Chapter 13 Statement of Cash Flows 599GLOSSARY
SUMMARY OF LEARNING GOALS
Summarize the types of cash flow activities reported
in the statement of cash flows. The statement of cash
flows reports cash receipts and cash payments by three
types of activities: operating activities, investing activities,
and financing activities.
Cash flows from operating activities are cash flows
from transactions that affect net income. The two methods
of reporting cash flows from operating activities are (1) the
direct method and (2) the indirect method.
Cash inflows from investing activities are cash flows
from the sale of investments, fixed assets, and intangible
assets. Cash outflows generally include payments to acquire
investments, fixed assets, and intangible assets.
Cash inflows from financing activities include proceeds
from issuing equity securities, such as preferred and com-
mon stock. Cash inflows also arise from issuing bonds, mort-
gage notes payable, and other long-term debt. Cash outflows
from financing activities arise from paying cash dividends,
purchasing treasury stock, and repaying amounts borrowed.
Investing and financing for a business may be affected
by transactions that do not involve cash. The effect of such
transactions should be reported in a separate schedule
accompanying the statement of cash flows.
Because it may be misleading, cash flow per share is
not reported in the statement of cash flows.
Prepare a statement of cash flows, using the indirect
method.To prepare the statement of cash flows, changes
in the noncash balance sheet accounts are analyzed. This logic
relies on the fact that a change in any balance sheet account
can be analyzed in terms of changes in the other balance sheet
accounts. Thus, by analyzing the noncash balance sheet ac-
counts, those activities that resulted in cash flows can be iden-
tified. Although the noncash balance sheet accounts may be
analyzed in any order, it is usually more efficient to begin
with retained earnings. Additional data are obtained by ana-
lyzing the income statement accounts and supporting records.
Cash conversion cycleThe number of days’ sales in ac-
counts receivable, plus the number of days’ sales in inven-
tory, less the number of days’ sales in accounts payable.
Cash flows from financing activitiesThe section of the
statement of cash flows that reports cash flows from transac-
tions affecting the equity and debt of the business.
Cash flows from investing activitiesThe section of the
statement of cash flows that reports cash flows from transac-
tions affecting investments in noncurrent assets.
Cash flows from operating activitiesThe section of the
statement of cash flows that reports the cash transactions
affecting the determination of net income.
Direct methodA method of reporting the cash flows from
operating activities as the difference between the operating
cash receipts and the operating cash payments.
Free cash flowThe amount of operating cash flow remain-
ing after replacing current productive capacity and maintain-
ing current dividends.
Indirect methodA method of reporting the cash flows from
operating activities as the net income from operations adjusted
for all deferrals of past cash receipts and payments and all ac-
cruals of expected future cash receipts and payments.
Statement of cash flowsA summary of the major cash
receipts and cash payments for a period.Prepare a statement of cash flows, using the direct
method.The direct and indirect methods will report
the same amount of cash flows from operating activities.
Also, the manner of reporting cash flows from investing and
financing activities is the same under both methods. The
methods differ in how the cash flows from operating activi-
ties data are obtained, analyzed, and reported. The direct
method reports cash flows from operating activities by ma-
jor classes of operating cash receipts and cash payments.
The difference between the major classes of total operating
cash receipts and total operating cash payments is the net
cash flow from operating activities.
The data for reporting cash flows from operating activi-
ties by the direct method can be obtained by analyzing the
cash flows related to the revenues and expenses reported on
the income statement. The revenues and expenses are ad-
justed from the accrual basis of accounting to the cash basis
for purposes of preparing the statement of cash flows.
When the direct method is used, a reconciliation of net
income and net cash flow from operating activities is re-
ported in a separate schedule. This schedule is similar to the
cash flows from operating activities section of the statement
of cash flows prepared using the indirect method.Calculate and interpret the cash conversion cycle, flow
ratio, and free cash flow. The cash conversion cycle and
flow ratio measure the efficiency of using noncash working
capital for operations. The cash conversion cycle is calculated
as the number of days’ sales in accounts receivable, plus the
number of days’ sales in inventory, less the number of days’
sales in accounts payable. Low or negative values for the cash
conversion cycle are considered very efficient. Free cash flow
is the amount of operating cash flow remaining after replac-
ing current productive capacity and maintaining current divi-
dends. Free cash flow is the amount of cash available to
reduce debt, expand the business, or return to shareholders
through increased dividends or treasury stock purchases.