In this presentation, we will take a look at classifications of cash flows on the statement of cash flows, there’s going to be three major categories on the statement of cash flows. Those will be operating activities, investing activities, and financing activities. So our goal here, when we go through the statement of cash flow as we work through the statement of cash flows is going to be in part to decide which area these cash flows should go, should they go into operating, investing or financing. It’s going to be common questions and common problems and really just information we need to know when reading the statement of cash flows. So we’ll start off with the operating activities. We’re just going to look at the major components of the cash flows within the operating activities. So we’ll talk about inflows and outflows. Remember what we’re talking about here is cash. So when we’re talking about the statement of cash flows, we’re talking about cash flows, the cash that goes into the company, they cashed out goes out to the company. We’re going to talk about inflows and outflows here related to operating activities. Before we go into the list of inflows and outflows related to operating activities, we want to know first, that operating activities is going to be similar to us thinking about the income statement on a cash basis. So when we think about the operating activities were really thinking or one way to think about it would be that if we were to have the income statement on a cash basis, then what would the inflows and outflows be that’ll basically be what are in the operating activities when we get to the thought process in terms of how to determine operating investing and financing activities.
We’ll go more through that in the thought process. But just note, operating activities you want to tie out in some way to income statement on not an accrual basis as a normal income statement, but a cash basis. So any kind of sales then, of course, would be the operating activities to sales related to cash sales or sales from collection on credit sales. So in other words, that would be sales from a cash flow basis, that would be the major component of the operating activities. And that would include the sales that would be cash sales that we made now, and sales that we collected on. So if we made a sale in the past say last month, we made a sale or last year. Let’s say we made a sale on account. We did the work recorded revenue last year, but we got the cash this year from the accounts receivable, we reduced accounts receivable and recorded the revenue this year. I mean, recorded the cash when we got the cash this time. Well, from a cash flow statement, of course, the cash was received now this year, even though the work was done last year, so that would be from a cash flow perspective, cash flow this year from the sale that happened last year. On the outflow side, we’d have payments for operating expenses. So that would be the typical outflow and again, you can think of it as a comparison to the income statement, where we would record the expense when we incur It in accordance with the matching principle.
But here, of course, we’re talking cash flows. And so the expenses that we have similar to the income statement, we’re going to record them here when the cash goes out whether they be for expenses that we paid at the same time as we consumed the expense. Or if they went through accounts payable, meaning for example, if last year, we paid for an expense, and then we didn’t pay for it last year, when we put it on account, we had an expense that we put on account into accounts payable and pay for it this year, because we’re paying off the payable, then that would be included in the cash flow this year, although it would not be an expense because we recorded the expense last year, when we incurred the expense, not when we paid for it. So you can see that relationship here. These are going to be items that are in the revenue cycle, meaning revenue and income and expenses are going to be our typical cash flows. For the operating activities, however, on a cash basis, rather than an accrual basis, we’re kind of converting the accrual basis to a cash basis for the operating activities. Now, there’s two ways that we can do that. We can do that with a direct method and an indirect method. We’ll talk about that later. But just note now that when we talked about those two methods, they apply only to the operating activities. Now we’re going to go to the investing activities, same things inflows and outflows for investing activities. Now note that when we look at cash inflows and outflows, we’re hoping that most of the activity like a lot of the action that’s happening is probably going to be in the operating activities because that’s what our normal operations are.
But we have other type of activities that we’ll be dealing with other areas income, investment activities, and financing activities. And these are the things you might want to think about in terms of the way I would think about it is if you think of the normal journal entries related to something Is there an income statement account of involved in it? If it is, then you probably have something dealing with an operating activity. If not, then you probably have something dealing with investing, or in financing. So we’ll talk more about that later. But just get an idea of that now. So sales of property, plant and equipment. This is often one that was confusing when I first learned the statement of cash flows because property plant and equipment is going to be an asset and we’re using the term investment activities here. So note that when you think about investments, you may be thinking, like I used to have just stocks and bonds as like the types of investments and property plants and investment vestments is a fixed asset. It’s not it’s not in the same category.
But in another sense, it is, you know, all assets that we have on the balance sheet are investments in a sense, because that’s why we bought them that we bought them in order to help us generate revenue in the future. They’re not helping us generate revenue now. That’s why they’re assets that’s why they’re on the books. As assets, we’re investing in them now. We put the cash, we, you know, we got the cash, we left the cash, we spent the cash, and we got something else we didn’t expend it now we didn’t get an expense and consume something, we got an investment, in this case in property, plant and equipment. So anything so you can see the journal entry, we, if we were to buy it with cash, we would credit cash, debit property, plant and equipment, an asset, neither of those two accounts, our income statement accounts, even if we financed it and got alone, it would be a liability. So therefore, it’s not going to be an operating activity. That’s one way you can think about it and say, Hmm, probably not an operating fair will leave you with investing or financing. And it’s going to be an investing activity because we’re investing in the equipment. And then we have the sale of long term investments. So if we have an investment on the books as an investment, possibly stocks, then we could sell the investment, and then that would be an investing activity as well.
That’s probably one that would come to mind as an investment. type of activity if we bought and sold our long term investments, if we go to the outflows, then we have the purchase of intangible assets. And we’ve got the purchase of property, plant and equipment. So once again, note that anything dealing with property, plant and equipment is going to be on the investments portion. And you can think of that journal entry again, what’s going to be the major journal entries related to property, plant and equipment? Well, we buy it, which would be a debit to property, plant and equipment, credit to cash, possibly a credit to a notes as well to finance it. None of them have to do with the income statement, and therefore it’s going to be something else either investing or financing in this case investing or you can just memorize property, plant and equipment is going to be investing we’re investing in something. When we sell the property, plant and equipment also, we we’re going to we’re going to debit cash, we’re going to credit property, plant and equipment that we might have a gain or loss. And you might think well that’s kind of a, you know, what do we do with that? That’s on the income statement. But really the main components are going to be balance sheet type of accounts there will talk about the gain or loss when we get to that information. But note that anything dealing with property plant and equipment typically will be investing whether we be buying it or selling it. And then we have the purchase of investments. And once again, that would be more of an investment activity clearly because we’re purchasing investments, possibly stocks or bonds that we’re investing into. And that would be part of the investing activities. Then we have the financing activities, the final component we’ll be taking a look at, we’ve taken a look at operating, investing and now financing, that’s going to include issue of common and preferred stock.
So when we issue stock, that’s going to be something that deals with the owner. So the owner, we’re issuing the stock to the owners, it’s kind of like an initial investment from the owner. So that’s going to be a financing type of activity. And then we have the reissuing of treasury stock. So if we had to treasury stock, financing activity, Then the issue of debt. So if we had debt that we’re going to be dealing with, then also financing activity. Note that these types of entries again, don’t deal with anything on the income statement. Typically, when we have the inflow for the issuance of stock, for example, we would be debiting the cash but not crediting income, we would be credited common stock or additional paid in capital and or additional paid in capital. So there’s no income statement account involved in that. So typically, we would say, okay, it’s not going to be operating. And therefore it needs to be something with investing or financing. And these two note, we’re not dealing with anything in terms of an asset. We’re not giving the cash away, to buy an asset that we’re investing into the future. We’re financing the company the point of this is to get the cash in the company to get capital to get cash and or paying back that capital or cash that we use to finance the company.
In the past, so that’s going to be the financing activities, then we have the outflows or owner’s contributions as well. So note here, when we have the contributions, if it’s a corporation, that would be the common stock, we would issue common stock, that would be like an owner investment because we would be getting more owner investment. If we’re sole proprietorship or partnership, then the owners would be investing their money back into the company. And we would debit cash and credit their capital account, another type of owner investment for that type of business entity, and then we’ve got the paying dividends. So when we pay back the dividends, that’s going to be part of the financing activities. And note again, what’s happening here is we’re crediting cash, and we’re debiting retained earnings or dividends. Neither of those two things are dealing with the income statement and neither of them are dealing with something we’re investing in in terms of an asset. They’re part of the financing activities. And then we have the purchase of treasury stock and the payment withdrawals. These two are similar again, this being for a corporation when we pay the owners back, this being for a sole proprietorship or partnership when we pay the owners back, and then when we pay the debt when we pay off the debt, same type of activity again, neither of the accounts we’re going to credit cash to pay off we’re going to debit a liability to note payable to pay off so it’s not typically operating typically going to be financing