16.1 – Purpose of the Statement of Cash Flows
16.2 – Cash and Cash Equivalents Defined
Cash: money in coins or currency or in a bank account that is available upon demand.
Cash equivalent: Convertible into a specific amount of cash within a short period of time and low risk.
16.3 – Structure of The Statement of Cash Flows
The statement of cash flows has three sections:
16.4 – Operating Section
The operating section is focused on cash inflows and outflows from primary operations which impacts current assets and current liabilities.
Two methods can be used to prepare the operation section: the indirect method and the direct method.
16.5 – Operating Section: Indirect Method
The indirect method begins with net income as reported on the income statement. We then adjust that amount by adding or subtracting non-cash accounts that were originally used to calculate net income.
The following chart summarizes these adjustments based on account:
|Add to Net Income||Deduct from Net Income|
|Amortization of intangible assets|
|Decrease in receivables||Increase in receivables|
|Losses on Assets||Gains on Assets|
|Decrease in inventory||Increase in inventory|
|Increase in accounts payable||Decrease in accounts payable|
|Increase in accrued liabilities||Decrease in accrued liabilities|
|Decrease in prepaid expenses||Increase in prepaid expenses|
|Increase in income tax payable||Decrease in income tax payable|
16.6 – Operating Section: Direct Method
The direct method is quite simple in theory: We take the operating cash inflows and then subtract the operating cash outflows.
Step 1: Add up Cash Received from Customers
Step 2: Subtract Cash Payments to Suppliers
Step 3: Subtract Cash Payments for General Expenses
Step 4: Less Cash Payments for Income Taxes
16.7 – Investing Section
The investing section shows changes in cash inflows and outflows that relate to a company’s long-term assets, such as, fixed assets or investments.
Step 1: Add up all Investing Cash Inflows
Step 2: Subtract all Investing Cash Outflows
16.8 – Financing Section
The financing section of the statement of cash flows shows cash inflows and outflows related to stockholder’s equity and long-term liabilities.
Step 1: Add up all Financing Cash Inflows
Step 2: Subtract all Financing Cash Outflows
16.9 – Disclosure of Noncash Activities
Noncash activities often impact the financing and investing section of the statement of cash flows. These are transactions which indirectly impact cash inflows or outflows and don’t directly impact cash. Noncash activities must be disclosed.
16.10 – Statement of Cash Flows Financial Ratios and Analysis
Two important ratios to understand: operating cash flow and cash debt coverage.
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
Cash Debt Coverage = Operating Cash Flow / Average Total Liabilities