Statement of Cash Flows

The statement of cash flows is one of the four primary financial reports that is used to evaluate a company's operating performance. Primary financial reports include the income statement, balance sheet, retained earnings report, and the statement of cash flows. The statement of cash flows is organized into three types of cash flows: operating, investing, and financing cash flows. This financial statement is a financial snapshot of a company's performance based on the operating, investing, and financing cash flows.

Preparing a Statement of Cash Flows

We will look at each section of the statement of cash flows and put them all together at the end. The Dells Company is preparing their annual financial statements for the year ended June 30, 2015. They have prepared the income statement, statement of retained earnings, and balance sheet. Now we need to prepare the statement of cash flows.

Operating Section

For the operating section, we need the income statement. Dells Company's income statement is below.

Dells Company Income Statement For Year Ended June 30, 2015

Sales

 

$1,000,000.00 

Cost of goods sold

$600,000.00 

 

Salaries and wages expense 

$200,000.00

 

Rent expense

$40,000.00

 

Depreciation expense

$20,000.00

 

Interest expense

$3,000.00

 

Loss on sale of equipment

$7,000.00

 

Total expenses

 

$870,000.00

Income before federal taxes

 

$130,000.00

Less: Federal income taxes

 

$(60,000.00)

Net Income

$ 70,000.00

To start the operating section, we need net income, depreciation expense, and any gains or losses (do not make this harder than it is—you must see the words gain or loss, or do not consider it a gain or loss). The following items summarize the needed calculations:

  • net income is $70,000
  • add depreciation expense of $20,000
  • add loss on sale of equipment of $7,000

Our statement of cash flows appears in the table below:

Dells Company Statement of Cash Flows

For Year Ended June 30, 2015

Cash flows from operating activities:

   

Net income

 

$ 70,000.00

Adjustments to reconcile net income to net cash:

 

Depreciation expense

$ 20,000.00

 

Loss on sale of equipment

7,000.00

 

Now we move on to the balance sheet for the current assets and liabilities. Notice the increase (or decrease) has already been calculated for you, but if it were not, you would take the current year amount minus the previous year amount. If the current year is more, there is an increase and if the current year is less that is a decrease.

Dells Company Comparative Balance Sheet

June 30 2015 and 2014

 

2015

2014

Increase (Decrease)

Assets

     

Current assets:

     

Cash

$30,000.00

$80,000.00

$(50,000.00)

Accounts receivable, net

160,000.00

100,000.00

60,000.00

Merchandise inventory

100,000.00

70,000.00

30,000.00

Prepaid rent

20,000.00

10,000.00

10,000.00

Total current assets

$310,000.00

$260,000.00

 

Property, plant, and equipment:

     

Equipment

$400,000.00 

$200,000.00

$200,000.00

Accumulated depreciation—equipment 

(60,000.00)

(50,000.00)

(10,000.00)

Total property, plant, and equipment

$340,000.00

$150,000.00

 

TOTAL ASSETS

$650,000.00

$410,000.00

 
       

Liabilities and equity

     

Current liabilities:

     

Accounts payable

$50,000.00

$40,000.00

$10,000.00

Notes payable—bank

0

50,000.00

(50,000.00)

Salaries payable

10,000.00

20,000.00

(10,000.00)

Federal income taxes payable

30,000.00

20,000.00

10,000.00

Total current liabilities

$ 90,000.00

$ 130,000.00

 

Stockholder’s equity:

     

Common stock, $10 par

$300,000.00

$100,000.00

$200,000.00

Paid in capital in excess of par, common

50,000.00

0

50,000.00

Retained earnings

210,000.00

180,000.00

30,000.00

Total Stockholder’s Equity

$560,000.00

$280,000.00

 

TOTAL LIABILITIES AND EQUITY

$650,000.00

$410,000.00

 

We will use the current assets (other than cash) and the current liabilities (other than the notes payable—bank, which we will report in financing). Remember, we add decreases and subtract increases in current assets, but in current liabilities we will add increases and subtract decreases:

  • Accounts receivable increased $60,000 so we will subtract $60,000 since this is a current asset.
  • Merchandise inventory increased $30,000 so we will subtract $30,000.
  • Prepaid rent increased $10,000 so we will subtract $10,000.
  • Accounts payable increased $10,000 but we will add $10,000 since this is a current liability.
  • Salaries payable decreased $10,000 so we will subtract $10,000.
  • Federal income Taxes payable increased $10,000 so we will add $10,000.

With this information, we can finish the operating section as follows:

Dells Company Statement of Cash Flows

For Year Ended June 30, 2015

Cash flows from operating activities:

     

Net income

 

$70,000.00

 

Adjustments to reconcile net income to net cash:

   

Depreciation expense

$20,000.00

   

Loss on sale of equipment

7,000.00

   

Increase in accounts receivable

(60,000.00)

   

Increase in merchandise inventory

(30,000.00)

   

Increase in prepaid rent

(10,000.00)

   

Increase in accounts payable

10,000.00

   

Decrease in salaries payable

(10,000.00)

   

Increase in federal income taxes Payable

10,000.00

   

Total adjustments

 

$(63,000.00)

 

Net cash provided by operating activities

 

 

$7,000.00

[$70,000 net income + (-63,000) in adjustments]

     

What does this tell us about the company? It tell us the company was able to generate $7,000 of cash from its day-to-day business operations. This could cause a concern, since the company owes $90,000 in the next year (see current liabilities on the balance sheet). But let's look at the other sections to see what else we can learn.

Investing Section

For the investing section, we will use the balance sheet and any additional information provided. On the balance sheet, the only long-term asset we have comes from property, plant, and equipment and is the equipment account. During 2015, equipment was sold for $3,000 cash with an original cost of $20,000 and $10,000 of accumulated depreciation. Additional equipment was purchased for $220,000 cash. Let's look at these transactions:

  • Equipment was sold for $3,000 cash (we do not need to know the rest of the information as the important part is the amount of cash). Notice how the $10,000 book-value of the equipment ($20,000 cost – $10,000 accumulated depreciation) less the $3,000 cash received is the loss reported on the balance sheet of $7,000. If we sold equipment, we receive cash, so we will add the $3,000 cash.
  • Dells purchased additional equipment for $220,000 cash, so they paid cash. We will subtract the $220,000 cash paid.

As such, he investing section would look like this:

Cash flows from investing activities:

   

Cash received from sale of equipment

$3,000.00

 

Cash paid for new equipment

 $ (220,000.00)

 

Net cash used by investing activities

 

 $(217,000)

Notice how the net cash heading changed from provided by in the operating section to used by investing, since the number is negative. We have a negative cash flow for investing—is that good or bad? Dells Company sold old equipment and purchased new equipment with cash, not with a loan! This is a good thing. 

When analyzing this section, you really want to see the asset sold, because you are purchasing new ones—it is not a good sign to sell assets without replacing them. Since Dells was able to pay cash for the equipment and not take out a loan, how did they pay for it? We know it was not from the day to day business because the operating activities cash was pretty low. So, we will look to the financing section for answers.

Financing Section

For the financing section, we will use the balance sheet and the statement of retained earnings. On the balance sheet, we are looking at the notes payable—bank, from the current liability section and any other long-term liabilities. If these balances increased, we can assume we received cash, and if the balances decreased, we can assume we paid on the debt unless we are given additional information on the subject. Notes payable is the only liability we haven't already accounted for on the balance sheet. Next, we look at the equity section of the balance sheet. We have common stock, paid in capital and retained earnings. Common stock and paid in capital both increased—why does this account increase?

 It increases when we issue shares of common stock. We will assume Dells issued the stock for cash unless we are given additional information to the contrary. In our case, we are given no additional information, so we will assume all increases or decreases involve cash. Lastly, we have retained earnings. What is involved in retained earnings? Let's look at the statement of retained earnings to find out.

Dells Company Statement of Retained Earnings

For Year Ended June 30, 2015

Retained Earnings, June 30 2014

 $180,000.00

Add: 2015 net income

 70,000.00

 

 $250,000.00 

Deduct: Cash dividends

 (40,000.00)

Retained Earnings, June 30, 2015 

 $210,000.00

Retained earnings include the beginning retained earnings + net income – dividends to get the ending retained earnings balance. 

What do we need for the statement of cash flows? We already accounted for net income in the operating section, but we need to know dividends. We will assume cash dividends unless the information given tells us otherwise. In this case, it shows we paid cash dividends:

  • Notes payable—bank decreased by $50,000; we assume we paid cash of $50,000 in 2015 and we will subtract cash.
  • Common stock increased $200,000 and, paid in capital increased $50,000, so the total cash received was $250,000 ($200,000 + $50,000), which will be added.
  • Cash dividends of $40,000 were paid, and we will subtract cash.

The financing section will look as follows:

Cash flows from financing activities:

     

Cash paid for notes payable

 $ (50,000.00)

   

Cash received from issuing stock

 250,000.00

   

Cash paid for dividends

 (40,000.00)

   

Net cash provided by financing activities 

 

 

 $160,000.00

Now we know how Dells was able to purchase new equipment with cash, by issuing stock. This helped Dells in the current year, but what about next year when they owe $90,000? We need to put all three sections together to finish the picture.

Net Increase (or Decrease) in Cash

The final part of the statement of cash flows is to calculate a net increase (or decrease if negative) in cash by adding the net cash from operating, investing, and financing. Cash flows from operating is $7,000 + Investing $(217,000) + Financing $160,000, which gives a net decrease in cash of $(50,000). We then take this increase (or decrease) and add it to the beginning cash balance (which is the previous year cash balance from the balance sheet) to calculate ending cash balance, which should agree to the cash balance reported on the balance sheet for the current year. We can always check our work with a built-in check figure of ending cash! This last section would look like this:

Net increase (or decrease) in cash

 $(50,000.00)

   

Cash balance, 2014

 $80,000.00

Cash balance, 2015

 $30,000.00

[ $80,000 2014 cash balance + (50,000 decrease) ] 


 

Check Your Knowledge

Question

In reviewing a statement of cash flows, which one of the following statements is not true?

Cash paid for rent is reported as an operating activity.

Cash contributed to the business by an owner is an investing activity.

Cash paid on a long-term note payable is a financing activity.

Cash received from the sale of inventory is an operating activity.

Licenses and Attributions

Preparing a Statement of Cash Flow from Financial Accounting by Lumen Learning is available under a Creative Commons Attribution 4.0 International license. UMGC has modified this work and it is available under the original license.