Unit 4: Statement of Cash Flows

Lesson 4.2
Preparation of a Statement of Cash Flows
Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 5

Guidelines in Preparing the Statement of Cash Flows 5
Types of Statements of Cash Flows 6
Direct Method 6
Indirect Method 10

Case Study 15

Keep in Mind 16

Try This 17

Practice Your Skills 18

Challenge Yourself 23

Photo Credit 24

Bibliography 24

0
Unit 4: Statement of Cash Flows

Lesson 4.2

Preparation of a Statement of Cash

Flows

Introduction

Where did the money go? Is the business earning significantly from its investments? Where does
the increase in cash come from? Is there a chance that the business will run out of cash? These
are just some of the fundamental questions that the statement on cash flow addresses.

The Statement of Cash Flows summarizes the inflow and outflow of cash from three
essential business operations: operating, investing, and financing activities. It provides a
preview of the company’s priority, its strategy for growth, and its management of cash.
Regardless of one’s position in the company—management, investor, employee—preparing
a Statement of Cash Flows can help users understand the inner workings of the
organization, and contribute to its growth. In this lesson, you will learn how to prepare a
Statement of Cash Flow.

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Unit 4: Statement of Cash Flows

Learning Objectives DepEd Competency

At the end of this lesson, you should be able to Prepare a Cash Flow Statement
do the following: (ABM_FABM12-If-11).

● Recall the components of the Statement

of Cash Flows.
● Prepare a Statement of Cash Flow.

● Assess the advantages and

disadvantages of direct and indirect
methods for preparing the Statement of
Cash Flows.

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Unit 4: Statement of Cash Flows

Quick Look

In or Out?
Examine the following transactions. Determine whether each one results in an inflow or
outflow of cash. At the same time, identify whether it should be classified as an operating,
investing, or financing activity. Write a plus symbol (+) if the transaction is an inflow,
otherwise put a minus sign (–), in the appropriate column where it should be categorized.

Transaction Operating Investing Financing

Receipts in cash from the provision of services,

₱35,000.00

Payment in cash to products and service

providers, ₱12,500.00

Extra funds received through a bank loan,

₱12,000.00

Interest is paid, ₱5,000.00

Rent is paid, ₱8,000.00

Proceeds from equipment sales, ₱10,000.00

Equipment purchase, ₱9,500.00

Owner’s withdrawal, ₱6,500.00

Once you are done analyzing and categorizing the transactions, calculate the total cash flow
for financing, investing, and operating activities. You may organize them using the following
table.

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Unit 4: Statement of Cash Flows

Transaction Operating Investing Financing

Cash Inflow

Cash Outflow

Total net cash flow

(Subtract the total cash
outflow from the total
inflow)

Questions to Ponder
1. How much is the net cash flow from operating, investing, and financing activities?
________________________________________________________________________________________

________________________________________________________________________________________

________________________________________________________________________________________

2. What does net cash flow represent?

________________________________________________________________________________________

________________________________________________________________________________________

________________________________________________________________________________________

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Unit 4: Statement of Cash Flows

3. Why must business owners need to understand their respective cash flow situations?
________________________________________________________________________________________

________________________________________________________________________________________

________________________________________________________________________________________

Learn the Basics

As presented in the previous lesson, the Statement of Cash Flows is a formal report that
categorizes an entity’s cash inflows (receipts) and outflows (disbursements) within a given
period into operating, investing, and financing activities.

The Statement of Cash Flow is a valuable tool for determining a company’s ability to:
● manage its cash flow from operations
● maintain and expand its capacity to operate
● fulfill its financial obligations
● pay dividends or increase the owner’s equity

Essential Question

What is the relationship between the information presented in the four

financial statements: financial position, comprehensive income, changes in
owner’s equity, and cash flows?

Guidelines in Preparing the Statement of Cash Flows

Understanding the effects of transactions on cash flow and on the business’s accounts is an
important requirement for preparing the Statement of Cash Flows. The following guidelines
will help you.

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Unit 4: Statement of Cash Flows
● Listed under Operating Activities are cash transactions related to day-to-day operations
that generate income and incur expenses.
● Listed under the Investing Activities are cash transactions that affect non-operating
current assets. It also includes transactions related to the acquisition or sale of
noncurrent assets.
● Listed under the Financing Activities are cash transactions that influence noncurrent
liabilities, non-operating current obligations, and owner’s equity (e.g., new investment
or withdrawals).

It is important to note that only cash transactions (collection and payments) are shown in the
SCF, and all transactions are taken from the general ledger’s cash account. In short, the
records in the general ledger are categorized in the SCF into operating, investing, and
financing activities.

Types of Statements of Cash Flows

The direct method and the indirect method are the two treatments used for preparing a
Statement of Cash Flows.

Figure 1. There are two methods used in generating a cash flow statement.

Direct Method
The direct approach uses actual cash flows from the company’s operations to prepare the
Statement of Cash Flows. It uses the cash receipts and cash disbursements such as
collections, payment of salaries, utilities, and supplies, and interests on bank deposits,
among others. Similarly, it also records all cash receipts and payments for the company's
other two primary activities: investing and financing.

4.2. Preparation of a Statement of Cash Flows 6

Unit 4: Statement of Cash Flows
The direct method of preparing a statement of cash flows usually involves four steps:
1. Determine which activities increased or diminished the cash asset.
2. Sort these into the appropriate categories: operating, investing, and financing.
3. Determine whether the asset cash has increased or decreased as a result of the effect
of the different activities under each category.
4. Add or subtract the net increase/decrease from the beginning balance to arrive at the
ending cash balance.

The Statement of Cash Flow that uses the direct method is illustrated below.

Company ABC
Statement of Cash Flows
(For the year ended December 31, 2021)

Cash flows from operating activities

Receipt from cash services ₱ x xxx.xx
Collections on accounts receivable x xxx.xx
Payments on salaries, rent, utilities, and other operating
(x xxx.xx) ₱x xxx.xx
expenses
Cash flows from investing activities
Purchase of delivery equipment (x xxx.xx
Redemption of mature placement in commercial x xxx.xx x xxx.xx
papers
Cash flows from financing activities
Additional investment by proprietor x xxx.xx
Cash withdrawal by the proprietor (x xxx.xx)
Cash receipts from loans x xxx.xx
Cash payment for loans (x xxx.xx) x xxx.xx
Increase / Decrease in Cash x xxx.xx
Cash at the beginning of the year x xxx.xx
Cash at the end of the year ₱ x xxx.xx

The direct method comprises key categories of cash receipts and payments, which are
individually reported in the Statement of Cash Flows' operating activities section.

● Cash Receipts
A cash receipt is a written recognition of the amount of money received during a
transaction that involves the transfer of money or money equivalents. The buyer
receives the original copy of the cash receipt, while the vendor keeps the other
duplicate for accounting purposes.

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Unit 4: Statement of Cash Flows

● Cash Payments
A cash payment is a banknote or coin given to the provider by the recipient of goods
or services. It can also refer to a payment made within a company to compensate
employees for their time worked or to reimburse them for minor expenses that aren't
large enough to be processed through the accounts payable system.

Closer Look

Preparing an SCF Using the Direct Method

Kyra started a wedding and events planning business. Blue Wedding and
Promises, in February 2019. During the first quarter of the year, the entity
had the following transaction.
● The owner has put up ₱200,000.00 in cash.
● ₱325,000.00 in wedding preparation services on account
● ₱128,500.00 in operating expenses on account
● ₱200,000 in accounts receivables were collected.
● Kyra needed money and took out a ₱20,000.00 withdrawal.
● ₱56,000.00 in accounts payable payment
● For a fee of ₱50,000.00, Kyra’s business provided party event
services.
● Miscellaneous expenses totaled ₱15,000.00.
● Purchase of printing machinery costing ₱30,000.00.

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Unit 4: Statement of Cash Flows

Blue Wedding and Promises

Statement of Cash Flows
March 2019

Cash flows provided from operating activities

Accounts receivable collected 200,000.00

Accounts payable payment (56.000.00)
Party event services collected 50,000.00
Miscellaneous expenses paid (15,000.00) ₱179,000.00
Cash flows provided from investing activities
Purchase of printing machinery (30,000.00)
Cash flows provided from financing activities
Investment of the owner 200,000.00
Cash withdrawal by the owner (20,000.00) ₱180,000.00
Increase in Cash 329,000.00
Beginning Cash Balance 10,000.00
Ending Cash Balance ₱ 339,000.00

You will notice that the transactions for wedding preparation services on account of
₱325,000 and operating expenses on account of ₱128,500 are not included in the SCF of
Blue Wedding and Promises. It is because those two transactions are still on account (on
credit), and there are no cash inflows or outflows yet.

Check Your Progress

How does the direct method for preparing the Statement of Cash Flows
start?
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________

4.2. Preparation of a Statement of Cash Flows 9

Unit 4: Statement of Cash Flows

Indirect Method
Companies that use the accrual method rather than the cash method in their accounting
system typically use the indirect approach. This format simplifies and shortcuts the
calculation of cash flows from operating activities. It begins with the data on the net income
or loss, and uses the increases and decreases in the balance sheet line items to modify and
reconcile the operational cash flows.

The indirect method does not report the specific cash inflows and outflows under the
operating activities category. Instead, it accounts for three sorts of modifications to net
income:

1. Additions/Subtractions to Net Income from Noncash Activities

This is the part of the income statement that deals with operations that do not
require any cash outflow or inflow throughout the period. The acknowledgment of
depreciation expense for the period is an example of this. Depreciation expense is
deducted to arrive at the net income. Since the SCF accounts only for cash
transactions, the effects of noncash expenses like depreciation should be added back
to net income to get the amount concerning cash only.

2. Change in Asset Accounts

This is the process of removing the effect of earnings and losses from investing and
financing activities from the net income to get the cash flows from operating activities.
Loss/gain on the sale of plant assets and gain/loss on bond retirement are two
examples of these adjustments. The process also involves taking into account the
changes in current operating assets that affect the cash flows.

● Such examples are trade and other receivables’ increase or decrease. For
example, an increase in accounts receivable for the period is deducted from
net income in the indirect method presentation of the SCF since it shows the
company sold more things or offered more services on account during the
period rather than cash collected. Decreases, on the other hand, should be
added to net income because it indicates that the company had more cash
collections rather than goods or services performed on credit.

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Unit 4: Statement of Cash Flows

● Prepaid expense increases or decreases. For example, in the Statement of

Cash Flows, an increase in prepaid insurance for the period is subtracted from
net income. It is so because increases in prepayments mean that there is a
cash disbursement (outflow) due to advance payment made for insurance, or
other prepaid expenses. On the other hand, the decrease is to be added.
Decreases in prepayments like prepaid insurance indicate that a portion of the
prepayment had already been utilized and therefore expensed. Such was
deducted when computing the net income. However, said expense does not
involve any cash outflow (insurance expense is debited, and prepaid insurance
is credited), hence the reason the decrease is added to the net income under
the indirect method.

● Inventory increases or decreases. For example, on the statement of cash

flows, an increase in merchandise inventory for the period is subtracted from
net income, whereas a drop is added. An increase in merchandise inventory is
deducted from net income, for it indicates an additional cash outflow. The
increase means the company purchased more and sold less of its inventory
during the period. A decrease in merchandise inventory suggests the opposite.
That is why the decrease in inventory means additional cash inflow for the
company and, therefore, an addition to net income.

3. Change in Liability Accounts

This process refers to the increases and decreases in trade and other payables. For
example, on the Statement of Cash Flows, an increase in accounts payable for the
period is added to net income because it shows the company paid less than the
amount of expense incurred and recorded during the period. On the other hand, a
decrease in accounts payable must be subtracted because it indicates that the
company paid more over the period compared to the expenses reflected in the
income statement.

4.2. Preparation of a Statement of Cash Flows 11

Unit 4: Statement of Cash Flows
The Statement of Cash Flows that uses the indirect method is illustrated below.

Company ABC
Statement of Cash Flows
(For the year ended December 31, 2021)
Cash flows from operating activities:

Net Income ₱ x xxx.xx

Adjustment for:

Noncash Expense (e.g., Depreciation) x xxx.xx

Increase in Current Asset Accounts (x xxx.xx)

Decrease in Current Asset Accounts x xxx.xx

Increase in Current Liability Accounts x xxx.xx

Decrease in Current Liability Accounts (x xxx.xx)

x xxx.xx

Cash flows from investing activities:

Cash received from sale of investments x xxx.xx

Cash paid for purchase of land (x xxx.xx)

Cash paid for purchase of equipment (x xxx.xx)

x xxx.xx

Cash flows from financing activities:

Investment by proprietor ₱ x xxx.xx

Cash withdrawal by proprietor (x xxx.xx)

Cash receipts from loans x xxx.xx

Cash payments for loans (x xxx.xx) x xxx.xx

Increase / Decrease in cash x xxx.xx

Cash at the end of the year ₱ xxxx.x

4.2. Preparation of a Statement of Cash Flows 12

Unit 4: Statement of Cash Flows

Closer Look

Preparing an SCF Using the Indirect Method

Rita started a food delivery business, Food Haven, in May 2020. During
the second quarter of the year, the entity had the following transactions.

Net income ₱200,000.00

Depreciation expense 25,000.00

Gain on sale of property and equipment 100,000.00

Decrease in trade and other receivables 70,000.00

Purchase of property and equipment 200,000.00

Receive loan from bank 150,000.00

Examine how Rita prepared the Statement of Cash Flows using an indirect
method. She prepared only the Cash Flows from the Operating portion of
the statement.

Food Haven
Statement of Cash Flows
For the quarter ended June 2020

Cash flows from operating activities

Net income ₱ 200,000

Adjustment for:

Depreciation expense ₱25,000.00

Gain on sale of property and equipment (100,000.00)

Decrease in trade and other receivables 70,000.00 (5,000)

Net Cash Flow from Operating Activities ₱ 195,000.00

4.2. Preparation of a Statement of Cash Flows 13

Unit 4: Statement of Cash Flows
The purchase of property and equipment amounting to ₱200,000 does not affect the net
income and is not a transaction involving current assets. It is not part of the operating
activities section. Instead, it should be under the investing activities. The receipt of a loan
from a bank amounting to ₱150,000 does not also affect the net income and is not a
transaction affecting trade and other payables. Hence, it is not a part of operating activities.
The said transaction is a financing activity.

It is crucial to remember that the two approaches (i.e., indirect and direct) always provide the
same cash flows from operating, financing, and investing activities and cash balance at the
end of the period. The only difference between the two methods lies in the presentation of
the cash flows from operating activities.

Check Your Progress

How is the operating activities section under the indirect method for
preparing the Statement of Cash Flows computed? Briefly explain.
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_________________________________________________________________________________
_________________________________________________________________________________

4.2. Preparation of a Statement of Cash Flows 14

Unit 4: Statement of Cash Flows

Case Study

Restructuring from Bankruptcy

Chrysler Group LLC, for example, sells its automobiles and trucks through
a network of separately owned and operated dealerships. The
automobiles are sold to dealerships on credit via the issuance of a trade
receivable, which is reimbursed to Chrysler Group LLC once the vehicles
are sold.

The 2008 financial crisis caused a drop in car sales that lasted well into
2009. By spring 2009, Chrysler dealers around the world had large
inventories of unsold cars and trucks, making it impossible for them to
repay their trade receivables to Chrysler Group LLC, resulting in a
significant drop in Chrysler's cash flow from operating activities, forcing
the company into financial restructuring.

Fiat made a major investment (cash inflow from financing activities) in the
company, and the US and Canadian governments lent and invested (cash
inflow from financing activities) to save it.

In the years that followed, Chrysler's cash position improved. The

corporation paid off the majority of the loans and outstanding debts from
the US and Canadian governments in May 2011 (cash used for financing
activities).

Restructuring Chrysler through Bankruptcy

Alexander Nye, “Restructuring Chrysler through Bankruptcy,”
PRELIMINARY YPFS DISCUSSION DRAFT, March 2020,
https://ypfsresourcelibrary.blob.core.windows.net/fcic/YPFS/2
020-03-17%20Nye%20Chrysler%20Bankruptcy_Preliminary_D
raft.pdf, last accessed on April 28 2022.

4.2. Preparation of a Statement of Cash Flows 15

Unit 4: Statement of Cash Flows

Keep in Mind

● The Statement of Cash Flows is a formal report that categorizes cash inflows (receipts)
and outflows (disbursements) into an entity's operating, investing, and financing
activities over a certain period. It is prepared through direct and indirect methods.
● The difference between the direct method and the indirect method lies in the
presentation of the cash flows from operating activities.
● The direct approach records cash receipts and payments from specified operating
transactions (i.e., every action in the entity's normal operation, such as customer
collections, payment of running expenses such as salaries, utilities, and supplies, and
interest on bank deposits, among others).
● Companies that use the accrual method rather than the cash method in their
accounting system typically use the indirect approach. This format starts with net
income and reconciles the actual cash flows from operating activities based on the
noncash items and increases/decreases in the balance sheet line items.

4.2. Preparation of a Statement of Cash Flows 16

Unit 4: Statement of Cash Flows

Try This

Modified True or False. Write true if the statement is correct. Otherwise, write false, then
correct the statement by replacing the underlined word or phrase to make the statement
true.

________________ 1. The Statement of Cash Flow provides an analysis of cash inflow

due to operating, investing, and financing activities.

________________ 2. Drawings are added to the owner’s equity account.

________________ 3. Cash payments for bank loans are reported under cash flows
from operating activities.

________________ 4. A company's ability to create cash is harmed by negative cash

flow from investing activities.

________________ 5. Cash receipts from the selling of goods and the provision of
services increase the cash inflow.

________________ 6. The indirect method of preparing SCF records the gross cash
receipts and payments from operating, investing, and financing
activities.

________________ 7. The Statement of Cash Flows reports all transactions.

________________ 8. The indirect method is used by companies that use the accrual
method in their accounting system.

________________ 9. The indirect method starts with the net income and makes
adjustments to reconcile these with actual cash flows.

________________ 10. New investments from owners or withdrawals are listed under
the financing activities.

4.2. Preparation of a Statement of Cash Flows 17

Unit 4: Statement of Cash Flows

Practice Your Skills

Preparing a Statement of Cash Flows

Based on the given data, prepare a Statement of Cash Flow. Use the space below to write
your answer.

A. Mariette’s sari-sari store had the following transactions during the year:

Purchase of goods for cash ₱ 100,000

Sale of goods for cash 150,000

Paid utilities 30,000

Paid rent 10,000

Sold equipment for cash 100,000

Owner withdraws from investment 10,000

1. How much is the net cash flow from operating activities?

4.2. Preparation of a Statement of Cash Flows 18

Unit 4: Statement of Cash Flows

2. How much is the net cash flow from investing activities?

3. How much is the net cash flow from financing activities?

4.2. Preparation of a Statement of Cash Flows 19

Unit 4: Statement of Cash Flows
4. Using the information above, prepare a Statement of Cash Flows of Mariette as of
December 31, 2020. Assume that the beginning cash balance is ₱ 20,000.

4.2. Preparation of a Statement of Cash Flows 20

Unit 4: Statement of Cash Flows
B. Prepare a Cash Flow Statement for Rocky Corporation based on the information
below, highlighting its operating, investing, and financing operations. You must
demonstrate that Rocky Corp's cash balance at the end of the period is reconciled.

Rocky Corporation
Rocky's cash account has a starting sum of ₱129,937.50. The company's year-end
balance is ₱254,925. The table below summarizes the transactions from Rocky
Company's account.

Customers' funds were received in cash ₱ 725,175.00

Payments to providers 300,547.50

Other operational expense payments 58,850.00

Salary payments 19,992.50

Equipment purchase 253,000.00

Equipment for delivery was sold. 6,875.00

Proceeds from the sale of computer hardware 42,762.50

Owners' withdrawals 229,350.00

Proceeds received through a bank loan 82,500.00

Owners' contributions 137,500.00

The data in the table above is drawn from Rocky Corporation's financial statements.
Calculate the amount of money the company got from its consumers using this
information. Does your response correspond to the table's summarized data from
the cash account? If you answered yes or no, then show your solution.

4.2. Preparation of a Statement of Cash Flows 21

Unit 4: Statement of Cash Flows

4.2. Preparation of a Statement of Cash Flows 22

Unit 4: Statement of Cash Flows

Challenge Yourself

Answer the following questions:

1. What is the difference between direct and indirect methods of preparing the SCF?
_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

2. What are the advantages and disadvantages of using the direct method in preparing
the Statement of Cash Flows?
_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

3. What are the advantages and disadvantages of using the indirect method in
preparing the Statement of Cash Flows?
_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

_________________________________________________________________________________________

4.2. Preparation of a Statement of Cash Flows 23

Unit 4: Statement of Cash Flows

Photo Credit
cash-register-printer-receipt-store-5610295 by PhotoMIX-Company is licensed under
Pixabay License via Pixabay.

Bibliography
Binuya, Maria Veronica Joy M. Fundamentals of Accountancy Business and Management Book
2. Pasay City: JFS Publishing Services, 2016.

Camerino, Danilo S. & Acol, Arcadio B. Fundamentals of Accountancy Business and

Management 2. Makati City: Diwa Learning Systems Inc., 2020.

Tuovila, Alicia. “Direct Method.” Investopedia. Last modified August 15, 2020.

Tuovila, Alicia. “Indirect Method.” Investopedia. Last modified July 16, 2022.

Warren, Carl S., Reeve, James M., and Duchac, Jonathan. Accountancy, Business, and
Management 2. Quezon City: Abiva Publishing House, Inc., 2017.

4.2. Preparation of a Statement of Cash Flows 24