​CASH FLOW STATEMENTS

NOTE:  In 1987, the Financial Accounting Standards Board (FASB, pronounced faz-bee) ruled that all Financial Statements prepared by Certified Public Accountants (CPA’ ) must be accompanied by a Cash Flow Statement. They allowed CPA’s to prepare them in one of two type formats—DIRECT or INDIRECT. Although FASB recommends the DIRECT METHOD most accountants prefer the INDIRECT METHOD (probably due to the convenience of use). From a business perspective the DIRECT METHOD is by far and away more preferable. The principal reason is that the DIRECT METHOD does not contain any non-cash items to distort the picture, such as depreciation.  If at all possible use the DIRECT CASH FLOW STATEMENT. The DIRECT CASH FLOW STATEMENT is analogous to a checkbook.  It portrays the actual cash flowing in and out of the company, and it organizes the information in a way that businesses can utilize to make sound decisions.


CASH FLOW STATEMENT (INDIRECT)

CASH FLOW FROM OPERATING ACTIVITIES

NET PROFIT from INCOME STATEMENT

Add:
•Depreciation
•Increase in Accounts Payable
•Reduction in all other Assets

Subtract:
•Increase in Inventory
•Prepaid Expenses
•Accounts Receivable
•Reduction in Accrued Taxes & Expenses

NET CASH FLOW FROM OPERATING ACTIVITIES

CASH FLOW FROM INVESTING ACTIVITIES

ALL CASH INFLOWS

•Monies received from Investments

Subtract:
•All Cash Outflows for Capital Investments
•All Cash Outflows for Marketable Securities
•Monies paid out in Investments

NET CASH FLOW FROM INVESTING ACTIVITIES

CASH FLOW FROM FINANCING ACTIVITIES

ALL CASH INFLOWS

•All Cash Inflows from Borrowing

Subtract:
•All Cash Outflows paid out to Reduce Principal

NET CASH FLOW FROM FINANCING ACTIVITIES


CHANGE IN CASH POSITION (Increase or Decrease)

BEGINNING CASH POSITION

ENDING CASH POSITION



CASH FLOW STATEMENT (DIRECT)

CASH FLOW FROM OPERATING ACTIVITIES

CASH INFLOWS

Add:
•All Monies from Operation of the Company

Subtract:
•All Cash Outflows paid out in Operation

(NOTE:Works Just Like The Checkbook)

NET CASH FLOW FROM OPERATING ACTIVITIES

CASH FLOW FROM INVESTING ACTIVITIES

ALL CASH INFLOWS

•Monies received from Investments

Subtract:
•All Cash Outflows for Capital Investments
•All Cash Outflows for Marketable Securities
•Monies paid out in Investments

NET CASH FLOW FROM INVESTING ACTIVITIES

CASH FLOW FROM FINANCING ACTIVITIES

ALL CASH INFLOWS

•All Cash Inflows from Borrowing

Subtract:
•All Cash Outflows paid out to Reduce Principal

NET CASH FLOW FROM FINANCING ACTIVITIES


CHANGE IN CASH POSITION (Increase or Decrease)

BEGINNING CASH POSITION

ENDING CASH POSITION



KEY CONSIDERATION POINTS FOR THE CASH FLOW STATEMENT

1.     In 1987, the Financial Accounting Standards Board (FASB, pronounced faz-bee) ruled that all Financial Statements prepared by 
        Certified Public Accountants (CPA’s ) must be accompanied by a Cash Flow Statement. They allowed CPA’s to prepare them in one 
        of two type formats—DIRECT or INDIRECT. Although FASB recommends the DIRECT METHOD most accountants prefer the 
        INDIRECT METHOD (probably due to the convenience of use). From a business perspective the DIRECT METHOD is by far and 
        away more preferable. The principal reason is that the DIRECT METHOD does not contain any non-cash items to distort the 
        picture, such as depreciation. If at all possible use the DIRECT CASH FLOW STATEMENT. The DIRECT CASH FLOW 
        STATEMENT is analogous to a checkbook. It portrays the actual cash flowing in and out of the company, and it organizes the 
        information in a way that businesses can utilize to make sound decisions.

2.     The CASH FLOW STATEMENT is designed to show the CHANGE IN CASH POSITION from the Beginning to the End of the 
        accounting period in question. It will show if there has been a net increase or decrease.

3.     THE CASH FLOW STATEMENT is divided into three (3) distinct areas of business concern. The first is NET CASH (FLOW) 
        PROVIDED BY OPERATING ACTIVITIES. Financial and accounting people often refer to this area as OPERATING CASH 
        FLOW (OCF). OCF is one of the three Bottom Lines in business. In fact, of the three, OCF is the most important in many respects.  
        It is considered by many to be the “LIFEBLOOD” of any organization.

4.     The second area addressed by the CASH FLOW STATEMENT is NET CASH (FLOW) PROVIDED BY INVESTING 
        ACTIVITIES. This area details investments the company makes in its own future. They may consist of Capital Expenditures or 
        investments in Marketable Securities.

5.     The third area considered is NET CASH (FLOW) PROVIDED BY FINANCING ACTIVITIES. It includes all activities related to 
        borrowing and repaying of capital. It may include mortgages, capital leases and dividends paid to shareholders.

6.     The hot metric on Wall Street today is “Free Cash Flow”. Perhaps the main reason for this is Warren Buffet’s company Berkshire 
        Hathaway. They have used this concept for years and it is possibly one reason for their success. (Mr. Buffet refers to it as “Owner 
        Earnings”.) FREE CASH FLOW is simple to calculate. Take the NET CASH FROM OPERATING ACTIVITIES and subtract the 
        amount invested in Capital Equipment (Capital Expenditures), found in the INVESTING ACTIVITY section. It’s that easy. FREE 
        CASH FLOW is nothing more or less than the cash generated by operating the business less monies invested to keep it vital.

7.     OPERATING CASH FLOW (OCF) can be used as an indicator of the general overall health of a company. It can also tell you if 
        a company merits your purchase of stock in it. Four tests can be applied to OCF to determine its efficacy. The 4 tests are:
  • OCF should be positive
  • OCF should be greater than NET PROFIT
  • OCF should be greater than Fixed Asset Investment
  • OCF should be trending in the same direction as NET PROFIT
        OCF is one of the most important things for a business to watch, because it will help you manage Cash Flow as well as profit.

8.     The BEGINNING CASH POSITION & the ENDING CASH POSITION can illustrate a major concept in Financial Statements that 
        is crucial to understanding them accurately. Consider this: The INCOME STATEMENT & the CASH FLOW STATEMENT cover 
        the entire accounting period in question. The BALANCE SHEET, however, covers only one day in time, usually the last day of the 
        accounting period. If you take two BALANCE SHEETS and “bookend them” you will have the same period of time covered as that 
        of the other two statements. By doing this you can track the differences from one BALANCE SHEET to the other by using the 
        INCOME STATEMENT and the CASH FLOW STATEMENT. In essence is allows you to see how the statements fit together like 
        a puzzle.

9.     NET CASH (FLOW) PROVIDED FROM OPERATING ACTIVITIES will include all disbursements for operating the company. So 
        monies paid by the company during the accounting period for such things as raw materials for inventory production, that is as of yet 
        unsold, will show up in this section. Always compare this section of the CASH FLOW STATEMENT to the costs and expenses found 
        on the INCOME STATEMENT.

10.   The ENDING CASH POSITION should be compared to NET PROFIT. It will tell you the actual dollars the company has to 
        spend.  Think of it as your checkbook balance.

11.   The NET CASH (FLOW) PROVIDED BY FINANCING ACTIVITIES may contain an item that every business should track 
        faithfully—Dividends paid to stockholders. Over the course of time you want to know if a company is capable of generating enough 
        profit to make the owner’s investment worthwhile.