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The third financial statement to compliment the balance sheet & Income statement by providing information on major sources of cash receipts & payments. Purpose of CFS is to identify cash flows associated with the periods operations and also about the investing & financing activities during the period.
Income Statement .
Thus, periods income through I/S bears no direct relationship to the cash flows associated with periods operating, investing of financing activities of the organization.
Observations
Companies collapsed only months after their financial statements showed that they were managing good profits. (Nirlon & Machinery Manufacturer Corpn. In 1980s, W.T.Grant Company in 1970s). It is because there has always been a great difference between a companys earnings & cash generated from operations.
Important Terms
CASH: refers to currency on hand, demand deposits with banks or F.I.s & other accounts that let the customers deposit & withdraw funds at any time. CASH EQUIVALENTS: Refers to shortterm, highly liquid investments when it has an original maturity of 3 months or less.
The total change in cash is added to the beginning cash balance to yield the ending cash balance, which should match cash on the current Balance Sheet.
OPERATING ACTIVITIES
Principal revenue generating activities of the firm. Operating cash inflows: Include receipts from customers for sale of goods or services (including collection of debtors). Operating cash Outflows: Include payments to suppliers for purchase of materials & services, payments to employees for services, & payments to government for taxes & duties.
If non-cash items are not included in COGS or other expenses but are shown separately in I?S then there is no need to deduct them.
4. Extra ordinary item should be shown separately, from operating cash inflows and outflows.
It starts with net profit & adjusts it for revenue & expense items that did not involve operating cash receipts or payments in the current period to arrive at Net Cash flows from Operating Activities.
INDIRECT METHOD
To use Indirect Method, start with net income and adjust it for non-cash items like gains, losses & depreciation expenses. Then, make adjustments for all of the changes in CAs & CLs that occurred during the year (except Dividends Payable, which will be related to Financing Cash flows). Increase in CA Decrease in CA Increase in CL Decrease in CL (-) from Net Income (+) to Net Income (+) to Net Income (-) from Net Income
INDIRECT METHOD
Net Profit ADD: Depreciation/Amortization, Bad Debts; Loss on Sale of Fixed assets/ Investments; Decrease in (Inv/A.R/Pre-paid Expenses); Increase in (Creditors/ Payables*) DEDUCT: Excess provision for Depreciation written back; Gain on Sale of Fixed assets/ Investments; Increase in (Inv/A.R/Pre-paid Expenses); Decrease in (Creditors/ Payables*) Net Cash flows from operating Activities * Includes Accounts, Wages, Interest and Taxes payables but does not include Notes Payable or Current portion of long-term debt.
Sales (net) Cost of goods sold Gross margin Operating expenses Salaries and wages Depreciation Other Income from operations Interest expense Income before tax Tax expense Net income
RE, beginning $11,000 Add: NI 4,830 Less:Dividends (930) RE, end $14,900
These three financial statements have all the info you need for a simple Stmt of Cash Flows
INVESTING ACTIVITIES
Involve purchase & sale of fixed assets & investments. Cash receipts & payments are calculated by analyzing changes in the two Balance sheet amounts for F.As & Investments & the cash effect of transactions took place during the year. Interest & dividends received are also cash inflows from investing activities.
FINANCING ACTIVITIES
Involve raising of capital & repayment of loan. Cash inflows & outflows are computed by analyzing the changes in the B/S items for shareholders equity & loan funds; & considering cash effect of transactions took place during the year. Interest & dividends paid are a part of Financing activities of a firm.
Cash from Financing Activities Cash inflow from borrowing Payment of dividends Net cash inflow from financing
And here is what the entire statement looks like, in the Indirect Method
Statement of Cash Flows, Indirect Method Cash from Operating Activities Net income $4,830 Add: Depreciation 10,000 Decrease in Mktable securities 1,000 Increase in other current liabilities 2,000 Less: Increase in Accts Receivable (18,000) Increase in other current assets Decrease in Accts Payable Net cash outflows from operations Cash from Investing Activities Sale of investment in bond Purchase of land investment Net cash outflow from investing Cash from Financing Activities Cash inflow from borrowing Payment of dividends Net cash inflow from financing Net Change in Cash Cash, beginning balance Cash, ending balance (10,000) (1,000) ($11,170)
And here is what the entire statement looks like, in the Direct Method
Statement of Cash Flows, Indirect Method Direct Cash from Operating Activities Cash receipts Collections from customers $182,000 Cash payments To suppliers To employees Other payments Interest Taxes Cash from Investing Activities Sale of investment in bond Purchase of land investment Net cash outflow from investing Cash from Financing Activities Cash inflow from borrowing Payment of dividends Net cash inflow from financing Net Change in Cash Cash, beginning balance Cash, ending balance
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Instructions
With whom do you agree, Greg or Debra? Explain your position. Using the data provided, prepare a statement of cash flows in proper form using the indirect method. The only noncash items in the income statement are depreciation and the gain from the sale of the investment.