The Statement of Cash Flows describes the cash inflows
and outflows for the firm based upon three categories of
Operating Activities: Generally include transactions in the
“normal” operations of the firm.
Investing Activities: Cash flows resulting from purchases
and sales of property, plant and equipment, or securities.
Financing Activities: Cash flows resulting from
transactions with lenders and owners.
· Funds received from lenders
· Payments to lenders (not interest)
· Contributions of capital from owners (sales of stock)
· Dividend payments
The Direct Method
The direct method lists the individual sources and uses of
cash. Typical line items include cash received from
customers, cash paid to suppliers, cash paid for wages, etc. Consider E3-18
Popovich Co. had the following transactions during June.
a. $20,000 of supplies were purchased with cash
b. $6,000 of supplies were consumed.
c. $60,000 of merchandise was sold. 40% of the sales
were on credit. The merchandise cost Popovich
d. $200,000 was borrowed from a bank
e. Interest of $2,000 was incurred and paid
f. $100,000 of equipment was purchased by issuing a
g. $4,000 of equipment value was consumed.
We could construct the following statement of cash flow:
Cash Flow from Operations:
Cash received from customers $36,000
Cash paid for supplies (20,000)
Cash paid for interest (2,000)
Cash provided by operations 14,000
Cash flow for investments 0
Cash flow from financing activities:
New bank borrowings $200,000
Net cash flow $214,000
The problem is that these items do not come from the
general ledger. There is no account for “cash received
from customers”, or “cash paid for supplies”. Instead, you would have to infer the amount from the firm’s accounting
For example, assume the following data from the firm’s
accrual based accounting system (all sales are credit sales); Accounts Receivable 1/1/00 $400,000
Accounts Receivable 12/31/00 $450,000
2000 Sales $3,000,000
How much cash did the firm receive from customers?
First, consider the entries used to record credit sales and the collection of cash.
Dr. Accounts Receivable
Cr. Accounts Receivable
Debits to accounts receivable result from sales transactions, and the credits result from cash collections.
Beginning Accounts Receivable
+ Credit Sales
- Cash Received
= Ending Accounts Receivable
Cash Received = Beg. AR + Credit Sales – Ending AR.
Define DAR = Ending AR – Beginning AR, where D means
the change in the account balance, then:
Cash Collections = Credit Sales – DAR.
In our example,
Cash collections = $3,000,000 - $50,000 = $2,950,000.
There was a total of $3,000,000 in sales, but not all of it
was collected in cash. Because there was an increase in
AR, the cash received was less than total sales.
We can use a similar approach to go from cost of goods
sold to cash payments. The balance sheet account affected
by cost of goods sold is inventory. Because inventory is
usually purchased on account, we also need to consider
Beginning Inventory Beginning Accounts Payable
+ Purchases + Purchases
- Cost of Goods Sold - Payments
= Ending Inventory = Ending Accounts Payable
D Inventory = Ending Inventory – Beginning Inventory
D Accounts Payable = Ending AP – Beginning AP
COGS = Purchases – D Inventory
Payments = Purchases – DAP
Purchases = DAP + Payments
COGS = DAP + Payments – D inventory
Payments = COGS + D inventory – DAP
Direct Method Example
ABC Co. Balance Sheets
Account 2000 1999
Cash $100,000 $130,000
Accounts Receivable 420,000 460,000
Inventory 800,000 700,000
Prepaid Rent 70,000 50,000
PP & E 1,000,000 800,000
Total Assets $2,390,000 $2,140,000
Accounts Payable $300,000 $360,000
Accrued Wages 175,000 120,000
Stockholders Equity 1,915,000 1,660,000
Total Liab & S.E. $2,390,000 $2,140,000
ABC Co.’s Income...