• Direct changes in retained earnings are not incorporated in cash flow statement.

The statement of cash flows is categorized in three parts namely:

Cash Flow From Operating Activities

Cash flows resulting from those activities relating to purchase and sale of the firm’s products and services. In other words cash flows from operating activities primarily accrue from the major revenue producing activities of the firm.

Cash Flows From Investing Activities

Investing activities relate to the acquisition and disposal of long-term assets. The cash flow from such activities is necessary to disclose because they show the cash invested in assets intended to generate future revenues for the firm.

Cash Flows From Financing Activities

[linkunit]Financing cash flows are cash flows that result from debt or equity financing transactions and include incurrence and repayment of debt cash inflows from the sale of shares and cash outflows to repurchase shares or pay cash dividends. The cash flows from financing activities is necessary to disclose because they represent future claims on the firm from the providers of the funds.

The formation of cash flow statement can be more broadly understood by the following example.

Example

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Solution

Cash Flow Statement $ In thousand $ In thousand
July 1, 2008 to June 30, 2009
Cash flow from operating activities:
Net earnings200,000
Adjustments:
Add Depreciation111,000
311,000
Changes in assets and liabilities:
Add Accounts receivables62,000
Add Accounts payables12,000
Add Accruals27,000101,000
Less Inventories94,000
Less Prepaid expenses3,500
Less Deferred income taxes6,000
Less Income Tax payable89,900(193,400)
218,600
Cash flows from investing activities:
Add Other assets500
Less fixed assets104,000
Less long term investments65,000(169,000)
(168,500)
Cash flows from financing activities:
Add Bank Loan91,000
Add Long term debt4,300
Add Common stock10095,400
Less Dividends(143,000)
(47,600)
Increase in cash and short term investments (Net cash flows)2,500
Cash at the beginning of the period175,000
Cash at the end of the period177,500

Importance of Cash Flow Statement

The statement of cash flows allows the financial manager and other stakeholders to analyze the firm’s cash flows. The manager should pay special attention both to the major categories of cash flow and to the individual items of cash flow and outflow to assess whether any developments have occurred that are contrary to the company’s financial policies. In addition the statement can be used to analyze the progress towards the financial goals and deficiencies. From the investors’ point of view cash flow statement provide information about the liquidity position of the firm. They can analyze the future cash streams of the firm and future expected dividends.

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