Study: What is the standard format for a Statement of Cash Flows and what information does it provide?
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Slides 1-3 (0m:52s)
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Welcome to Introduction to Accounting Preparing for a User's Perspective
What is the standard format for a Statement of Cash Flows and what information does it provide?
Statement of Cash Flows
Cash is the life blood of business. It is extremely rare for businesses to fail that have sufficient cash to pay their creditors on time AND do actually pay their creditors on time. If lenders & creditors get paid on time, they rarely will take the necessary steps to force the business into bankruptcy because it is unlikely that they will ever, get as much out of a bankrupt business as they would from a business that keeps making timely payments.
Wise creditors, lenders, and investors should understand how a business gets its cash (i.e. its sources of cash inflows) and what it spends it on (i.e. its uses of cash outflows). The Statement of Cash Flows Links to an external site. was developed to help creditors, lenders and investors better understand the cash flows of a business.
Slide 4 (0m:26s)
Links to an external site.Just like the Income Statement
Links to an external site. and the Statement of Stockholder Equity, the Statement of Cash Flows provides financial information for a period of time. It specifically explains changes in Cash from the beginning of the period to the end of the period. It too is like a financial video of transactions that occurred over a period of time, but its focus is solely on cash and its inflows, referred to as cash sources, and its outflows, referred to as cash uses.
Slide 5 (0m:47s)
Links to an external site.You may recall the following slide from an earlier lesson. Here are two simple ways of understanding the math involved in the Statement of Cash Flows:
Beginning Cash + Cash Inflows - Cash Outflows = Ending Cash
When the Statement of Cash Flows is more formally prepared, you would see the title, including the company name, the statement name and the period of time and then you would see the Cash Inflows and Cash Outflows broken out into the following three activities:
- Operating activities
- Investing activities
- Financing activities
The total of these activities equals the Change in Cash, which is then added to Beginning Cash to arrive at Ending Cash.
If you want to review the original 1m:25s video in which a similar slide was introduced, you see can find it in YouTube under the following name: What are the General-Purpose Financial Statements - Video Slide 10
Links to an external site.Next, we will discuss the types of transactions that should be classified into each of the three activity types.
Slides 6-8 (1m:12s)
Links to an external site.Operating Activity Cash Flows: In general, operating activity cash flows represent the receipt and payment of cash to support the core operations of the business. Operating cash inflows and outflows usually impact the balances in current assets and current liabilities.
- Operating activity cash inflows primarily represent cash received by selling goods and services to customers. They also include cash dividends received on investments, and cash received for interest on loans. Operating cash receipts will always affect cash and usually will also impact other non-cash current assets such as a receivable account.
- Operating activity cash outflows represent cash paid to run the basic operations of the business, such as paying for inventory, salaries & wages, utilities and the like. Although under IFRS Links to an external site.interest paid can be classified as an operating or as a financing cash flow, US GAAP Links to an external site. classifies it as an operating cash flow. Operating cash outflows will always reduce cash and will usually impact current liabilities.
Slide 9-11 (1m:20s)
Links to an external site.Investing Activity Cash Flows: In general investing activity cash flows involve the purchasing and selling of long-term assets
Links to an external site.. Those assets would include vehicles, buildings, equipment, furniture and intangible assets. Therefore, investing activity cash flows represent cash paid to purchase and cash received upon sale of long-term assets thus causing them to increase or decrease from one accounting period to the next.
- Investing activity cash inflows: When a company sells a long-lived asset and receives cash, the cash received will appear in the investing activities section as cash received from the sale of vehicles, or of buildings, or of, etc. etc. Investing cash inflows increase cash but reduce long-term assets. Such cash inflows can be a sign that the company is shrinking and is divesting of assets that it no longer needs.
- Investing activity cash outflows: When a company purchases a long-lived asset using cash, the cash paid will appear in the investing activities section as purchase of vehicles, or buildings, or, etc. etc. Investing cash outflows reduce cash but increase long-term assets. Such cash outflows can be a sign of growth as the company expands.
Slide 12-14 (0m:47s)
Links to an external site.Financing Activity Cash Flows: In general financing cash flows involve receipts from and payments to lenders under long-term debt financing agreements, and investors related to contributed capital
Links to an external site. (i.e. equity) financing.
- Cash inflows from financing activities represent the cash received from long-term borrowings and from the issuance of ownership shares. Financing cash inflows increase cash and either increase long-term debt or increase contributed capital.
- Cash outflows for financing activities represent cash used to pay off the principal on long-term borrowings, cash paid out in dividends, and cash paid to repurchase stock from investors. Financing cash outflows reduce cash and usually will reduce long-term debt, or decrease contributed capital, or decrease retained earnings Links to an external site..
Slide 15 (1m:07s)
Links to an external site.Let’s look at a summarized example of two Statements of Cash Flows for two, 10-year old businesses, Business 1 and Business 2 operating in the same industry. As you can see, the numbers are presented here in millions $ (M):
You should first note that both businesses have exactly the same beginning and ending cash balances for each of the three years. They both started with cash balances of $4 M in year X1 and ended the year X3 with $13 M , for a $9 M increase in cash. If you didn't have access to both business' Statements of Cash Flows, you might mistakenly assume they are performing about the same; however, their summarized statements of cash flow give an even better video of how they are doing cash-wise.
Assuming their balance sheets at the beginning of X1 were identical, which company do you wish you were the 100% owner of?
Which company do you think is more capable of paying off debt, increasing shareholder value and paying dividends Links to an external site.?
To answer these questions, you will want to compare their operating, investing and financing cash flows against each other.
Slide 16 (0m:50s)
Links to an external site.Operating activities. Based on their operating activity cash flows, Business 1 is producing much more cash from its core operations (i.e. +$65 M) than Business 2 (i.e. -88 M). Because Business 1 generated so much cash from its operations, it could then choose to use it for investing activities, such as purchasing long-term assets, or financing activities, such as paying down long-term debt, paying dividends and repurchasing stock. Because Business 2's operating cash flows were a negative $88 M it was unable to use any of its net cash flows to invest in long-term assets, pay off long-term debts, pay dividends to shareholders, or repurchase its own stock. Business 1 is in a much healthier cash position than Business 2.
Slide 17 (0m:17s)
Links to an external site.Investing activities. Business 1 was able to use some of its excess operating cash inflows to invest in $27 M of long-term assets. These new long-term assets could then be used to generate even more cash inflows from operations. On the other hand, Business 2 had $79 M of net cash inflows from investing activities. This appears to indicate that it is selling off its long-term assets, and likely reducing its production capacity. If the long-term assets really were not being used, it was probably smart for Business 2 to sell them, but it appears that Business 2's ability to generate positive cash flows from operating activities continues to decline. For example, maybe Business 2 is a long-haul trucker that has been selling off all of its trucks. No trucks? No sales? No operating cash inflows.
Slide 18 (1m:24s)
Links to an external site.Financing activities: Business 1's financing cash outflows over the three-year period totaled $29 M. You might think this is a bad sign, but if you really think about what it represents, it should become clear that Business 1 is probably paying off some long-term debt, or maybe it is repurchasing its own stock, or maybe it is paying Dividends out to its owners. In other words, financing cash outflows can actually be a good sign that the company is paying down its debts or rewarding its shareholders.
Business 2 had $18 M of financing activity cash inflows. These inflows may have been the result of borrowings under long-term debt or the issuing of shares to investors. What is clear, is that Business 2 needed the cash to be able to pay for the cash outflows in its operating activities.
I am not saying that positive financing cash inflows are necessarily bad, in fact most start-up companies will usually have negative operating cash flows (because they are just starting up and have no customers, but have lots of expenses), negative investing cash flows (because they are having to buy vehicles, equipment, buildings, etc.) and positive financing cash flows (because they need cash to pay for operations and investing). Business 2 has been around for 10 years, and instead of using its financing to invest in new long-term assets, it is actually selling its long-term assets, so it is actually in a financially precarious position.
Slides 19-20 (0m:30s)
Links to an external site.Here is a realistic Statement of Cash Flows for Super Big Tech Company. It is modeled after Microsoft's. Please take a moment to read each line and then see if you can find the total Operating, Investing and Financing cash flows and how they add up to the change in cash for the year.
Hopefully you enjoyed learning more about the Statement of Cash Flows and can see the value of studying it to gain greater insight into the business and how it manages its cash.
Good luck on the quiz.