VI. General Format for a Statement of Cash Flows

The Investing and Financing Activities sections of the statement of cash flows are straightforward. The Operating Activities section, however, is more complex. It requires analysis of operating accounts that converts figures from an accrual to a cash format.

The following is the general format for a statement of cash flows:

Cash provided (or used) by:

Operating activities                                                                            $XXX
Investing activities                                                                              $XXX
Financing activities                                                                            $XXX
Net increase (decrease) in cash and cash equivalents            $XXX
Cash and cash equivalents at beginning of year                        $XXX
Cash and cash equivalents at end of year                                    $XXX

There are two methods that are used in calculating and reporting the amount of net cash flow from operating activities: the indirect method and the direct method. Although both produce identical results, the indirect method is used more often because it reconciles the difference between net income and the net cash flow provided by operations.

VII. Indirect Method

Popular because of its relative simplicity, the indirect method has you start with a figure for net income (from your income statement) and helps you adjust this accrual amount for any items that do not affect cash flows. There are three basic types of adjustments:

•    revenues and expenses that do not involve cash inflows or outflows (e.g., cost allocations such as depreciation and amortization)
•    gains and losses on events reported in other sections of the statement of cash flows
•    conversions of current operating assets and liabilities from the accrual to the cash basis

Note: When determining the change in current assets do not include the cash and cash equivalent accounts.

VIII. Sample Indirect Method Statement of Cash Flows

XYZ COMPANY
STATEMENT OF CASH FLOW
FOR THE YEAR ENDED DECEMBER 31, 2005

DIRECT METHOD
Cash flow from operating activities..
Cash receipts from customers..     

Cash paid for inventory..     

Cash paid for operating expenses..     

Cash paid for interest expense..     

Cash paid for Corporate Income taxes..     

Net cash provided (used)..
By operating activities..     

Cash flow from investing activities..
Purchase of equipment..     

Proceeds from sale of equipment..     

Net cash provided (used)..
By investing activities..     

Cash flow from financing activities..
Long term borrowings..     

Reduction of long term-debt..     

Net cash provided (used)..
By financing activities..     

Net increase (decrease) in cash..     

Cash at beginning of year..     

Cash at end of year..     
  

IX. Notes on Indirect Method Statement of Cash Flow

1.    Take net income directly from your statement of income. In this example, the financial statements are on the accrual basis.
2.    Depreciation expense also comes directly from the statement of income.
3.    Gain from sale of equipment, in this example, the company sold equipment during 1997 and recognized a gain from the sale. The profit from the gain is removed from the operating activities section of the cash flow statement and recorded later in the investing activities section.
4.    Increase in current assets, do not include cash or cash equivalents when determining this item.

Instead use this formula:
Current Assets 12/31/06    $ 75,500
Current Assets 12/31/05    $70,000
Increase    $5,500

5.    Note: Since current assets increased, $5,500 is reported as a negative amount. Cash was spent or converted into current assets, therefore reducing the cash balance.
6.    Increase in current liabilities, an increase in liabilities allows for more cash. Therefore, the increase is presented as a positive amount increasing the cash flow.
Note: Do not include any change in short-term debt from loans or mortgages. Changes in short-term debt are reported under the financing activities (see notes 8 and 9 below).
7.    Purchase of equipment, don’t worry whether the company used its own cash or borrowed funds to buy equipment. If a check was written, cash decreased.
8.    Proceeds from sale of equipment cash received from the sale of equipment.
9.    Reduction in long term debt cash spent on reducing the company’s long-term debt.
10.    Long-term borrowings indicates what the company borrowed in the form of long-term debt, while number 8 reported what was repaid on the new and old long-term debt. If the company had short-term debt, numbers 8 and 9 should be repeated.
Note: The change in short-term debt is not part of number 5.


To be continued…