STATEMENT OF CASH FLOW

Statement of cash flow

 also referred as Cash Flow Statements
 act as a bridge between the income statement and balance sheet by showing how money or
the cash and cash equivalents moved in and out of the business.  
 Is a component of financial statements summarizing the operating, investing and financing
activities of an entity.1
Cash Flow Statement is Utilized;

a) allows investors to understand how a company's operations are running, where its money is
coming from, and how money is being spent
b) Creditors, on the other hand, can use the CFS to determine how much cash is available (referred
to as liquidity) for the company to fund its operating expenses and pay its debts. 2

Purpose of Statement of cash flows

1. The primary purpose of the statement of cash flows is to provide relevant information about cash
receipts and cash payments of an entity during a period. 3
2. Cash flow information is useful in assessing the ability of the entity to generate cash and cash
equivalents.
3. The statement of cash flows also enhances the comparability of operating performance by
different entities.
4. Users of an entity’s financial statements are interested in how the entity generates and uses cash
and cash equivalents.
5. Entities need cash to conduct their operations, to pay their obligations and to provide returns to
their investors.4

Cash and Cash Equivalents

The statement of cash flows is designed to provide information about the change in an entity’s
cash and cash equivalents.

Cash comprises cash on hand and demand deposits.

Cash equivalents are short term highly liquid investments that are readily convertible to known amount of
cash and which are subject to insignificant risk of change in value.

PAS 7, paragraph 7, provides that an investment normally qualifies as a cash and cash equivalent only
when it has a short maturity of three months or less from the date of acquisition. In other words, the
investment must be acquired three months of less before the date of maturity.

Examples of Cash Equivalents

a. Three-month BSP treasury bill

b. Three-year BSP Treasury bill purchases three months before date of maturity
c. Three-month time deposit

1
CFI.What is the Statement of Cash Flows?. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/accounting/statement-of-cash-flows/.
2
Murphy, C(May 2019). Investopedia. What is a Cash Flow Statement?. Retrieved from https://www.investopedia.com/investing/what-is-a-cash-flow-statement/
3
Statement of Cash Flows. Retrieved from http://web.csulb.edu/~mdchase/CashFlows500.pdf.
4
Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.
 d. Three-month money market instrument or commercial paper.

CLASSIFICATION OF CASH FLOWS

Cash flows are inflows and outflows of cash and cash equivalents.

The statement of cash flow shall report cash flows during the period classified as operating, investing
and financing activities.

Classification by activity provides information that allows users to assess the impact of those activities on
financial position of the entity and the amount of its cash and cash equivalent. 5

The cash flow statement is partitioned into three segments, namely:

1. Cash flow resulting from operating activities

2. Cash flow resulting from investing activities
3. Cash flow resulting from financing activities
4. A fourth category, disclosure of noncash activities, is sometimes included when prepared under
the generally accepted accounting principles, or GAAP.

Components and Presentation of Statement of Cash Flows

PRESENTATION OF STATEMENT OF CASH FLOWS

CASH FLOWS FROM (Used in) OPERATING

ACTIVITIES
Cash receipts from customers XX
Less: Cash paid to suppliers and employees (XX)
Cash generated from operation XX
Less: Interest paid (XX)
Less: Income taxes paid (XX)
Net cash flows from operating activities XX

5
Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.
 CASH FLOWS FROM (Used in) INVESTING
ACTIVITIES
Proceeds from the sale of equipment XX
Dividends received XX
Net cash flows from investing activities XX
CASH FLOWS FROM (Used in) FINANCING
ACTIVITIES
Dividends paid (XX)
Net cash flows in financing activities (XX)

Net increase in cash and cash equivalents XX

Cash and cash equivalents, beginning of year XX
Cash and cash equivalents, end of year XX

Direct and Indirect Method of Preparation

Cash flow is calculated by making certain adjustments to net income by adding or subtracting
differences in revenue, expenses and credit transactions (appearing on the balance sheet and income
statement) resulting from transactions that occur from one period to the next. These adjustments are made
because non-cash items are calculated into net income (income statement) and total assets and liabilities
(balance sheet). So, because not all transactions involve actual cash items, many items have to be re-
evaluated when calculating cash flow from operations.

As a result, there are two methods of calculating cash flow: The direct method and the indirect method. 

 Direct Method
 Shows in detail or itemizes the major classes of gross cash receipts and gross cash payments.
 The cash receipts are listed one by one, the cash payments are listed one by one, and the
difference represents the net cash flow from the operating activities.
 It is “cash basis” income statement.

Formulas may be necessary for determining for determining cash receipts and cash payments:
Computation of collections
Trade accounts and notes receivable-beginning XX
Add: Sales(accrual basis) XX
Total XX
Less: Trade accounts and notes receivable-end XX
Collections of accounts and notes receivable XX

Computation of payments to merchandise creditors

Trade accounts and notes payable - beginning XX
Add: Purchases (accrual basis) XX
Total XX
Less: Trade accounts and notes payable - end XX
Payment to merchandise creditors XX

Computation of payments for expenses

Expenses (accrual) XX
Add: Prepaid expense - end XX
Accrued expense - beginning XX
 Total XX
Less: Prepaid expense - beginning XX
Accrued expense - end XX XX
Expenses paid XX

ILLUSTRATION-OPERATING ACTIVITIES

Luhan Company reported the following comparative statement of financial position and income statement
for 20x6.

ASSET
S 20x6 20x5

Cash 3,000,000 2,000,000

Accounts Receivable 940,000 350,000
Inventory 175,000 100,000
Prepaid Insurance 15,000 20,000
Property, Plant, and Equipment 2,000,000 2,000,000
Accumulated Depreciation (550000) (500000)
Patent 40,000 50,000
Total Assets 5,620,000 4,020,000

LIABLITIES AND EQUITY

Accounts payable 170,000 150,000

Accrued Salaries Payable 25,000 10,000
Accrued Interest Payable 10,000 15,000
Income Tax Payable 350,000 250,000
Unearned Rent Income 10,000 40,000
Mortgage Payable 5,000,000 500,000
Share Capital 2,000,000 2,000,000
Retained Earnings 2,555,000 1,055,000

Total Liabilities and Equity 5,620,000 4,020,000

 Income Statement
Year Ended December 31,
20x6

Sales 6,500,000
Cost of goods sold

Inventory-January 1 100,000

Purchases 3,200,000

Goods Available for sale 3,300,000

Inventory-December 31 (175000) 3,125,000

Gross Income 3,375,000

Rent Income 80,000

Total Income 3,455,000

Expenses:
Salaries
 950,000

Insurance 40,000

Other Expenses 500,000

Depreciation 50,000

Amortization of patent 10,000

Interest Expense 55,000 1,605,000

Income before tax 1,850,000

Income tax 350,000

Net Income 1,500,000

COMPUTATIONS UNDER DIRECT METHOD

Accounts Receivable – 20x5 350,000 Insurance 40,000

Sales 6,500,000 Prepaid Insurance-20x6 15,000
Total 6,850,000 Total 55,000
Accounts Receivable-20x6 (940,000) Prepaid Insurance-20x5 (20,000)
Payment for
Collections from customers 5,910,000 Insurance 35,000

Rent Income 80,000 Other Expenses 500,000

Unearned Rent Income-20x6 10,000
Total 90,000 Interest Expense 55,000
Unearned Rent Income-20x5 (40,000) Accrued Interest payable-20x5 15,000
Rent Received 50,000 Total 70,000
Accrued Interest payable-20x6 (10,000)
Accounts Payable-20x5 150,000 Interest Paid 60,000
Purchases 3,200,00
Total 3,350,000 Income Tax 350,000
Accounts Payable-20x6 (170,000) Income Tax Payable-20x5 250,000
Payments to merchandise creditors 3,180,000 Total 600,000
Income Tax Payable-20x6 (350,000)
Salaries 950,000 Payment for Income Tax 250,000
Accrued Salaries Payable-20x5 10,000
Total 960,000
Accrued Salaries Payable-20x6 (25,000)
Salaries Paid 935,000
DIRECT METHOD-OPERATING ACTIVITIES

Cash Received from the customers 5,910,000

Rent Received 50,000
Cash payments to merchandise creditors (3,180,000)
Salaries paid (935,000)
Insurance Paid (35,000)
Other Expenses (500,000)
Cash generated from the operations 1,310,000
Interest paid (60,000)
Income tax paid (250,000)
Net cash provided
operating activities 1,000,000

Indirect Method

 cash flows from operating activities are reported by adjusting net income for revenues, expenses,
gains, and losses that appear on the income statement but do not have an effect on cash.
 It means that the net income/loss is adjusted for the effects of transactions of anon-cash nature,
any deferrals or accruals of past or future operating cash receipts and payments, and items of
income or expense associated with investing and financing activities.

The following general guidelines are offered for the adjustments of net income to cash basis:
1. All increases in trade noncash current assets are deducted from net income.
2. All decreases in trade noncash current assets are added to net income.
3. All increases in trade current liabilities are added to net income.
4. All decreases in trade current liabilities are deducted from net income.
5. Depreciation, amortization and other noncash expenses are added back to net income to
eliminate the effect they had on net income.
6. Any gain on disposal of property or gain on early retirement of nontrade liabilities is included
in net income but it is a nonoperating item.Thus, this is deducted from net income.
7. Any loss on disposal of property of property or loss on early retirement of nontrade liabilities
is deducted from net income but this is a nonoperating item.
Thus, this is added back no net income.

ILLUSTRATION OF INDIRECT METHOD. Changes in the current assets and current liabilities are
summarized as follows:6

Increase
20x6 20x5
(Decrease)

Accounts Receivable 940,000 350,000 590,000

Inventory 175,000 100,000 75,000
Prepaid Insurance 15,000 20,000 (5000)
Accounts Payable 170,000 150,000 20,000
Accrued Salaries Payable 25,000 10,000 15,000
Accrued Interest Payable 10,000 15,000 (5000)
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Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.
 Income Tax Payable 350,000 250,000 10,000
Unearned Rent Income 10,000 40,000 (30000)

Operating Activities

 Include any sources and uses of cash from business activities.

 also includes the production, sales, and delivery of the company’s product as well as collecting
payments from its customers.
 This could include purchasing raw materials, building inventory, advertising, and shipping the
product.

These operating activities might include:

 Cash receipts from sales of goods and rendering services

 Cash receipts from royalties, rental, fees, commissions and other revenue
 Cash payments to suppliers for goods and services
 Cash payments for selling, administrative and other expenses
 Cash receipts and payments of an insurance enterprise for premiums and claims, annuities and
other policy benefits
 Cash receipts and payments for securities held for dealing or trading purposes

FINANCING ACTIVITIES

 are the cash flows derived from the equity capital and borrowings of the entity. In other words,
financing activities are the cash flows that result from transactions;
a) Between the entity and owner – equity financing
b) Between the entity and creditors – Debt financing7
 Financing cash flows typically include cash flows associated with borrowing and repaying bank
loans, and issuing and buying back shares. The payment of a dividend is also treated as a
financing cash flow.
 Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when
dividends are paid. Thus, if a company issues a bond to the public, the company receives
cash financing; however, when interest is paid to bondholders, the company is reducing its cash.8

INVESTING ACTIVITIES

 include any sources and uses of cash from a company's investments. A purchase or sale of an
asset, loans made to vendors or received from customers or any payments related to a merger or
acquisition are included in this category. In short, changes in equipment, assets, or investments
relate to cash from investing.

 Usually, cash changes from investing are a "cash out" item, because cash is used to buy new
equipment, buildings, or short-term assets such as marketable securities. However, when a
company divests an asset, the transaction is considered "cash in" for calculating cash from
investing.

 Cash Flow from Investing Activities includes the acquisition and disposal of non-current assets
and other investments not included in cash equivalents. Investing cash flows typically include the

7
Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.
8
CFI.What is the Statement of Cash Flows?. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/accounting/statement-of-cash-flows/.
 cash flows associated with buying or selling property, plant, and equipment (PP&E), other non-
current assets, and other financial assets.

Cash spent on purchasing PP&E is called capital expenditures (or CapEx for short).9

ABC Company had the following cash flows during the current year:
Cash receipts from issuance of ordinary shares P 4,000,000
Cash receipts from customers 2,000,000
Cash receipts from repayment of loan made to another entity 2,200,000
Cash payments for wages and other operating expenses 1,200,000
Cash payments for insurance 100,000
Cash payments for dividends 200,000
Cash payments for taxes 400,000
Cash payment to purchase land 800,000
Cash balance – beginning 3,500,000

Operating Activities:
Cash receipts from customers P 2,000,000
Cash payments for insurance (100,000)
Cash payments for wages and other operating expenses (1,200,000)
Cash payments for taxes (400,000)
Net cash provided by operating activities P 300,000
Investing Activities:
Cash receipts from repayment of loan made to another entity P 2,200,000
Cash payment to purchase land (800,000)
Net cash provided by investing activities P 1,400,000
Financing Activities:
Cash receipts from issuance of ordinary shares P 4,000,000
Cash payments for dividends (200,000)
Net cash provided by financing activities P 3,800,000

Cash balance at year-end:

Cash balance beginning P 3,500,000
Net cash provided by operating activities 300,000
Net cash provided by investing activities 1,400,000
Net cash provided by financing activities 3,800,000
Cash balance – end P 9,000,000

NON-CASH TRANSACTIONS

Pas 7, paragraph 43, provide that investing and financing transactions that do not require use of cash and
cash equivalents shall be excluded from the statement of cash flows.10

9
CFI.What is the Statement of Cash Flows?. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/accounting/statement-of-cash-flows/.
10
Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.