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statement of cash flows
- A financial statement that lists cash inflows (receipts) and cash outflows (payments) during a period; arranged by operating, investing, and financing.
- Cash flows are defined to include both cash and cash equivalents.
must satisfy two criteria: (1) be readily convertible to a known amount of cash and (2) be sufficiently close to its maturity so its market value is unaffected by interest rate changes.
Activities that involve the production or purchase of merchandise and the sale of goods or services to customers, including expenditures related to administering the business.
- Transactions that involve purchasing and selling of long-term assets, includes making and collecting notes receivable and investments in other than cash equivalents.
- They also include (1) the purchase and sale of short-term investments in the securities of other entities, other than cash equivalents and trading securities and (2) lending and collecting money for notes receivable.
Transactions with owners and creditors that include obtaining cash from issuing debt, repaying amounts borrowed, and obtaining cash from or distributing cash to owners.
Noncash Investing and Financing
When important investing and financing activities do not affect cash receipts or payments, they are still disclosed at the bottom of the statement of cash flows or in a note to the statement because of their importance and the full-disclosure principle.
Computing the net increase or net decrease in cash
It equals the current period's cash balance minus the prior period's cash balance.
Analyzing the Cash Account
- A company's cash receipts and cash payments are recorded in the Cash account in its general ledger. The Cash account is therefore a natural place to look for information about cash flows from operating, investing, and financing activities.
- Individual cash transactions are summarized in this Cash account according to the major types of cash receipts and cash payments.
- Preparing a statement of cash flows requires determining whether an individual cash inflow or outflow is an operating, investing, or financing activity, and then listing each by activity.
Analyzing Noncash Accounts
all cash transactions eventually affect noncash balance sheet accounts. Thus, we can determine cash inflows and outflows by analyzing changes in noncash balance sheet accounts.
Information to Prepare the Statement
- usually comes from three sources: (1) comparative balance sheets, (2) the current income statement, and (3) additional information.
- Comparative balance sheets are used to compute changes in noncash accounts from the beginning to the end of the period. The current income statement is used to help compute cash flows from operating activities. Additional information often includes details on transactions and events that help explain both the cash flows and noncash investing and financing activities.
Presentation of net cash from operating activities for the statement of cash flows that lists major operating cash receipts less major operating cash payments.
Presentation that reports net income and then adjusts it by adding and subtracting items to yield net cash from operating activities on the statement of cash flows.
Application of the Indirect Method of Reporting
- Net income is computed using accrual accounting, which recognizes revenues when earned and expenses when incurred.
- Revenues and expenses do not necessarily reflect the receipt and payment of cash.
- The net income figure is adjusted to obtain the net cash provided or used by operating activities. This includes subtracting noncash increases (credits) from net income and adding noncash charges (debits) back to net income.
Adjustments for Changes in Current Assets and Current Liabilities
- Decreases in noncash current assets are added to net income.
- Increases in noncash current assets are subtracted from net income.
- Increases in current liabilities are added to net income.
- Decreases in current liabilities are subtracted from net income.
- Expenses with no cash outflows are added back to net income.
- Revenues with no cash inflows are subtracted from net income.
- Nonoperating losses are added back to net income.
- Nonoperating gains are subtracted from net income.
compute and report cash flows from investing activities
- Identify changes in (1) all noncurrent asset accounts and (2) the current accounts for both notes receivable and investments in securities (excluding trading securities).
- We then analyze changes in these accounts to determine their effect, if any, on cash and report the cash flow effects in the investing activities section of the statement of cash flows.
- Reporting of investing activities is identical under the direct method and indirect method.
Three-Stage Process of Analysis
- Information to compute cash flows from investing activities is usually taken from beginning and ending balance sheets and the income statement.
- We use a three-stage process to determine cash provided or used by investing activities: (1) identify changes in investing-related accounts, (2) explain these changes using reconstruction analysis, and (3) report their cash flow effects.
Steps for the Three-Stage Process of Analysis
- Analysis of Non-current Assets: identify and analyze
- Analysis of Other Assets: Many other asset transactions (including those involving current notes receivable and investments in certain securities) are considered investing activities and can affect a company's cash flows.
- Compute and report cash flows from financing activities
compute and report cash flows from financing activities
- Identify changes in all noncurrent liability accounts (including the current portion of any notes and bonds) and the equity accounts.
- These accounts include long-term debt, notes payable, bonds payable, common stock, and retained earnings.
- Analyze changes in these accounts using available information to determine their effect, if any, on cash.
- Results are reported in the financing activities section of the statement.
Three-Stage Process of Analysis
We again use a three-stage process to determine cash provided or used by financing activities: (1) identify changes in financing-related accounts, (2) explain these changes using reconstruction analysis, and (3) report their cash flow effects.
cash flow on total assets
- Ratio of operating cash flows to average total assets; not sensitive to income recognition and measurement; partly reflects earnings quality.
- Helps measure a company's ability to meet its obligations, pay dividends, expand operations, and obtain financing.
- Cash Flow from Operations/Average Total Assets
- This ratio reflects actual cash flows and is not affected by accounting income recognition and measurement. It can help business decision makers estimate the amount and timing of cash flows when planning and analyzing operating activities.