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Summary of Investing and Financing Transactions on the Cash Flow Statement
Investing and financing transactions are critical activities of business, and they often represent significant
amounts of company equity, either as sources or uses of cash. Common activities that must be reported as
investing activities are purchases of land, equipment, stocks, and bonds, while financing activities normally
relate to the company’s funding sources, namely, creditors and investors. These financing activities could
include transactions such as borrowing or repaying notes payable, issuing or retiring bonds payable, or
issuing stock or reacquiring treasury stock, to name a few instances.
16.4 Prepare the Completed Statement of Cash Flows Using the Indirect
Method
In this section, we use the example of Virtual Co. to work through the entire process of preparing the
company’s statement of cash flows using the indirect method. Virtual’s comparative balance sheet and income
statement are provided as a base for the preparation of the statement of cash flows.
Y O U R T U R N
Cash Flow from Investing Activities
Assume your specialty bakery makes gourmet cupcakes and has been operating out of rented facilities in
the past. You owned a piece of land that you had planned to someday use to build a sales storefront. This
year your company decided to sell the land and instead buy a building, resulting in the following
transactions.
What are the cash flows from investing activities relating to these transactions?
Solution
Note: Interest earned on investments is an operating activity.
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Review Problem: Preparing the Virtual Co. Statement of Cash Flows
Figure 16.6 Comparative Balance Sheet. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-
SA 4.0 license)
972 Chapter 16 Statement of Cash Flows
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Figure 16.7 Income Statement. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0
license)
Additional Information
The following additional information is provided:
1. Investments that originally cost $30,000 were sold for $47,500 cash.
2. Investments were purchased for $50,000 cash.
3. Plant assets were purchased for $66,000 cash.
4. Cash dividends were declared and paid to shareholders in the amount of $8,000.
Directions:
Prepare the statement of cash flows (indirect method), for the year ended December 31, 2018.
Chapter 16 Statement of Cash Flows 973
Figure 16.8 Statement of Cash Flows. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA
4.0 license)
16.5 Use Information from the Statement of Cash Flows to Prepare Ratios to
Assess Liquidity and Solvency
Cash flow ratio analysis allows financial statement users to see the company’s liquidity position from a clearer
perspective. The ratios presented in this section focus on free cash flow, calculated as operating cash,
reduced by expected capital expenditures and by cash dividends payments. The free cash flow value is thus an
adaptation of cash flow from operating activities. The result obtained in the initial free cash flow calculation is
then used to calculate the free cash flow to sales ratio, which is the ratio of free cash flow to sales revenue,
and the free cash flow to assets ratio, which is the ratio of free cash flow to total assets. These three tools
give indicators about the company’s flexibility and agility, which equates to their ability to seize opportunities
in the future, as they arise.
974 Chapter 16 Statement of Cash Flows
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Free Cash Flow
Free cash flow calculations start with cash flows from operating activities, reduced by planned capital
expenditures and planned cash dividend payments. In the example case demonstrated, free cash flow would
be as follows:
Free cash flow calculation:
The absence of free cash flow is an indicator of severe liquidity concern for Propensity Company and could be
an early indicator that the company may not be able to continue operations. This could also be a one-time
occurrence, in a year where a large capital investment was planned, to be financed with resources from the
company’s capital reserves from previous years’ profits. In such a case, the negative free cash flow would not
be an issue of concern.
E T H I C A L C O N S I D E R A T I O N S
Cash Flow Analysis
Cash is required to pay the bills. All businesses need to have a clear picture of available cash so they can
plan and pay their bills. The statement of cash flows allows investors direct insight into the actual activity
on the company’s cash balances. Mark A. Siegel wrote in The CPA Journal that “as Wall Street analysts
have lost faith in earnings-based metrics in the wake of Enron, WorldCom, and others, many have
gravitated toward the cash flow statement. Companies are regularly evaluated on the basis of free cash
flow yield and other measures of cash generation.”[3] The operating cash flow ratio, and the cash flow
margin ratio, and the other cash flow–related metrics discussed allow an investor and other users of the
financial statements to analyze financial statement data to see a company’s ability to pay for current
debt and assess its operational cash flow to function as a going concern.[4] This helps investors and other
users of the financial statements ensure the veracity of a company’s financial statements and its ability
to pay its bills.
L I N K T O L E A R N I N G
This article by Investopedia presents information about how to use free cash flow (https://openstax.org/
l/50FreeCashFlow) to evaluate strengths of various businesses:
3 Marc A. Siegel. “Accounting Shenanigans on the Cash Flow Statement.” CPA Journal. March 2006. http://archives.cpajournal.com/2006/306/
essentials/p38.htm
4 Steven D. Jones. “Why Cash Flow Matters in Evaluating a Company.” The Wall Street Journal. August 11, 2016. https://www.wsj.com/articles/
SB997466275287616386. Miriam Gottfried. “Spoiler Alert for Netflix: Debt and Cash Flow Matter.” The Wall Street Journal. April 17, 2017.
https://www.wsj.com/articles/spoiler-alert-for-netflix-debt-and-cash-flow-matter-1492468397
Chapter 16 Statement of Cash Flows 975
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https://openstax.org/l/50FreeCashFlow
	Chapter 16. Statement of Cash Flows
	16.4. Prepare the Completed Statement of Cash Flows Using the Indirect Method*
	16.5. Use Information from the Statement of Cash Flows to Prepare Ratios to Assess Liquidity and Solvency*