8 Statement of Cash Flow
Exploring Sources and Uses of Cash
Dr. Jacqueline Gagnon
Link to the Statement of Financial Position
I’d like to link what we know about the Statement of Cash Flows back to the fundamental accounting equation: assets = liabilities + equity. Remember that the Cash Flow Statement tells us about the change in cash and cash equivalents. Where is cash and cash equivalents found? Absolutely, these accounts are found on the Statement of Financial Position as current assets.
Back to the fundamental accounting equation. Let’s relate the change in cash and cash equivalents to the other elements of this equation. For brevity, I’ll refer only to cash, but cash equivalents would also be included in cash.
Assets = Liabilities + Equity
- We can also express the fundamental accounting equation as changes in elements. The change in assets equals the change in liabilities plus the change in equity.
This is how journal entries work. If you increase an asset like cash with a debit, you need a corresponding credit. Maybe you received cash from a customer on A/R, resulting in an increase and a decrease in assets: and . Or maybe you received cash through bank debt: assets and liabilities. In either case, the accounting equation balances because the left-hand side and right-hand side change by the same amount. So let’s represent these elements as changes, where this lovely triangle, delta: ∆, means change in….
∆A = ∆L + ∆E
- We are working on the Statement of Cash Flows, and cash is a current asset. So, let’s split cash out:
∆Cash + ∆Non-Cash Assets = ∆Liabilities + ∆Equity
- Now let’s look at the change in cash on its own. We want to know what makes up the change in cash. After all, that’s the whole purpose of the Statement of Cash Flow!
∆Cash = ∆Liabilities + ∆Equity –∆Non-Cash Assets
- Almost there. Let’s break the remaining elements into current and non-current. In just a minute we’ll categorize changes in cash into operating, investing, and financing activities, and you’ll see why current and non-current matter.
∆Cash = ∆Current Liab + ∆Non-Current Liab + ∆Equity – ∆Non-Cash Current Assets – ∆Non-Current Assets
- A little rearranging…
- Group current items together: current assets and current liabilities. Changes in current accounts affect operating activities.
- Then we have non-current assets. These are our long-term investments and PPE. Changes in these accounts are investing activities.
- Last are our non-current liabilities and equity accounts. Changes in debt and Common Shares, as well as dividends paid, are financing activities.
Let’s write this out:
∆Cash = ∆Current Liab – ∆Non-Cash Current Assets – ∆Non-Current Assets + ∆Non-Current Liab + ∆Equity
Tell Me More
Note here that net income consists of all three activities: operating, investing, and financing. We have seen this already. Operating activities result in operating income, and investing and financing activities result in peripheral income statement items which are found in other income and expenses; gains and losses.
So we see that the change in cash comes from operating, investing, and financing activities. And we’ve listed out the underlying accounts related to each activity. It deserves restating, so here it is:
*I know, this is strange, right? Shouldn’t interest expense be a financing activity, as a payment on debt? This is just convention so don’t try to make sense of it.
| Source/Use of Cash | Related Income Statement Accounts | Related Statement of Financial Position Accounts |
|---|---|---|
| Operating Activity | Sales, Cost of Goods Sold, Operating Expenses, Interest Expense*, Income Tax Expense | Current Assets (A/R, Inventory, Prepaid Expenses, Trading Investments), Current Liabilities (A/P, Salaries Payable, Unearned Revenue, Other Accrued Liabilities) |
| Investing Activity | Interest Income, Dividend Revenue, Gain (Loss) on Sale | Non-Current Assets (PPE, Non-Current Investments, Intangible Assets) |
| Financing Activity | None | Debt, Dividends, Common and Preferred Shares |