Lecture Notes: Chapter 12 – Statement of
Cash Flows
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
1. Introduction
The statement of cash flows provides critical information about a company's ability to generate
cash, meet financial obligations, and fund operations and investments. Unlike the income
statement, which is based on accrual accounting, the cash flow statement focuses strictly on
actual cash transactions. This chapter explores how to classify cash flows, prepare the statement
using the indirect method, and analyze key financial ratios like the quality of income and capital
acquisitions ratios.
2. Cash Flow Categories: Operating, Investing, Financing
The statement of cash flows is divided into three sections:
2.1 Operating Activities
These involve the core business activities—producing, selling, and delivering products and
services.
Examples:
Cash received from customers
Cash paid to suppliers and employees
Interest paid
Income taxes paid
2.2 Investing Activities
These include transactions related to long-term assets.
Examples:
Buying or selling property, plant, and equipment (PP&E)
, Buying or selling investments
Loans made to others or collections from loans
2.3 Financing Activities
These involve changes in a company's equity and borrowings.
Examples:
Issuing stock or bonds
Repaying principal on loans
Paying dividends
Repurchasing stock
3. The Indirect Method for Operating Activities
The indirect method is the most commonly used approach for preparing the operating section of
the cash flow statement.
3.1 Starting Point: Net Income
Begin with net income from the income statement.
3.2 Adjust for Non-Cash Items:
Depreciation/Amortization → Add back
Gains on Asset Sales → Subtract
Losses on Asset Sales → Add back
3.3 Adjust for Changes in Working Capital:
Increase in current assets → Subtract
Decrease in current assets → Add
Increase in current liabilities → Add
Decrease in current liabilities → Subtract
Example:
Net income: $120,000
Depreciation: $15,000
Increase in Accounts Receivable: $10,000
Increase in Accounts Payable: $8,000
Cash Flows
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
1. Introduction
The statement of cash flows provides critical information about a company's ability to generate
cash, meet financial obligations, and fund operations and investments. Unlike the income
statement, which is based on accrual accounting, the cash flow statement focuses strictly on
actual cash transactions. This chapter explores how to classify cash flows, prepare the statement
using the indirect method, and analyze key financial ratios like the quality of income and capital
acquisitions ratios.
2. Cash Flow Categories: Operating, Investing, Financing
The statement of cash flows is divided into three sections:
2.1 Operating Activities
These involve the core business activities—producing, selling, and delivering products and
services.
Examples:
Cash received from customers
Cash paid to suppliers and employees
Interest paid
Income taxes paid
2.2 Investing Activities
These include transactions related to long-term assets.
Examples:
Buying or selling property, plant, and equipment (PP&E)
, Buying or selling investments
Loans made to others or collections from loans
2.3 Financing Activities
These involve changes in a company's equity and borrowings.
Examples:
Issuing stock or bonds
Repaying principal on loans
Paying dividends
Repurchasing stock
3. The Indirect Method for Operating Activities
The indirect method is the most commonly used approach for preparing the operating section of
the cash flow statement.
3.1 Starting Point: Net Income
Begin with net income from the income statement.
3.2 Adjust for Non-Cash Items:
Depreciation/Amortization → Add back
Gains on Asset Sales → Subtract
Losses on Asset Sales → Add back
3.3 Adjust for Changes in Working Capital:
Increase in current assets → Subtract
Decrease in current assets → Add
Increase in current liabilities → Add
Decrease in current liabilities → Subtract
Example:
Net income: $120,000
Depreciation: $15,000
Increase in Accounts Receivable: $10,000
Increase in Accounts Payable: $8,000
