Reporting and Analyzing Cash Flows
Reporting and Analyzing Cash Flows 201
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This 0 page Class Notes was uploaded by Ebony Notetaker on Wednesday December 9, 2015. The Class Notes belongs to 201 at Ball State University taught by Jason Owens in Fall 2015. Since its upload, it has received 12 views. For similar materials see Financial Accounting in Accounting at Ball State University.
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Date Created: 12/09/15
Reporting and Analyzing Cash 0 Purpose of the Statement of Cash Flows o The purpose of the statement of cash ows is to report cash receipts in ows and cash payments out ows during a period This includes separately identifying the cash ows related to operating investing and nancing activities The statement of cash ows does more than simply report changes in cash It is the detailed disclosure of individual cash ows that makes this statement useful to users 0 Importance of Cash Flows 0 Information about cash ows can in uence decision makers in important ways For instance we look more favorably at a company that is nancing its expenditures with cash from operations than one that does it by selling its assets Information about cash ows helps users decide whether a company has enough cash to pay its existing debts as they mature It is also relied upon to evaluate a company39s ability to meet unexpected obligations and pursue unexpected opportunities External information users especially want to assess a company39s ability to take advantage of new business opportunities Internal users such as managers use cash ow information to plan day today operating activities and make longterm investment decisions 0 Classi cation of Cash Flows o A net cash in ow source occurs when the receipts in a category exceed the payments A net cash out ow use occurs when the payments in a category exceed the receipts 0 Operating Activities Operating activities include those transactions and events that determine net income Examples are the production and purchase of merchandise the sale of goods and services to customers and the expenditures to administer the business Not all items in income such as unusual gains and losses are operating activities 0 Investing Activities Investing activities generally include those transactions and events that affect longterm assets namely the purchase and sale of longterm assets They also include o The purchase and sale of the shortterm investments in the securities of other entities other than cash equivalents and trading securities 0 Lending and collecting money for notes receivable Investing 0 Cash In ows From selling investments in From collecting principal on loans From selling longterm productive assets From selling discounting of notes 0 Cash Out ows O To make loans to others To purchase longterm productive assets To purchase investments in securities Financing Activities Financing activities include those transactions and events that affect longterm liabilities and equity Examples are Obtaining cash from issuing debt and repaying the amount borrowed Receiving cash from or distributing cash to owners These activities involve transactions with a company39s owners and creditors 0 Preparing the Statement of Cash Flows O 0 Preparing a statement of cash ows involves ve steps Compute the net increase or decrease in cash Compute and report the net cash provided or used by operating activities using either the direct or indirect method Compute and report the net cash provided or used by investing activities Compute and report the net cash provided or used by nancing activities Compute the net cash ow by combining net cash provided or used by computing the net increase or net decrease in cash is a simple but crucial computation lt equals the current period39s cash balance minus the prior period39s cash balance This is the bottomline gure for the statement of cash ows and is a check on accuracy The information we need to prepare a statement of cash ows comes from various sources including comparative balance sheets at the beginning and end of the period and an income statement for the period There are two alternative approaches to preparing the statement Analyzing the Cash account Analyzing noncash accounts 0 Analyzing the Cash Account 0 A company39s 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 ows from operating investing and nancing activities 0 Indirect and Direct Methods of Reporting 0 O The direct method separately lists each major item of operating cash receipts such as cash received from customers and each major item of operating cash payments such as cash paid for merchandise The cash payments are subtracted from cash receipts to determine the net cash provided used by operating activities The indirect method reports net income and then adjusts it for items necessary to obtain net cash provided or used by operating activities It does not report individual items of cash in ows and cash out ows from operating activities Instead the indirect method reports the necessary adjustments to reconcile net income to net cash provided or used by operating activities 0 Application of the Indirect Method of Reporting 0 Net income is computed using accrual accounting which recognizes revenues when earned and expenses when incurred Revenues and expenses do not necessarily re ect the receipt and payment of cash The indirect method of computing and reporting net cash ows from operating activities involves adjusting the net income gure 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 o Adjustments for changes in noncash current assets Changes in noncash current assets normally result from operating activities Examples are sales affecting accounts receivable and building usage affecting prepaid rent Decreases in noncash current assets normally result from operating activities 0 Adjustment for changes in current liabilities Changes in current liabilities normally result from operating activities An example is a purchase that affects accounts payable Increases in current liabilities yield the following adjustment to net income when computing operating cash ows Adjustments for Operating Items Not Providing or Using Cash 0 The income statement usually includes some expenses that do not re ect cash out ows in the period Examples are depreciation amortization depletion and bad debts expense The indirect method for reporting operating cash ows requires that Adjustments for Nonoperation Items 0 Net income often includes losses that are not part of operating activities but are part of either investing or nancing activities Examples area loss from the sale of plant asset and a loss from retirement of notes payable The indirect method for reporting operating cash ows requires that 0 Cash Flows From Financing 0 We normally do this by identifying changes in all noncurrent liability accounts and the equity accounts These accounts include longterm debt notes payable bonds payable common stock and retained earnings Proving Cash Balances o The fth and nal step in preparing the statement is to report the beginning and ending cash balances and prove that the net change in cash is explained by operating investing and nancing cash ows
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