Let’s review Sunny Sunglasses Shop’s sample cash flow statement example step by step to understand how each transaction affects cash.
Notice that the sample cash flow statement begins with net income of $15,283 as reported on the 2010 profit and loss statement and ends with the cash balance of $41,383 as reported on the 2010 balance sheet analysis page. The statement of cash flows therefore reconciles net income for the year with the ending cash balance on the balance sheet.Sample Cash Flow Statement
The $41,383 as reported on the December 31, 2010 company balance sheet also represents the net change in cash for the period of 2010 since Sunny began his business in 2010, and the beginning cash balance was $0. This net change in cash is also reflected on the sample cash flow statement.
For a complete description of the purpose and use of each section in the statement of cash flows, see the statement of cash flow purpose and format.
Accounts receivable represents sales to customers on account, and not for cash actually received for the sale. Because net income includes this amount in sales and net income, we subtract this increase in accounts receivable for the year to determine actual cash received. Had the balance of accounts receivable decreased, the decrease would indicate a cash payment on the account which the income statement does not report, and we would add it as an actual cash receipt.
An increase in inventory represents products purchased for sale, and therefore decreases the cash balance. Since the inventory for the period increased from zero to $5,625, and inventory is not part of the income statement, we subtract this amount on the sample cash flow statement since it represents cash paid in operations for inventory.
The sample balance sheet for 2010 had a balance of $2,400 for prepaid expenses. This amount represents insurance on the business paid for the full year. The business reported the $2,400 at the beginning of the year as an asset for future use. By year end, the total amount expensed equaled $2,400, so the asset reported on the December 31 Balance Sheet is now zero.
Any prepaid expense amount represents what the business paid in cash for an asset for future use. We would subtract prepaid expenses in cash operations since the business would not report it on the income statement as an expense, but the business already paid for it. Since the company already expensed the item completely by year-end, and the prepaid amount is now zero at year-end, the amount paid in cash and the amount reported on the income statement are equal ($2,400), and no adjustment to cash is necessary.
Accounts payable represents inventory or other items purchased for which the business did not actually pay cash. Rather, the business promised to pay in the future by purchasing items on account. Therefore, an increase in accounts payable for the year is added back to cash on the sample cash flow statement. Inventory purchased in the operations section decreased cash. Since part of the inventory was purchased on account, we add this amount back to cash.
The statement of cash flows is formatted based on purchases or sales classified as investing and financing activities. This means that even if an asset is purchased with financing, the entire amount of the asset is shown in the investing section, and any amount financed is shown separately to determine the actual cash outlay.
For example, the purchase of a company vehicle for $12,800 and land for $20,000 represent a total cash outlay of $32,800 in the investing section.
The statement of cash flows includes both assets purchased in the investing section, as well as amounts used to finance purchases in the finance section. Since the company actually borrowed $8,800 to finance the purchase of the automobile reported in the investing section, and $18,000 to finance the purchase of land also reported in the investing section, these amounts are added back to cash since they do not represent cash paid for the assets acquired.
The company actually paid a total of $2,000 for the land, and $4,000 for the automobile, which represents the net cash paid for the investing and financing activities of these two items.
Finally, the financing section also includes any amount the owner invested into the business. Sunny started the year by investing $50,000 into his new business. This represents actual cash received for the year.
The total cash received and paid during the year equals the total net change in cash for the year of $41,383. The different examples for cash flow statements may sometimes follow a different format but always come to the same result: the difference between the beginning balance of cash on the balance sheet for the period, and the ending cash balance.