Professional Documents
Culture Documents
1. The basic financial statements (income statement, retained earnings statement and
the balance sheet) are prepared under the accrual basis. Under this basis revenue
is recorded when earned and expenses are recorded when incurred. These basic
financial statements were difficult for managers to utilize since you could
possibly have a high level of income but a low level of cash since under the
accrual basis concept, the revenue was recorded when earned and not when it was
received.
2. Does net income under accrual basis equate to high levels of cash? NO Why?
(a) The revenue could be awaiting collection in the form of receivables on the
balance sheet
(b) Investment is made in plant and equipment will require the use of cash
but does not reduce income, since the equipment is an asset. When will
the cost of the equipment acquisition be recovered? The recovery of the
initial acquisition of the equipment begins, and the reduction of income
occurs, as the equipment is being depreciated.
(d) Payment of liabilities for general operating expenses. The payment of the
liability reduces cash but does not reduce net income when paid.
3. Therefore a company could be profitable under accrual basis accounting and have
a significant cash flow problem.
4. Cash is the necessary element which runs the business. We need to know where
the cash comes from (sources, or inflows) and where it is spent (uses or outflows).
5. Presenting a comparative balance sheet and income statement does not show any
details of what occurred during the year. All we know is the beginning and
ending balances. We can derive a net change based upon dollar amount and
percentages but the details are not disclosed.
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6. Therefore to obtain informative data relations to cash a separate statement must be
prepared and analyzed.
9. As part of the budgeting and planning process, budgeted financial statements and
the SCF should be prepared during the last quarter of the current year for the
forthcoming year.
This allows management to budget and predict the cash inflows and outflows on a
monthly basis.
The early identification of potential cash overages and/or shortages will allow
management to plan better.
10. The actual reporting results per the SCF should be compared with the budgeted
statement and investigate unusual favorable or unfavorable variances in an effort
to increase operational efficiency.
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11. When preparing the SCF what sources should be analyzed?
- Income statement
- Balance sheet (comparative)
- Retained earnings
- General ledger for specific details affecting accounts
detected by the examination of the appropriate financial
statements
- Inquires of management
- Minutes of Board of Directors meetings
13. The SCF can be prepared using the direct or indirect method.
NOTE: This method relates to the preparation of the SCF operating activities
section.
The investing and financing section is completed the same way regardless if the
indirect or direct method is used.
b. Starts with net income (accrual basis) and reconciles to cash provided or
used by operating activities.
d. Used by the majority of the companies that prepare annual reports as per
Accounting Trends and Techniques (Book which summarizes all the
reporting practices of the Fortune 100 Companies)
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CASH FLOW CLASSIFICATIONS
1. OPERATING ACTIVIES (Cash received and paid in the daily operations of the
business)
- Cash effects of revenue and expense transactions
- Deal with the income statement accounts
- Included interest paid (on debt) and income taxes (to the
government) which enters in the determination of net
income
- Cash receipts from sales of good and services,
miscellaneous income
- Cash payments for inventory, wages, insurance, utilities,
rent
- Changes in current asset and liability accounts from the
prior year.
Note: The majority of cash inflows should come from the operating activities section.
This indicates that the company is able to generate cash to satisfy its current operating
performance.
2. INVESTING ACTIVIES
a. Investing in your own company
- Cash flows arising from purchases and disposals of plant
assets and/or investments (which are not considered as cash
equivalents)
3. FINANCING ACTIVITIES
- Cash flows between an organization and its owners
(stockholders) and creditors who lend money to the
business.
- Proceeds of borrowings from creditors
- Proceeds from issuance of stock and/or bonds
- Retirement of notes, bonds, mortgages
- Cash dividends paid to stockholders
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- Repurchase of stock (treasury stock) and subsequent
reissue
- Withdrawals paid to owners
- Excludes interest paid on the debt
- NOTES: 1.The decision to finance the business through debt is a financing activity. However,
the cash to pay for the interest comes from operating activities.
2. Income taxes are paid from operating activities
3. Dividends received on investment activities
Used to report transactions that are investing and/or financing activities but do not bring
in or use up any cash. These transactions need to be reported because they will affect
cash flows in the future.
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NOTES: (1) In general, only investments purchases within three
months of their maturity dates satisfy these criteria
(2) Examples include: short term investment in the US, treasury
bills, commercial paper (short term corporate notes payable)
and money market funds.
(3) Cash payments to purchase cash equivalents and cash
receipts from selling cash equivalents do not appear on the
statement of cash flows.