CASH FLOW

CASH FLOW is the difference in amount of cash available at the

beginning of a period (opening balance) and the amount at the end of
that period (closing balance). It is called positive if the closing balance is
higher than the opening balance, otherwise called negative.
Purpose of Cash Flow Statement Analysis
The purpose of the cash flow statement is to show where an entities cash
is being generated (cash inflows), and where its cash is being spent (cash
outflows), over a specific period of time (usually quarterly and annually).
It is important for analyzing the liquidity and long term solvency of a
company.

The cash flow statement uses cash basis accounting instead of accrual
basis accounting which is used for the balance sheet and income
statement by most companies. This is important because a company may
accrue accounting revenues but may not actually receive the cash. This
could produce profits and taxes payable but not provide the resources to
stay solvent.
Cash Flow Basics

Cash flow is a continual cycle of the actual cash coming into

and going out of a business during a specific reporting period.
The starting point is cash a small business has on hand at the
beginning of the month. It continues with cash inflows
generated mainly from sales revenues, but can also include
cash inflows originating from financing, interest income or the
sale of long-term business assets. Next are cash outflows
used to pay operating expenses and short-term debt
obligations. The cycle for a reporting period ends by creating
a cash flow statement, a process of adding starting cash to
cash inflows to calculate total cash, then subtracting cash
outflows to get a starting point for the next reporting period.
Cash Flow Statement Function

Without a positive cash flow, a small business can’t meet

its monthly financial obligations. The cash flow statement
helps a small-business owner identify the sources of cash
inflows within a specific reporting period as well as identify
the expenses in which cash was utilized. As a cash
management tool, a cash flow statement is essential in
annual cash planning and for helping maintain a balance
between cash inflows and cash outflows. A small business
owner can determine, for example, whether the business is
generating enough cash from its regular operations or
needs to look to other sources such as a short-term loan
during a seasonal sales decline.
 Cash Flow Statement Components
Cash Flow from Operating Activities
The net amount of cash coming in or leaving from the day to
day business operations of an entity is called Cash Flow From
Operations. Basically it is the operating income plus non-cash
items such as depreciation added. Since accounting profits are
reduced by non-cash items (i.e. depreciation and amortization)
they must be added back to accounting profits to calculate cash
flow.
Cash flow from operations is an important measurement
because it tells the analyst about the viability of an entities
current business plan and operations. In the long run, cash flow
from operations must be cash inflows in order for an entity to be
solvent and provide for the normal outflows from investing and
finance activities.
Examples of cash inflow from operating activities:

• Cash receipts from customers.

• Interest income received in cash.
• Dividend income received in cash.
• Cash received as a result of the settlement of litigation.

Examples of cash outflow from operating activities:

• Cash payment to suppliers for purchase of merchandise or

raw materials.
• Cash payment for expenses such interest, electricity bills,
salaries, wages etc.
• Cash payment for income tax.
• Cash paid as a result of the settlement of litigation.
Cash Flow From Investing Activities

Cash flow from investing activities would include the outflow of

cash for long term assets such as land, buildings, equipment,
etc., and the inflows from the sale of assets, businesses,
securities, etc. Most cash flow investing activities are cash out
flows because most entities make long term investments for
operations and future growth.

Investing activities include acquisition and disposal of long

term assets and investments in the form of shares and bonds
etc. The cash flows arising from such activities are shown
under investing activities section.
Examples of cash inflow from investing activities:

• Proceeds from sale of fixed assets (sale of equipment, machinery and plan
etc.)
• Proceeds from sale of land
• Proceeds from sale of investment (shares and bonds of other companie
etc.)
• Proceeds from sale of intangible assets
• Repayment of the principle amount of loans and advances made to others.
• Cash receipts from future contracts

Examples of cash outflow from investing activities:

• Cash paid to purchase fixed assets (purchase of equipment, machinery and

plant etc.)
• Cash paid to purchase land
• Loans and advances made to others
• Cash paid to purchase investments (shares and bonds of other companie
Cash Flow From Finance Activities

Cash flow from finance activities is the cash out flow to the
entities investors (i.e. interest to bondholders) and shareholders
(i.e. dividends and stock buybacks) and cash inflows from sales
of bonds or issuance of stock equity. Most cash flow finance
activities are cash outflows since most entities only issue bonds
and stocks occasionally.

Cash flow resulting from financing activities of the company are

shown under financing activities section of the statement of cash
flows. Financing activities include those activities that change the
size and composition of the equity ( i.e., common or preference
stock) and the long term liabilities (i.e., borrowings) of the
company.
Examples of cash inflow from financing activities:

• Cash received from borrowings (both short and long

term).
• Cash received from issuing of common or preferred
stock.

Examples of cash outflow from financing activities:

• Payment of borrowings to others (principle amount

only).
• Payment of cash dividends to the stockholders.
 Cash Flow Statement Format

Operating Activities:
Net Income

+ Depreciation and Amortization

+/- One Time Adjustments (i.e. investment gains or

losses not related to operations, deferred taxes, stock
compensation)

+/- Changes in Working Capital

= Cash Flow From Operations

Investing Activities:
+/- Net Capital Expenditures

+/- Net Investments

= Cash Flow from Investing

Financing Activities
Activities
– dividends

+/- sale or purchase of

company stock

+/- net borrowings

= Cash Flow from Financing

Activities
Summary of Cash Flow Activities:
+/- Cash Flow From Operating Activities

+/- Cash Flow From Investing Activities

+/- Cash Flow From Financing Activities

= Net Change in Cash

+ Beginning Cash Balance

= Ending Cash Balance

Note: You should be able to reconcile the Net Change in Cash

with the cash balances reported on the Balance Sheet.
 Investment Analysis Summary

The cash inflows and cash outflows in the cash

flow statement are segmented into cash flow from
operations, investing, and financing. These details
provide insight in the liquidity and solvency, as
well the entities ability to meet future needs for
capital and growth.

http://www.arborinvestmentplanner.com/cash-flow-statement-analysis-purpose-
components-and-format/
Format:
Under direct method, the operating cash receipts and disbursements
described above are arranged in a certain way. A comprehensive format
of operating activities section under direct method is illustrated below:

Operating-activities-section-by-direct-method-
To calculate cash receipts and payments in the above format we use
relevant data from income statement, comparative balance sheet and
some additional information. Following is the explanation of how each
item can be worked out.
Cash received from customers:

If all the sales are made for cash then the amount of sales
revenue and cash received from customers will be equal. In
today’s business world, however, we can rarely find a company
that sells all the goods for cash. Most of the companies make
sales on cash as well as on account. Therefore, the amount of
sales revenues generated during a certain period is usually
different from the amount of cash received from customers
during that period. A company that sells goods on account can
calculate the cash received from customers during the period
by using three figures. These are net sales, beginning balance
of accounts receivable, and ending balance of accounts
receivable. The procedure is given :
If accounts receivable increase during the period:

If accounts receivable at the end of the year are more than

at the beginning of the year (an increase in accounts
receivable), it means the company’s credit sales are more
than its collections from customers. The increase in
accounts receivable is, therefore, deducted from the net
sales figure to calculate cash received from customers.

Cash received from customers = Net sales – Increase in

accounts receivable

The net sales figure is available from the income statement

and increase or decrease in account
If accounts receivable decrease during the period:
If accounts receivable at the end of the year are less than at the
beginning of the year (a decrease in accounts receivable), it means
the company’s collections from customers are more than credit sales.
The decrease in accounts receivable is, therefore, added to the net
sales figure to calculate cash received from customers.

Cash received from customers = Net sales + Decrease in accounts

receivable.

The above concept can be summarized as below:

ACTIVITY 1

ABC company sells goods on account. The income

statement for the year 2013 shows a net sales of
$177,000. The accounts receivable at the beginning and at
the end of the year 2013 were $25,000 and $35,000
respectively. Calculate total cash that ABC company
collected from its customers during the year 2013.
Solution:
Interest and dividend received:

Interest and dividend income is reported in the income statement on

accrual basis but we need to covert it to cash basis for the purpose of
statement of cash flows. The above concept developed for converting
accrual basis sales revenue to the cash basis sales revenue can also be
used to convert interest and dividend income from accrual basis to cash
basis. The accrual based interest or dividend revenues figure is taken
from the income statement and decreased by any increase in interest or
dividend receivable during the year and increased by any decrease in
interest or dividend receivable during the year.

For the purpose of statement of cash flows, the amounts of interest and
dividend received are added together.
ACTIVITY 2

The income statement of ABC company for the year 2013

shows an interest revenue of $5,000 and a dividend revenue of
$3,200. The interest receivable at the beginning and at the
end of the year 2013 was $1,000 and $1,200 respectively. The
dividend income was received in cash and there was no
dividend receivable at the beginning and at the end of the
year. Calculate the total amount of cash that ABC company
received during the year 2013 from interest and dividend.
Solution: