Professional Documents
Culture Documents
Operating Section:
The operating section of the statement of cash flows will represent
the cash inflows and outflows from operating activities. There are
two methods of preparing the operating section of the statement of
cash flows that you should be familiar with, the direct method and
the indirect method.
Direct Method – US GAAP prefers that the operating section of the statement of cash flows
be prepared under the direct method. Generally, the direct method will begin with the
amount of all cash received from customers and subtract the amount of cash that has been
used for operating expenses. Additional factors such as depreciation and amortization will
be excluded when using the direct method.
Indirect method - most companies prefer the use of the indirect method. The indirect
method is used more as a reconciliation of cash, and while the direct method begins with
the amount of cash received from customers, the indirect method will begin with the
company’s net income amount. The key difference is that net income will be adjusted for
non-cash items such as depreciation and amortization. Additionally, the indirect method will
add losses and subtract gains as they are non-operating amounts.
Please note – the ending balance of both the investing section and the financing section will
result in the same amount, regardless of the method used in preparing the operating
section of the statement of cash flows.
Increases to cash flows from operating activities - Increases in net cash flows from operating
activities will indicate that a company will be receiving more cash from the ordinary course
of business activities.
Decreases in cash flows from operating activities - Decreases in net cash flows indicate the
expenditure of more cash from the ordinary course of a company’s business operations.
Losses – Losses are adjusted out of the operating section of the statement of cash flows
and moved into the investment section. This will be added to net income.
Investing Activities:
Investing activities represent a company’s cash flows from the acquisition or sale of
noncurrent assets. Furthermore, the investing section will include loans extended to other
entities, the purchase or sale of available-for-sale and held-to-maturity securities, and the
acquisition or a subsidiary or business unit under the equity method or acquisition method.
Financing Activities:
Financing activities will include cash flows from debt and equity activities. Additionally, the
issuance of equity (e.g., common or preferred stock) would result in an increase in cash on
the statement of cash flows, whereas the acquisition of equity would result in a decrease in
cash. The issuance of debt (e.g., sale of bonds) would result in an increase to cash, whereas
the purchase of debt or the repayment of debt (principal only) would result in a decrease in
cash. This section will include the following:
Conclusion:
The CPA exam will really test whether you understand which section (operating, investing, or
financing) certain items should be classified to. The mental map below is meant to highlight
the key activities that students typically confuse and where the exam might try and trick you!