Then they can activities. 2ther receipts from operations3 for example, proceeds from settlement of litigation litigation
Cash $ayments 00000000000000000000000000000000000000000000000000 1ayment to suppliers of merchandise and services, including payments to 1ayments interest assess forofthemselves the reliability of the income number. 1ayments of income taxes 2ther expenditures relating to operations3 for example, payments in settlement of
4. The cash inesting and financing transactions during the period. #y examining a company’s investing and financing transactions, a financial statement reader can better understand why assets and liabilities changed during the period.
Classification of Cash Flows
The cash flows shown in the statement are grouped into three ma5or categories! 6"7 operating actiities . 6%" inesting actiities , and 6)7 financing actiities . 8e will now loo$ briefly at the way cash flows are classified among these three categories.
%perating &ctiities. The operating activities section shows the cash effects of revenue and expense transactions. tated another way, the operating activities section of the statement of cash flows includes the cash effects of those transactions reported in the income statement. To illustrate this concept, consider the effects of credit sales. Credit sales are reported in the income statement in the period when the sales occur. #ut the cash effects occur later 9 when the receivables are collected in cash. &f these events occur in different accounting periods, the income statement and the operating activities section of the statement of cash flows will differ. imilar differences may exist between the recognition of an expense and the related cash payment. Consider, for example, the expense of postretirement benefits earned by employees during the current period. &f this expense is not funded with a trustee, the cash payments may not occur for many years 9 after today’s employees have retired.
Cash flows from operating activities include!
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Cash #eceipts Cash $ayments Cash #eceipts Cash $ayments 00000000000000000000000000000000000000000000000000000 0000000000000000000000000000000000000000000000000000000 00000000000000000000000000000000000000000000000000 00000000000000000000000000000000000000000000000000 Cash proceeds from selling investments and 1ayments to ac'uire investments and6excluding plant 1roceeds from both short0term and long0term :epayment of amounts borrowed plant assets assets borrowing interest payments7 Cash proceeds from collecting principal +mounts advanced to borrowers Cash received from owners 6for example, 1ayments to owners, such as cash withdrawals +mounts on loans otice that receipts and payments of interest are classified as operating activities, not as From investment7
investing or financing activities because these are shown in the income statement.
'nesting &ctiities . Cash flows relating to investing activities present the cash effects of transactions involving plant assets, intangible assets, and investments. They include!
Financing &ctiities . Cash flows classified as financing activities include the following items that result from debt and e'uity financing transactions!
:epayment of amounts borrowed refers to repayment of loans, not to payments made on accounts payable or accrued liabilities. 1ayments of accounts payable and of accrued liabilities are considered payments to suppliers of merchandise and services and are classified as cash outflows from operating activities. +lso, remember that all interest payments are classified as operating activities.
The following illustration lists typical cash receipts and cash payments within each of the three classifications. tudy the list carefully. &t will prove very useful in solving homewor$
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ote the following general guidelines! 6"7 2perating activities involve income statement items. 6%7 &nvesting activities involve cash flows resulting from changes in investment and long0 term asset items. 6)7 Financing activities involve cash flows resulting from changes in long0term liability and owner’s e'uity items.
ome cash flows related to investing or financing activities are classified as operating activities. For example, receipts of investment revenue 6interest and dividends7 are classified as operating activities. o are payments of interest to lenders. 8hy are these considered operating activitiesA (ecause these items are reported in the income statement) where results of operations are shown.
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