• 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
Solution
| Cash Flow Statement | $ In thousand | $ In thousand |
| July 1, 2008 to June 30, 2009 | ||
| Cash flow from operating activities: | ||
| Net earnings | 200,000 | |
| Adjustments: | ||
| Add Depreciation | 111,000 | |
| 311,000 | ||
| Changes in assets and liabilities: | ||
| Add Accounts receivables | 62,000 | |
| Add Accounts payables | 12,000 | |
| Add Accruals | 27,000 | 101,000 |
| Less Inventories | 94,000 | |
| Less Prepaid expenses | 3,500 | |
| Less Deferred income taxes | 6,000 | |
| Less Income Tax payable | 89,900 | (193,400) |
| 218,600 | ||
| Cash flows from investing activities: | ||
| Add Other assets | 500 | |
| Less fixed assets | 104,000 | |
| Less long term investments | 65,000 | (169,000) |
| (168,500) | ||
| Cash flows from financing activities: | ||
| Add Bank Loan | 91,000 | |
| Add Long term debt | 4,300 | |
| Add Common stock | 100 | 95,400 |
| Less Dividends | (143,000) | |
| (47,600) | ||
| Increase in cash and short term investments (Net cash flows) | 2,500 | |
| Cash at the beginning of the period | 175,000 | |
| Cash at the end of the period | 177,500 |
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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