REPORTING CASH FLOWS
We have already introduced and illustrated the statement of cash flows throughout
this text. In this chapter, we will address this key financial statement in greater detail.
Recall that the statement of cash flowsreports a firm’s major cash inflows and out-
flows for a period.^1 The statement of cash flows is a required financial statement that
explains how a company generates and uses cash during an accounting period. It pro-
vides useful information about a firm’s ability to generate cash from operations, main-
tain and expand its operating capacity, meet its financial obligations, and pay dividends.
It is useful to managers in evaluating past operations and in planning future investing
and financing activities. It is useful to investors, creditors, and others in assessing a
firm’s profit potential. In addition, cash flows are particularly important in evaluating
firms in financial distress, because the ultimate cause of bankruptcy is lack of cash.
Thus, the statement is also used to assess the firm’s ability to pay its maturing debt.
The cash flow statement is made up of three sections. Each section reports the cash
flows of a different type of activity:- Cash flows from operating activitiesare cash flows from transactions that affect
net income. Examples of such transactions include the purchase and sale of mer-
chandise by a retailer. - Cash flows from investing activitiesare cash flows from transactions that affect
the investments in noncurrent assets. Examples of such transactions include the
sale and purchase of fixed assets, such as equipment and buildings. - Cash flows from financing activitiesare cash flows from transactions that affect
the equity and debt of the business. Examples of such transactions include issuing
or retiring debt securities as well as paying dividends.
In the statement of cash flows, the cash flows from operating activities are nor-
mally presented first, followed by the cash flows from investing activities and financ-
ing activities. The total of the net cash flow from these activities is the net increase or
decrease in cash for the period. The cash balance at the beginning of the period is
added to the net increase or decrease in cash, resulting in the cash balance at the end
of the period. The ending cash balance on the statement of cash flows equals the cash
reported on the balance sheet.
Exhibit 1 shows common cash flow transactions reported in each of the three sec-
tions of the statement of cash flows. By reporting cash flows by operating, investing,
and financing activities, significant relationships within and among the activities can
be evaluated. For example, the cash receipts from issuing bonds can be related to re-
payments of borrowings when both are reported as financing activities. Also, the im-
pact of each of the three activities (operating, investing, and financing) on cash flows
can be identified. This allows investors and creditors to evaluate the effects of cash
flows on a firm’s profits and ability to pay debt.Cash Flows from Operating Activities
The most important cash flows of a business often relate to operating activities. The
two alternative methods for reporting cash flows from operating activities in the state-
ment of cash flows are (1) the direct method and (2) the indirect method.
Thedirect methodreports the sources of operating cash and the uses of operating
cash. The major source of operating cash is cash received from customers. The major580 Chapter 13 Statement of Cash Flows
Summarize the types
of cash flow activities
reported in the statement
of cash flows.1
1 As used in this chapter, cash refers to cash and cash equivalents. Examples of cash equivalents include
short-term, highly liquid investments, such as certificates of deposit, U.S. Treasury bills, and money mar-
ket funds.International Perspective
Under International
Accounting Standards,
interest received or paid
can be reported as either
a cash flow from operat-
ing activities, cash flow
from investing activities, or
cash flow from financing
activities.