CHAPTER

16 Statement of Cash Flows

Accounting
27e

human/iStock/360/Getty Images
Warren
Reeve
Duchac
Learning Objectives

• LO1: Describe the cash flow activities

reported in the statement of cash flows.
• LO2: Prepare a statement of cash flows,
using the indirect method.
• LO3: Prepare a statement of cash flows,
using the direct method.
• LO4: Describe and illustrate the use of free
cash flow in evaluating a company’s cash
flow.

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Reporting Cash Flows
(slide 1 of 4)

• The statement of cash flows reports a

company’s cash inflows and outflows for a
period.
• The statement of cash flows provides
useful information about a company’s
ability to do the following:
o Generate cash from operations
o Maintain and expand its operating capacity
o Meet its financial obligations
o Pay dividends

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reporting Cash Flows
(slide 2 of 4)

• The statement of cash flows is used by

managers in evaluating past operations
and in planning future investing and
financing activities.
• It is also used by external users such as
investors and creditors to assess a
company’s profit potential and ability to
pay its debt and pay dividends.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Reporting Cash Flows
(slide 3 of 4)

• The statement of cash flows reports cash flows

from three types of cash flow activities, as follows:
1. Cash flows from operating activities are the cash
flows from transactions that affect the net income of a
company.
 Example: Purchase and sale of merchandise by a retailer.
2. Cash flows from investing activities are the cash
flows from transactions that affect investments in the
noncurrent assets of the company.
 Example: Purchase and sale of fixed assets, such as
equipment and buildings.
3. Cash flows from financing activities are the cash
flows from transactions that affect the debt and equity
of the company.
 Example: Issuing or retiring equity and debt securities.

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Reporting Cash Flows
(slide 4 of 4)

• The cash flows are reported in the

statement of cash flows as follows:

o The ending cash on the statement of cash

flows equals the cash reported on the
company’s balance sheet at the end of the
year.

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Sources and Uses of Cash

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Cash Flows from Operating Activities

• Cash flows from operating activities

reports the cash inflows and outflows from
a company’s day-to-day operations.
• Companies may select one of two
alternative methods for reporting cash
flows from operating activities in the
statement of cash flows:
o The direct method
o The indirect method
• Both methods result in the same amount
of cash flow from operating activities. They
differ in the way they report cash flows
from operating activities.
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Flows from Operating Activities:
The Direct Method (slide 1 of 2)
• The direct method reports operating cash
inflows (receipts) and cash outflows (payments)
as follows:

o The primary operating cash inflow is cash received from

customers.
o The primary operating cash outflows are cash payments
for merchandise, operating expenses, interest, and
income tax payments.
o The cash received from operating activities less the cash
payments for operating activities is the net cash flow
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
from operating activities.
Cash Flows from Operating Activities:
The Direct Method (slide 2 of 2)

• The primary advantage of the direct

method is that it directly reports cash
receipts and cash payments in the
statement of cash flows.
• Its primary disadvantage is that these data
may not be readily available in the
accounting records.
o Thus, the direct method is normally more costly
to prepare and, as a result, is used infrequently
in practice.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cash Flows from Operating Activities:
The Indirect Method (slide 1 of 2)
• The indirect method reports cash flows from
operating activities by beginning with net income
and adjusting it for revenues and expenses that
do not involve the receipt of cash or payment of
cash, as follows:

o The adjustments to reconcile net income to net cash

flow from operating activities include such items as
depreciation and gains or losses on fixed assets.
o Changes in current operating assets and liabilities such
as accounts receivable or accounts payable are also
added or deducted, depending on their effect on cash
flows.
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Cash Flows from Operating Activities:
The Indirect Method (slide 2 of 2)

• A primary advantage of the indirect

method is that it reconciles the differences
between net income and net cash flows
from operations.
• Because the data are readily available, the
indirect method is less costly to prepare
than the direct method.
o As a result, the indirect method of reporting
cash flows from operations is most commonly
used in practice.

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Cash Flow from Operations:
Direct and Indirect Methods—NetSolutions

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Cash Flows from Investing Activities

• Cash flows from investing activities show

the cash inflows and outflows related to
changes in a company’s long-term assets.
• Cash flows from investing activities are
reported on the statement of cash flows as
follows:

o Cash inflows from investing activities normally

arise from selling fixed assets, investments,
and intangible assets.
o Cash outflows normally include payments to
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Cash Flows from Financing Activities

• Cash flows from financing activities show the cash

inflows and outflows related to changes in a
company’s long-term liabilities and stockholders’
equity.
• Cash flows from financing activities are reported
on the statement of cash flows as follows:

o Cash inflows from financing activities normally arise

from issuing long-term debt or equity securities.
 For example, issuing bonds, notes payable, preferred stock, and
common stock creates cash inflows from financing activities.
o Cash outflows from financing activities normally include
paying cash dividends, repaying long-term debt, and
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acquiring treasury stock.
Noncash Investing and Financing Activities

• A company may enter into transactions

involving investing and financing activities
that do not directly affect cash.
o For example, a company may issue common
stock to retire long-term debt.
• Because such transactions indirectly affect
cash flows, they are reported in a separate
section that usually appears at the bottom
of the statement of cash flows.

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Format of the Statement of Cash Flows

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Example Exercise Classifying Cash Flows

Identify whether each of the following would be reported as an

operating, investing, or financing activity in the statement of
cash flows:
a. Purchase of patent
b. Payment of cash dividend
c. Disposal of equipment
d. Cash sales
e. Purchase of treasury stock
f. Payment of wages expense

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