Accounting-Statement of Cash flows

investing activities

section of the statement of cash flows includes the cash inflows and outflows related to the purchase and sale of long-term assets and investments.

The indirect method:

starts with ACCRUAL BASIS net income then makes a series of adjustments to convert it to a CASH BASIS net income.

Liquidity

the ability of a business to pay its debts as they come due • One measure of liquidity is the current ratio. • A disadvantage of the current ratio is that it uses year-end balances of current assets and current liabilities (may not be representative of a company's position during most of the year.)

KEY POINT:

Not all accounts on the income statement have a cash effect. In other words, we have some revenues and expenses which do not result in an inflow or outflow of cash. Three Examples of Non-Cash Revenues and Expenses: 1. Depreciation Expense 2. Losses 3. Gains NOTE: These items should be ignored when using the direct method to calculate net cash provided by operating activities!

Assessing Liquidity Using Cash Flows

Rather than using numbers solely from the balance sheet for assessment purposes, we will use numbers from the statement of cash flows and from balance sheets at several points in time. The ratios are cash-based instead of accrual-based.

Under IFRS, interest paid to creditors is classified:

either an operating or a financing activity, but treated consistently from period to period.

Direct Method details:

• The FASB prefers the direct method but allows the use of either method. • When the direct method is used, the net cash flow from operating activities as computed using the indirect method must also be reported in a separate schedule. • The direct method involves listing each specific cash flow. An example is shown on the next slide.

The indirect method details

• The indirect method is used extensively in practice. • Most companies favor the indirect method for the following reasons: • It is easier to prepare. • It focuses on the differences between net income and net cash flow from operating activities. • It tends to reveal less company information to competitors. • The indirect method starts with net income and makes a series of adjustments to convert the accrual net income into cash net income. An example is shown on the next slide.

The operating activities section of the statement of cash flows can be presented in two different ways: 1. Direct Method 2. Indirect Method

• Both methods arrive at the same total amount for 'net cash provided (used) by operating activities'. • The methods differ in disclosing the items that make up the total amount. • The choice of methods affects only the operating activities section; the investing and financing activities sections are the same.

Three cash flow categories

-operating activities -financing activities -investing activities

• Cash inflows:

- From sale of goods or services - From return on loans (interest received) and on equity securities (dividends received

Question: If the income statement reports sales revenue of $1 million, does that mean the company collected $1 million dollars from customers?

Answer: No!!! Sales could have been made on account.

The major purpose of the operating activities section of the cash flow statement is to

Convert net income from an accrual basis to a cash basis • The net cash provided (used) by operating activities represents what the net income of the company would have been had the company used a cash accounting basis rather than accrual accounting. • This conversion can be done by two methods: 1. Direct method 2. Indirect method

More indirect method stuff

The direct method lists each individual cash inflow and cash outflow for all items appearing on the income statement. This method will require use to analyze t-accounts to calculate the amount of each individual cash flow.

operating activities section

is the cash effect of all items appearing on the income statement (the cash effect of transactions that create revenues and expenses and thus enter into the determination of net Income)

RELEVANT FACTS

Companies preparing financial statements under IFRS must prepare a statement of cash flows as an integral part of the financial statements. Both IFRS and GAAP require that the statement of cash flows should have three major sections—operating, investing, and financing—along with changes in cash and cash equivalents. Similar to GAAP, the cash flow statement can be prepared using either the indirect or direct method under IFRS. For both IFRS and GAAP, most companies use the indirect method for reporting net cash flow from operating activities. Statement of Cash Flows - Module 7 RELEVANT FACTS IFRS requires that non-cash investing and financing activities be excluded from the statement of cash flows. Instead, these non-cash activities should be reported elsewhere. This requirement is interpreted to mean that non-cash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under GAAP, companies may present this information in the cash flow statement.

The process to follow in calculating net cash provided by operating activities:

1. For each item on the income statement, determine a corresponding balance sheet account (i.e., sales revenue on the income statement will match up with accounts receivable on the balance sheet). 2. For these balance sheet accounts, draw a t-account and analyze it to determine the cash effect of the income statement item.

Question: How does the statement of cash flows differ from the other major financial statements?

Answer: The other financial statements (i.e., the income statement and balance sheet) are based on ACCRUAL ACCOUNTING (the realization principle and the matching concept) whereas the cash flow statement simply shows all of the increases and decreases in CASH.

statement of cash flows

shows the changes in cash for the same period of time as that covered by the income statement. The cash flow statement shows all sources (i.e., receipts) of cash and all of the uses (i.e.payments) of cash. It provides information about: • Cash receipts (inflows) • Cash payments (outflows)

• Cash outflows:

- To suppliers for inventory - To employees for services - To government for taxes - To lenders for interest - To others for expenses

The cash flow statement helps users assess:

1. Ability to generate future cash flows. 2. Ability to pay dividends and meet obligations. 3. Why net income is different from operating cash flows. 4. Cash investing and financing transactions.

Under GAAP, which of the following would be an example of a cash flow from operating activities?

Payment of cash to lenders for interest.

Which of the following would be an example of a cash flow from investing activities?

Receipt of cash from the sale of equipment.

Significant Non-cash Activities

Significant financing and investing activities that do not affect cash are reported in either a separate schedule at the bottom of the statement of cash flows or in the notes to the financial statements. Examples of significant non-cash activities include: Issuance of common stock to purchase assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges on long-lived assets.

CASH FLOW ANALYSIS

1. The firm should have positive cash flow provided by operating activities. The operating activities are the operations of the company. If there is a negative cash flow here, then it is costing the company more money to operate the business than they are bringing in - not a good thing. A net negative cash flow from operations would indicate the company had a net loss using the cash basis of accounting (meaning they spent more cash on operations than they generated from their operations). 2. The company should have a negative cash flow (i.e., cash used) from investing activities. A negative cash flow here indicates the company is re-investing in itself in order to grow and expand. A positive cash flow here would indicate the company is selling off its long-term assets which is not a good sign for financial health. 3. The cash flows from financing activities can be either a positive net cash flow or a negative net cash flow.