A Statement of Cash Flows (or Cash Flow Statement) shows the movement in the Cashaccount 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.
This lesson takes a look at the Statement of Cash Flows and provides some important points in
understanding it.
Statement of Cash Flows Example
Here is a sample cash flow statement for Strauss Printing Services, a service type sole
proprietorshipbusiness.
All amounts are assumed and simplified for illustration purposes.
Strauss Printing Services
Statement of Cash Flows
For the Year Ended December 31, 2016
       
Cash Flow from Operating Activities:    
  Cash received from customers $  146,000 
  Cash paid for expenses (81,000) 
  Cash paid to suppliers (47,500) $   17,500
Cash Flow from Investing Activities:    
  Cash paid to acquire additional equipment   (20,300)
Cash Flow from Financing Activities:    
  Cash received from investment of owner $   10,000 
  Cash received from bank loan 50,000 
  Cash paid for bank loan – partial payment (27,000) 
  Cash paid to owner – withdrawal (20,000) 13,000
Net Increase (Decrease) in Cash for the
  $   10,200
Year
Add: Cash – January 1, 2016 10,800
Cash – December 31, 2016 $   21,000
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, 2016.
4. Cash inflows and outflows are classified in three activities: operating, investing, and financing.
5. 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.
6. 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.
7. 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.
8. All inflows are presented in positive figures while all outflows in negative (in parentheses).
9. 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. Easy, right? 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.
10. Notice that the cash balance at the end, $ 21,000, is the same as the cash balance presented in
the company's Balance Sheet.
11. 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.

Cash Flow from Operating Activities: Direct Method

The direct method to calculate cash flow from operating activities involves determination of various
types of cash receipts and payments such as cash receipts from customers, cash paid to suppliers,
cash paid for salaries, etc. and then putting them together under the cash flow from operating section
of cash flow statement. These figures are calculated using the beginning and ending balances of
various accounts of the business and the net increase or decrease in the account. The exact formulas
to calculate various cash inflows and outflows vary. The most importan ones are given below:

Formulas

Cash Receipts from Customers =

+ Net Sales

+ Beginning Accounts Receivable

 − Ending Accounts Receivable

Cash Payments to Suppliers =

+ Purchases

+ Ending Inventory

− Beginning Inventory

+ Beginning Accounts Payable

− Ending Accounts Payable

Cash Payments to Employees =

+ Beginning Salaries Payable

− Ending Salaries Payable

+ Salaries Expense

Cash Payments for Purchase of Prepaid Assets =

+ Ending Prepaid Rent, Prepaid Insurance etc.

+ Expired Rent, Expired Insurance etc.

− Beginning Prepaid Rent, Prepaid Insurance etc.

Interest Payments =

+ Beginning Interest Payable

− Ending Interest Payable

+ Interest Expense

Income Tax Payments =

+ Beginning Income Tax Payable

− Ending Income Tax Payable

+ Income Tax Expense

In the formulas given above it is assumed that accounts receivable are only used for credit sales. It is
also assumed that all sales are on credit. If there are cash sales as well, then receipts from cash sales
must be included in the cash receipts from customers to obtain a correct figure of cash flow from
operating activities.

Similarly, it is assumed that accounts payable are used merely for purchases on account and that all
purchases are on credit. If there are cash purchases as well, then cash payments for them must be
included in the cash paid to suppliers. It is important to note that here may be receipts & payments
other than those discussed above.

Once the all the cash inflows and outflows from operating activities are calculated, they are added in
the operating section of cashflows to obtain the net cashflow from operating activities.

The following example shows the format and calculation of cash flows from operating activities using
direct method.

Example
Prepare the cash flows from operating activities section of cash flow statement by direct method using
the following information:

December 31 2011 2010

Accounts Receivable $34,130 $28,410

Prepaid Rent 20,000 25,000

Prepaid Insurance 6,800 6,000

Inventory 23,030 15,450

Accounts Payable 14,590 31,300

Salaries Payable 8,310 5,120

Interest Payable 700 360

Income Tax Payable 2,340 0

     

Year Ended December 2011

31

Net Sales 64,970

Salaries Expense 8,610

Rent Expense 5,000

Insurance Expense 3,200

Interest Expense 1,650

Solution:
Cash Flow from Operating Activities:

Cash Receipts

From Customers (1) $59,250

Cash Payments

To Suppliers (2) −24,290

To Employees (3) −5,420

For Purchase of Prepaid Assets (4) −4,000

Interest (5) −1,310

Income Tax (6) −0

Net Cash Flow from Operating Activities 24,230

Working Notes

1) 64,970 + 28,410 - 34,130

2) 23,030 - 15,450 + 31,300 - 14,590

3) 5,120 - 8,310 + 8,610

4) 20,000 + 6,800 + 5,000 + 3,200 - 25,000 - 6,000

5) 360 - 700 + 1,650

6) 0 - 2,340 + 2,340
The Direct Method

For items that normally appear on the income statement, cash flows from operating activities
display the net amount of cash that was received or disbursed during a given period of time. The
direct method for calculating this flow involves deducting from cash sales only those operating
expenses that consumed cash. In this method, each item on an income statement is converted
directly to a cash basis, and each cash effect is directly reported. To employ this direct method,
use the following equation:

 add net sales

 add ending accounts receivable
 subtract beginning accounts receivable
 add ending assets (prepaid rent, inventory, et al)
 subtract beginning assets (prepaid rent, inventory, et al)
 subtract ending payables (tax, interest, salaries, accounts payable, et al. )
 add ending payables (tax, interest, salaries, accounts payable, et al. )

Once the cash inflows and outflows from operating activities are calculated, they are added
together in the “Operating Activities” section of the cash flow statement to obtain the net cash
flow for a company’s operating activities.

Indirect Method

In the indirect (addback) method for calculating cash flows, the accrual basis net income is
established first. This net income is then indirectly adjusted for items that affected the reported
net income but did not involve cash. The indirect method adjusts net income (rather than
adjusting individual items in the income statement) for the following phenomena: changes in
current assets (other than cash), changes in current liabilities, and items that were included in net
income but did not affect cash.

Preparation of the Statement of Cash Flows: Indirect Method

The indirect method starts with net-income while adjusting for non-cash transactions and from
all cash-based transactions.

LEARNING OBJECTIVES

Explain how to use the indirect method to calculate cash flow

 KEY TAKEAWAYS

Key Points

 The indirect method adjusts net income (rather than adjusting individual items in the income
statement).
 The most common example of an operating expense that does not affect cash is depreciation
expense.
 Depreciation expense must be added back to net income.
Key Terms

 indirect method: a way to construct the cash flow statement using net-income as a starting point,
and makeing adjustments for all transactions for non-cash items, then adjusting from all cash-
based transactions
 accrual: A charge incurred in one accounting period that has not been paid by the end of it.
 income statement: A calculation which shows the profit or loss of an accounting unit (company,
municipality, foundation, etc.) during a specific period of time, providing a summary of how
the profit or loss is calculated from gross revenue and expenses.

Calculating Cash Flows

There are two different methods that can be used to report the cash flows of operating activities.
There is the direct method and the indirect method.

Calculating cash flow: The indirect method adjusts net income (rather than adjusting individual items in the income statement).
Indirect Method

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 indirect method uses net income as a starting point, makes adjustments for all transactions
for non-cash items, then adjusts for all cash-based transactions. An increase in an asset account is
subtracted from net income, and an increase in a liability account is added back to net income.
This method converts accrual-basis net income (or loss) into cash flow by using a series of
additions and deductions. The following rules can be followed to calculate cash flows from
operating activities:

 Decrease in non-cash current assets are added to net income;

 Increase in non-cash current asset are subtracted from net income;
 Increase in current liabilities are added to net income;
 Decrease in current liabilities are subtracted from net income;
 Expenses with no cash outflows are added back to net income (depreciation and/or amortization
expense are the only operating items that have no effect on cash flows in the period);
 Revenues with no cash inflows are subtracted from net income;
 Non operating losses are added back to net income;
 Non operating gains are subtracted from net income.

Under the indirect method, since net income is a starting point in measuring cash flows from
operating activities, depreciation expenses must be added back to net income. So, depreciation
expense is shown (or captioned) on the statement of cash flows. Also, in the indirect method cash
paid for taxes and cash paid for interest must be disclosed.

Direct Method Versus Indirect Method

Consider a firm reporting revenues of $125,000. During the reporting period, the firm’s accounts
receivables increased by $36,000. Therefore, cash collected from these revenues was $89,000.
Operating expenses reported during the period were $85,000, but accounts payable increased
during the period by $5,000. Therefore, cash operating expenses were only $80,000. The net
cash flow from operating activities, before taxes, would be:

Cash flow from revenue: 89,000

Cash flow from expenses: (80,000)

Net cash flow: 9,000

The indirect method would find these cash flows as follows.

Revenue: 125,000

Expenses: (85,000)

Net Income: 40,000

The adjustments for cash flow would then be made to this amount of net income. $36,000 would
be subtracted due to the increase in accounts receivable, and $5,000 would be added due to the
increase in accounts payable. This leaves us with the amount of $9,000 for net income.