Chapter 4 cash flow statement

10/19/2020Fundamentals of Accountancy, Business and Management 2 2

By the end of the chapter, the students should be able to:
1. appreciate the significance of the information
presented in the Statement of Cash Flow;
2. identify the sections of the Statement of Cash Flows;
3. classify cash flows into operating, investing and
financing activities;
4. Understand the transactions recorded in the t-account
of cash; and
5. prepare the operating section of the Statement of Cash
Flow from completed Statement of Comprehensive
Income.

CASH is an important asset. It is an account affected
by many transactions. The debit and credit side of
the cash account generally represent cash receipts
and cash disbursements, respectively. Cash receipts
may come from (1) cash sales to customers, (2)
collection of customer accounts, (3) loans and other
borrowings, and (4) owner’s contributions. On the
other hand, cash disbursements may be for
payments of: (1) business expenses, (2) purchases of
inventories and other assets (3) liabilities to
creditors, and (4) dividends to owners.

SCF is the financial statement that explains the
net change in cash for the year. Like the SCI
and SoCE, the SCF is dated “for the year
ended.” The statement shows the transactions
for the year that reconciles the beginning
balance of cash to its year-end balance. The
report is presented based on the three major
activities of the business – operating, investing,
and financing.

The SCF reports cash flow transactions during
the year classified by operating, investing and
financing activities. Operating activities are
related to the main revenue-producing activities
of the business. Cash transactions related to
acquisition and disposal of long-term assets such
as property, plant, and equipment, and intangible
assets are classified as investing activities.
Finally, cash transactions with equity owners and
creditors are reported as financing activities.

Cash flows from operating activities are
primarily derived from the main revenue producing
activities of the business. This means that the
transactions reported in this section represents the
cash components of the events that enter into the
determination of net income in the SCI.
Cash flows from operations reveals the present
ability of the company to generate cash from its
operations. This is an important figure to the
readers of financial statements.

Positive cash flows from operations suggest that there is
excess cash that can be used to purchase long-term assets,
pay debts or distribute to owners.
The following are examples of cash flows transactions
reported under operating activities:
a. Cash received from customers (cash receipts from sale of
goods and rendering of services.)
b. Cash received from fees, commissions, and other income.
c. Cash payments to employees.
d. Cash payments to suppliers
e. Cash payments for other operating expenses.
f. Interest payments.

This the second section of SCF. Reported within
this classification are cash used for acquisition of
property, plant and equipment, intangible assets
and other long-term assets as well as cash
proceeds from the disposals of such long-term
assets. Cash flows from operations reports the
current ability of the business to generate cash
from its operations. On the other hand, cash flows
from investing activities hints on the company’s
ability to generate cash in the future.

A negative cash flows from investing activities implies that the
company used cash to acquire long-term assets intended to generate
cash and revenue in the future. On the other hand, a positive cash
flow from investing activities may indicate that the company is
divesting or downsizing.
The following are examples of cash flow transactions reported
under investing activities:
a. Cash payments to acquire property, plant and equipment,
intangible and other long-term assets.
b. Cash receipts from sale of property, and equipment, intangibles and
other long-term assets.
c. Cash loans made to other parties (long-term note receivables)
d. Cash collection on long-term note receivable.

This section reports cash received and cash paid to
equity owners and long-term creditors. Below are
examples of cash flows transactions reported under
financing activities:
a. Cash received from issuing common shares (or
capital contribution from owner.)
b. Cash received from issuing notes getting a long-term
loan from a bank.
c. Cash dividends distributed to shareholders.
d. Cash withdrawals of owners.
e. Cash payments for principal of long-term loan.

Excerpt from the 2 Statement of Financial Position
December 31, 2018 December 31, 2017
Accounts Receivable (AR) P 18,400.00 P 10,000.00
December 31, 2018 Statement of Comprehensive Income revealed the
following:
Credit Sales P 120,000.00
Cash Sales 8,100.00
Determine the (1) collection from credit sales and (2) total collection
from customers.

Let us begin with the analysis of the AR
account. Recall that credit sales increases AR
because credit sales represent right to collect
from the customers. On the other hand, the right
to collect (AR) is extinguished when customers
pay their accounts. Therefore, collections of
receivables decrease AR. Following this, the
accounts receivable ending balance will be
computed as follows:

AR, Beg
Balance
Credit
Sales
Customer
payments
AR, End
Balance
We get the beginning balance of AR from the December 31, 2017 SFP. The
December 31, 2018 SFP gives us the ending balance of AR. Moreover, we look at
the current year SCI to determine credit sales.
AR, End
Balance
P 18,400
AR, Beg
Balance
P 10,000
Credit
Sales
P 120,000
Customer
payments
?

Using algebra, we determine that customer payments
amount to P 111,600. However, this amount represents
only the collections on credit sales. The company also
generated cash sales. Therefore, total collections is
Collections form credit sales P 111,600.00
Add: Receipts from cash sales 8,100.00
P 119,700.00
Receipts from Customers
Compare this to
the total
collections from
sales in the cash
T-account in the
prior example.

The analysis above implies that when
collection from customers is less than credit
sales, then the uncollected portion of credit sales
increase AR. On the other hand, when collection
from customers is greater than credit sales, then
the excess must mean some of the beginning AR
were collected leading to a decrease in AR at the
end of the year.

The following are excerpts form the 2 SFPs:
December 31, 2018 December 31, 2017
Inventory P 4,800.00 P 5,000.00
Accounts Payable 1,090.00 2,300.00
December 31, 2018 Income Statement revealed the following:
Cost of Goods Sold P 37,690.00
Determine the amount paid to suppliers?

Let us begin with the analysis of the Inventory
account. Recall that purchases increase the Inventory
account. On the other hand, inventory is decreased
when goods are sold. We refer to this as Cost of Goods
Sold (C2). Follow this, Inventory ending balance is
Inventory,
Beg.
Balance
Purchases
Cost of
Goods
Sold
Inventory,
End
Balance

We get the beginning balance of Inventory from
the December 31, 2017 SFP. The December 31, 2018
SFP gives us an ending balance of Inventory. Moreover,
we look at the current year SCI to determine Cost of
Goods Sold.
Inventory,
Beg.
Balance
P 5,000
Purchases
?
Cost of
Goods Sold
P 37,690
Inventory,
End Balance
P 4,800

Using algebra, we determine that Purchases amount to P
37,490. However, this is not necessarily the payment to
supplier. So far, we know how much we have purchased from
the suppliers during the year. To determine the amount we
have paid to the suppliers, we need to look at Accounts
Payable.
Accounts payable (AP) is the liability account that
represents the claim of the suppliers against the company.
Purchases made during the year increase AP. On the other
hand, the supplier’s claim is extinguished when payment is
made. Therefore, payments to suppliers decrease AP.
Following this, AP ending balance is computed as follows:

AP, Beg
Balance
Purchases Payments AP, End
Balance
We get the beginning balance of AP from the December 31, 2017 SFP. The
December 31, 2018 SFP gives us the ending balance of AP. We will use the
amount of inventory purchases computed in the previous section.
AP, End
Balance
P 1,090
AP, Beg
Balance
P 2,300
Purchases
P 37,490
Payments
?
Using algebra, we determine that payments to suppliers amount to P 38,700

P 38,700.00
Payments to Suppliers
This was the total amount paid
to suppliers recorded on the
cash T-account in the prior
example.
From the analysis, it is deduced that AP
increases when there are unpaid portions of current
year purchases such that payment to suppliers is
less than purchases. On the other hand, payment to
supplier is greater than purchases when AP
decreases which implies that some of the beginning
AP must have been paid.

Examples 1 and 2 are examples of the direct
method of preparing the operating section. The same
method was used in the operating section of the SCF
in Table 3. An alternative presentation of the
operating section of the SCF is referred to as
“indirect method”. Recall our previous comparison of
net income and net cash flows from operations. The
indirect method shows the reconciliation from accrual
net income to net cash flows from operations.
Adjustments to net income include the following:

a. Non-cash expenses such as depreciation and
amortization are added back to net income. Recall
that depreciation decreases the net book value of
property, plant, and equipment and increase
expenses. This is an expense that does not have a
cash counterpart. We refer to these as “non-cash”
expenses.
b. Changes in current assets and current liabilities.

Cost of
goods
sold
Inventory,
End
Balance
Inventory,
Beg
Balance
Purchases
Using algebra, we move the variables around to determine
inventory purchased during the year.

Our starting point is net income. Our goal is to arrive at
payments to suppliers (as part of CFO). Recall the cost of goods
sold is deducted from sales to determine net income. Hence, in
our equation, cost of goods sold is a negative number.
The second component of the computation is ending balance
less beginning balance of inventory. We refer to this as change in
Inventory. From the equation, we see that increase in inventory
is deducted from net income. A decrease in inventory is positive
adjustment to net income.
The third component of the computation is the ending
balance less beginning balance of AP. We refer to this as change
in AP. We see that an increase in AP is added to net income. On
the other hand, a decrease in AP is deducted from net income.

Based on the above analysis, we summarize the adjustment for
current assets and current liabilities as follows:
Change in current assets/
current liabilities
Adjustment to net income
Increase in current assets Deduct from net income
Decrease in current assets Add to net income
Increase in current liabilities Add to net income
Decrease in current liabilities Deduct from net income

6/13/2017Fundamentals of Accountancy, Business, and Management 2 36

Chapter 4 cash flow statement

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