Accounting: The Language of Business - Vol. 2 (Intermediate: Part 70)

On a personal level, as a Christian, it will not be Barbra Streisand I'm standing in front of when I have to make an accounting of my life.

Patricia Heaton

Statement of Financial Position and Cash Flows and the Annual Report (Part H)

by

Charles Lamson 

The Statement of Cash Flows

Cash, one of the company's most important assets, is critical to successful operations and growth. a company needs cash to purchase equipment to manufacture products, to pay employees, and to invest in research. The importance of cash flow merits a separate financial statement devoted to explaining how a company generates cash and indicating where cash is employed. The statement of cash flows summarizes a firm's cash inflows and outflows over a period of time. 

In this section, we discuss the purpose of the statement of cash flows and the classifications used in the statement. A later post will present an overview of the preparation of the statement of cash flows. 

THE CONCEPTUAL FRAMEWORK:

Purpose of the Statement of Cash Flows 

The statement of cash flows provides information to financial statement users about a firm's cash receipts and cash payments during a period of time. The statement reconciles the change in the cash balance (where cash is defined as cash and cash equivalents) to the cash flows for the period and summarizes the firm's cash flows by operating, investing, and financing activities. the statement of cash flows enables financial statements users to:

1. Assess the entity's ability to meet its obligations and pay dividends.

2. Determine whether the entity will require external financing.

3. Identify the differences between net income and the associated cash receipts and payments.

The statement of cash flows explains and reconciles many other significant changes in balance sheet items, particularly when it is analyzed with the other financial statements and related footnote disclosures.

Statement of Cash Flows Classifications

The statement of cash flows is divided into three distinct sections: operating, investing, and financing activities. The statement presents operating activities first, followed by cash flows from investing activities, and finally cash flows from financing activities. The sum of cash inflows or outflows for these three activities results in the net increase or decrease in cash and cash equivalents for the period. The next step is reconciling this change in cash and cash equivalents to the beginning and ending cash and cash equivalents balances. Therefore, the change in cash and cash equivalents on the statement of cash flows plus the beginning cash and cash equivalents balance equals the ending cash and cash equivalents balance as depicted in Exhibit 6.5.

EXHIBIT 6.5 Statements of Cash Flows Classifications

Operating Activities. Operating activities include cash receipts and disbursements related to the production and delivery of goods and services that are reported on an accrual basis (received or accumulated in regular or increasing amounts over time) on the statement of net income. A firm must have a positive net cash flow related to operating activities over the long run in order to sustain its operations. Analyzing cash flows from operating activities enables financial statement users to assess the firm's ability to generate future cash flows from its normal earnings cycle.

Cash flows from operating activities primarily include:

1. Cash receipts from customers.

2. Cash receipts from interest and dividends.

3. Cash payments for the purchase of goods for resale or for use in production.

4. Cash payments to suppliers and employees.

5. Cash payments for taxes.

6. Cash payments for interest.

From Exhibit 6.6, Golden Enterprises, Inc., a food company making Gold Flake brand snack foods, net cash provided by operating activities was $7,135,855 for the year ended June 3, 2016.

EXHIBIT 6.6 Statement of Cash Flows, Golden Enterprises, Financial Statements, June 3rd, 2016

Click to enlarge.

Source: https://www.sec.gov/Archives/edgar/data/42228/000114420416120097/v447241_10ka.htm

Investing Activities. Cash flows from investing activities relate to acquiring and disposing of productive property, investing in debt and equity securities, and making and collecting loans. Cash flows from investing activities primarily include:

1. Cash receipts from the collection or sale of notes receivable for lending to others.

2. Cash receipts from the sale of debt and equity securities of other entities.

3. Cash receipts from the sale of productive assets (e.g., property, plant, and equipment).

4. Cash payments for extending credit to others.

5. Cash payments for investments in the debt and equity securities of other entities.

6. Cash payments for property, plant, and equipment, and other productive assets.

From Exhibit 6.6, Golden Enterprises' net investing cash flows were $(1,126,408)  for the year ended June 3, 2016. Its investing cash outflows include cash payments for items such as the acquisition of property, plant, and equipment whereas its investing cash inflows are from the sale of property, plant, and equipment. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 244, 246-247*

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