Preparing a Statement of Cash Flow

We will look at each section of the statement of cash flows and put them all together at the end.  The Dells Company is preparing their annual financial statements for the year ended June 30, 2015.  They have prepared the income statement, statement of retained earnings, and balance sheet.  Now, we need to prepare the statement of cash flows.

1.  Operating Section

For the operating section, we need the income statement.  Dells Company income statement is below.

Dells Company  
Income Statement  
For Year Ended June 30, 2015  
Sales  $  1,000,000.00
Cost of goods sold  $       600,000.00
Salaries and wages expense            200,000.00
Rent expense              40,000.00
Depreciation expense              20,000.00
Interest expense                3,000.00
Loss on sale of equipment                7,000.00  
  Total Expenses  $  870,000.00
Income before federal taxes  $  130,000.00
  Less: Federal income taxes    (60,000.00)
Net Income    $    70,000.00
To start the operating section, what do we need?  We need net income, depreciation expense and any gains or losses (do not make this harder than it is -- you must see the words "gain" or "loss" or do not consider it a gain or loss):

  • Net Income is $70,000
  • Add depreciation expense $20,000
  • Add loss on sale of equipment $7,000

Our statement of cash flows looks like this:

Dells Company  
Statement of Cash Flows  
For Year Ended June 30, 2015  
Cash flows from operating activities:
Net Income  $  70,000.00
Adjustments to reconcile net income to net cash: 
Depreciation expense  $  20,000.00
Loss on sale of equipment        7,000.00
Now we move on to the balance sheet for the CURRENT assets and liabilities.  Notice the increase (or decrease) has already been calculated for you but if not you would take the current year amount - previous year amount.  If the current year is more, there is an increase and if the current year is less that is a decrease.

Dells Company   
Comparative Balance Sheet   
June 30  2015 and 2014   
2015 2014 Increase (Decrease)
Current Assets:
Cash  $     30,000.00  $   80,000.00  $ (50,000.00)
Accounts Receivable, Net       160,000.00     100,000.00      60,000.00
Merchandise Inventory       100,000.00       70,000.00      30,000.00
Prepaid Rent         20,000.00       10,000.00      10,000.00
  Total Current Assets  $    310,000.00  $  260,000.00
Property, plant, and equipment:
Equipment  $   400,000.00  $  200,000.00  $ 200,000.00
Accumulated Depreciation - Equipment       (60,000.00)      (50,000.00)    (10,000.00)
  Total Property, plant, and equipment  $   340,000.00  $   150,000.00
TOTAL ASSETS  $    650,000.00  $  410,000.00
Liabilities and Equity
Current Liabilities:
Accounts Payable  $   50,000.00  $   40,000.00  $  10,000.00
Notes Payable - bank           0       50,000.00     (50,000.00)
Salaries Payable  10,000.00     20,000.00 (10,000.00)
Federal Income Taxes Payable  30,000.00      20,000.00  10,000.00
   Total Current Liabilities $  90,000.00  $  130,000.00
Stockholder's Equity:
Common stock, $10 par  $   300,000.00  $   100,000.00  $ 200,000.00
Paid in capital in excess of par, Common        50,000.00        0      50,000.00
Retained earnings       210,000.00       180,000.00      30,000.00
  Total Stockholder' s Equity  $    560,000.00  $   280,000.00
TOTAL LIABILITIES AND EQUITY  $    650,000.00  $   410,000.00
We will use the current assets (other than cash) and the current liabilities (other than the notes payable - bank which we will report in financing).  Remember, we ADD decreases and SUBTRACT increases in current assets but in current liabilities we will ADD increases and SUBTRACT decreases.

  • Accounts Receivable increased $60,000 so we will SUBTRACT $60,000 since this is a current asset
  • Merchandise inventory increased $30,000 so we will subtract $30,000
  • Prepaid Rent increased $10,000 so we will subtract $10,000
  • Accounts Payable increased $10,000 but we will ADD $10,000 since this is a current liability
  • Salaries Payable decreased $10,000 so we will subtract $10,000
  • Federal Income Taxes payable increased $10,000 so we will add $10,000

With this information, we can finish the operating section as follows:

Dells Company   
Statement of Cash Flows   
For Year Ended June 30, 2015   
Cash flows from operating activities:
Net Income  $ 70,000.00
Adjustments to reconcile net income to net cash: 
Depreciation expense  $  20,000.00
Loss on sale of equipment        7,000.00
Increase in Accounts Receivable    (60,000.00)
Increase in Merchandise inventory    (30,000.00)
Increase in Prepaid rent    (10,000.00)
Increase in Accounts Payable      10,000.00
Decrease in Salaries Payable    (10,000.00)
Increase in Federal income Taxes Payable      10,000.00
   Total adjustments  $(63,000.00)
Net cash provided by operating activities      $  7,000.00  
[$70,000 net income + (-63,000) in adjustments]
What does this tell us about the company?  It tell us the company was able to generate $7,000 of cash from its day to day business operations.  This could cause a concern since the company owes $90,000 in the next year (see current liabilities on the balance sheet).  But let's look at the other sections to see what else we can learn.

2.  Investing Section

For the investing section, we will use the balance sheet and any additional information provided.   On the balance sheet, the only long term asset we have comes from property, plant and equipment and is the Equipment account.   During 2015, equipment was sold for $3,000 cash with an original cost of $20,000 and $10,000 of accumulated depreciation.  Additional equipment was purchased for $220,000 cash.  Let's look at these transactions:

  • Equipment was sold for $3,000 cash (we do not need to know the rest of the information as the important part is the amount of cash).  Notice how the $10,000 book value of the equipment ($20,000 cost - $10,000 accumulated depreciation) less the $3,000 cash received is the loss reported on the balance sheet of $7,000.  If we sold equipment, we receive cash so we will add the $3,000 cash.
  • Dells purchased additional equipment for $220,000 cash so they paid cash.  We will subtract the $220,000 cash paid.

The investing section would look like this:

Cash flows from investing activities:
Cash received from sale of equipment  $      3,000.00
Cash paid for new equipment   (220,000.00)
Net cash used by investing activities   $ (217,000)  
Notice how the net cash heading changed from provided in by the operating section to "used" by investing since the number is negative.  We have a negative cash flow for investing, is that good or bad?  Dells Company sold old equipment and purchased new equipment with CASH not with a loan!  This is a good thing.  When analyzing this section, you really want to see the asset sold because you are purchasing new ones -- it is not a good sign to sell assets without replacing them.  Since Dells was able to pay cash for the equipment and not take out a loan, how did they pay for it?  We know it was not from the day to day business because the operating activities cash was pretty low.  So, we will look to the financing section for answers.

3.  Financing Section

For the financing section, we will use the balance sheet and the statement of retained earnings.  On the balance sheet, we are looking at the notes payable - bank from the current liability section and any other long term liabilities.  If these balances increased, we can assume we received cash and if the balances decreased, we can assume we paid on the debt unless we are given additional information on the subject.   Notes Payable is the only liability we haven't already accounted for on the balance sheet.  Next we look at the Equity section of the balance sheet.  We have common stock, paid in capital and retained earnings.  Common stock and paid in capital both increased -- why does this account increase?  It increases when we issue shares of common stock.  We will assume Dells issued the stock for cash unless we are given additional information to the contrary.  In our case, we are given no additional information so we will assume all increases or decreases involve cash.  Lastly, we have retained earnings.  What is involved in retained earnings?  Let's look at the statement of retained earnings to find out.

Dells Company 
Statement of Retained Earnings 
For Year Ended June 30, 2015 
Retained Earnings, June 30 2014  $    180,000.00
Add: 2015 Net Income           70,000.00
 $    250,000.00
Deduct: Cash Dividends         (40,000.00)
Retained Earnings, June 30 2015  $    210,000.00
Retained earnings includes the beginning retained earnings + net income - dividends to get the ending retained earnings balance.  What do we need for the statement of cash flows?  We already accounted for net income in the operating section but we need to know dividends.  We will assume cash dividends unless the information given tells us otherwise.  In this case, it shows we paid cash dividends.

  • Notes Payable - Bank decreased by $50,000, we assume we paid cash of $50,000 in 2015 and we will subtract cash
  • Common stock increased $200,000 and paid in capital increased $50,000 so the total cash received was $250,000 ($200,000 + $50,000) which will be added
  • Cash dividends of $40,000 were paid and we will subtract cash

The financing section will look like this:

Cash flows from financing activities:
Cash paid for notes payable  $ (50,000.00)
Cash received from issuing stock     250,000.00
Cash paid for dividends     (40,000.00)
Net cash provided by financing activities      $       160,000.00
Now we know how Dells was able to purchase new equipment with cash, by issuing stock.  This helped Dells in the current year but what about next year when they owe $90,000?  We need to put all 3 sections together to finish the picture.

4.  Net Increase (Decrease) in Cash

The final part of the statement of cash flows is to calculate a Net Increase (or Decrease if negative) in Cash by adding the net cash from operating, investing and financing.  Cash flows from Operating is $7,000 + Investing $(217,000) + Financing $160,000 which gives a net decrease in cash of $(50,000).  We then take this increase (or decrease) and add it to the beginning cash balance (which is the previous year cash balance from the balance sheet) to get a calculate Ending Cash Balance which should agree to the cash balance reported on the balance sheet for the current year.  We can always check our work with a built in check figure of ending cash!  This last section would look like this:

Net Increase (or Decrease) in Cash    $ (50,000.00) 
Cash Balance, 2014  $   80,000.00
Cash Balance, 2015    $   30,000.00
[ $80,000 2014 cash balance + (50,000 decrease) ]
To see the full statement of cash flows, click Dells Cash Flow

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