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1

The purpose of the statement of cash flows is to provide

a more detailed picture of what happened to a business’ cash during an accounting period. It shows the different areas in which a business used or received cash, and reconciles the beginning and ending cash balances.

2

The sections of a statement of cash flows are:

Operating Activities, Investing Activities, and Financing Activities.

3

The Cash Flows from Operating Activities section includes information on

cash used or received in the process of preparing and providing goods or services to customers. This section is closely tied to net income; it essentially shows what net income would be under the cash accounting method.

4

Typical cash flows from Operating Activities include the following:

Cash received from customers:

cash received from current period sales
cash collections from previous period credit sales
cash received in advance for future period sales


Cash paid to suppliers:

cash paid for current period operating activity purchases
cash paid for previous period credit purchases
cash paid in advance for future period purchases

5

There are two methods for preparing the operating section:

the direct method, and the indirect method.

6

Calculating the operating section of the statement of cash flows using the direct method:

take all of the cash collections from operating activities and subtract all of the cash disbursements from operating activities. This method uses transactional information that impacted cash during the period.

7

when using the indirect method, we start with

net income from the income statement and make adjustments to undo the impact of the accruals that were made during the period.

8

The Cash Flows from Investing Activities section of the statement of cash flows contains

cash flows relating to long-lived assets, such as property, plant, and equipment. Additional inflows and outflows that would be included in this section relate to loans made to another entity, called loans receivable, and certain investment securities.

9

The Cash Flows from Financing Activities includes

cash flows associated with raising and paying back money to investors and creditors. Dividends paid are included in this section under US GAAP, but under IFRS dividends paid may be included in the operating rather than the financing section. While interest paid is included in the operating section under US GAAP, it can sometimes be included here under IFRS.

10

A start-up will typically have:

Negative or very low cash flow from operating activities, negative cash flow from investing activities, and large fluctuations in cash flow from financing activities.


Operating: This often leads to negative or very low cash flows from operations. This is especially true if it takes a business longer to collect cash from sales than it has to pay its suppliers. In this situation, even if the business has a positive gross profit and net income, it could still have negative cash flows from operations. Some businesses spend years in this phase before achieving positive cash flows from operations.

Investing: The investing section is also likely to be negative for a startup. These businesses will be purchasing equipment and buildings, and since they are just getting started, they won’t often have equipment to dispose of to provide cash inflow.

Financing: The financing section can have large fluctuations for a startup. When a business has negative cash flow from operations and investments, it needs a source of cash to fund both of these activities as it grows and becomes more profitable. This money comes from the financing section. However, a company in the startup phase will often have difficulty raising funds from a bank because there is so much risk involved in a startup. Much of the financing will likely come from equity investments, either by the founders or outside equity investors. In some cases, a business may not need to raise money every year; it could raise a lot of money one year and then use it to purchase equipment and assets over multiple periods.

11

A profitable/growing business will usually have

A profitable/growing business will usually have positive cash flow from operating activities, negative cash flow from investing activities, and positive, negative, or neutral cash flow from financing activities.

Operating: Cash flow from operating activities will usually be positive. These businesses are generating cash receipts large enough to cover regular operating cash outflows and are growing at a slow enough rate that internally generated cash can cover the growth.

Investing: Continued growth means that machinery and equipment will need to be purchased. So, investing cash flows will usually be negative for growing companies because more is spent to purchase new equipment than is received from disposing of old equipment.

Financing: Financing cash flows could easily be positive or negative depending on how fast the business is growing and how much cash flow from operations it generates.

12

A mature company will generally have

A mature company will generally have positive cash flow from operating activities, slightly negative cash flow from investing activities, and negative cash flow from financing activities.

Operating: Operating cash flows will generally be positive for these businesses. They will have a consistent and steady stream of cash from revenue and will generally be one of the major players in their market.

Investing: Because they aren’t looking to grow or expand rapidly, cash flow from investing activities will generally be slightly negative as the new equipment being purchased replaces the equipment that has worn out.

Financing: Although it can fluctuate, cash flow from financing activities will generally be negative for mature companies. This is because they are generating cash through operations that is sufficient to cover their investment needs.

13

A business in decline will typically have

A business in decline will typically have negative cash flow from operating activities, positive cash flow from investing activities, and cash flow from financing activities that could be either positive or negative.

Operating: Operating cash flows will generally be negative as business conditions have deteriorated and the business hasn’t adapted to a changing environment.

Investing: Cash flow from investing activities for a business in decline is likely to be positive. Fewer customers and less revenue means less work to be done, which means lower investments in new equipment. The business could also sell off existing assets that aren’t being used, creating positive cash from investing activities.

Financing: Financing cash flow could be positive or negative. These businesses could find it difficult to obtain new loans due to their deteriorating circumstances.

14

How to account for asset accruals when using the indirect method if an asset account INCREASES

If an asset account increases, it must be that the company acquired an additional asset. Acquisitions of assets generally require a cash payment, so the general inference is that if an asset account increased (for example, inventory was purchased, or more sales were on account), then the cash account decreased.

15

How to account for asset accruals when using the indirect method if an asset account DECREASES

if an asset account decreases, it must be that the company sold or disposed of an asset. The sale of assets is generally accompanied by a receipt of cash. So the general inference is that if an asset account decreased (for example, inventory was sold, or accounts receivable was collected), then the cash account increased.

16

How to account for liability accruals when using the indirect method if an account such as accounts payable INCREASES

If an account such as accounts payable increases during the period, it indicates that a benefit was received, such as receiving inventory, before the actual cash was paid out. To adjust for this we add that increase to net income.

17

How to account for liability accruals when using the indirect method if an account such as accounts payable DECREASES

If the same account decreases, it means we paid cash to reduce the liability previously created, so we expensed less than we paid and we subtract the difference from net income. Consider this to be similar to spending more cash than we incurred for the related expenses. The same rule applies to all operating liability accounts.

18

4 rules to convert net income to operating cash flow using the indirect method:

An increase in operating current assets is subtracted from net income.
A decrease in operating current assets is added to net income.
An increase in operating current liabilities is added to net income.
A decrease in operating current liabilities is subtracted from net income.

19

US GAAP vs. IFRS: The Statement of Cash Flows for INTEREST

Under US GAAP, interest paid on loans is considered an operating activity. This can be counterintuitive because interest is a component of loans, which are a financing activity. Interest received on loans made to others is also an operating activity under US GAAP.

Under IFRS, the entity chooses its own policy for classifying interest based on what it considers to be more appropriate, generally placing interest paid in either the operating or financing sections and interest received in either the operating or investing sections.

20

US GAAP vs. IFRS: The Statement of Cash Flows for DIVIDENTS

Dividends paid to investors are part of the financing section under US GAAP. Again, under IFRS, the entity chooses its own policy for classifying dividends paid as either operating or financing activities based on what it considers to be most appropriate. Dividends received are part of the operating section under US GAAP, while under IFRS, the entity chooses either the operating or investing sections.

21

A decrease in a liability or owners' equity account represents a use of funds, and an increase in these accounts represents

a source of funds.

22

A decrease in an asset account is a _____, while an increase is ______.

A decrease in an asset account is a source of funds, while an increase is a use of funds. Changes in cash are ignored.

23

We use the statement of cash flows to manage the business in three distinct ways:

1 - the statement of cash flows allows us to look at our financing and investing activities to understand are we appropriately investing capital. So we look at are our assets depreciating at the same level that we're reinvesting in the organization? So that's kind of one pillar that we use the cash flows for.

2 - we look at the cash flows to make sure that we're managing our working capital appropriately, that we have alignment with our investment cycle in inventory, and our receivables and our payables are aligned. Because we don't want to use donor dollars to fund additional working capital.

3 - the last area is really in those working capital or cash flow requirements for our long term liabilities. As an aging organization, we have a pension plan. We have an insurance, captive insurance organization. So we're always looking at the cash flow requirements that are being absorbed for those longer term liabilities, and make sure that we have alignment with those future requirements that are growing, especially in the pension plan.

24

How does the following transaction impact cash flow?

Receiving cash for goods or services yet to be provided

Positive (Increase)

Although revenue is not recognized until goods or services are provided, cash is received at the time of this transaction.

25

How does the following transaction impact cash flow?

Paying cash for property insurance covering next 2 years

Negative (Decrease)

Although expense is not recognized until prepaid insurance is amortized, cash is paid out at the time of this transaction.